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Small and Micro-cap companies with common stock listings are turning to innovative financial strategies to protect and enhance their market position while increasing capital on hand. One such strategy being pioneered by Digital Offering, LLC, an SEC-registered broker-dealer and a leader in crowd-financed offerings[1], involves a best-efforts preferred stock offering under Regulation A with a post-offering listing on a national securities exchange. This approach serves several purposes: creating a more favorable capital structure, providing the company with much-needed, non-toxic capital, and acting as protection from and a deterrent against short selling.

The Problem of Toxic Financing

The small and micro-cap market has struggled in recent years.  Capital-raising options have been limited in the public markets, with issuers having difficulty raising capital.  What used to be financing based on fundamentals has evolved into investor-driven terms with toxic features that drive down prices and force companies to perform dilutive financings that do not reflect the true value of the company.  Such features include significant dilution, unit structures that include up to 200% warrant coverage, prefunded warrants, and down round resets that prohibit these companies from conducting future financings, as any financing done at a lower level creates massive dilution from exploding warrants.  Issuers are left with no viable options for funding and are forced to take predatory terms. Toxic financing also sets the stage for short sellers to further damage a company’s market performance.

The Threat of Short Selling to Small and Micro-Cap Companies

Short selling, where investors bet against a company’s listed stock, typically common stock, presents a tangible threat to small and micro-cap companies listed on national exchanges. Short selling can significantly depress a company’s stock price, especially if short sale trades are executed in large volumes, driven by toxic financings, or propelled by negative rumors. The resulting common stock price drop erodes investor confidence and can adversely affect the company’s market valuation and capacity to secure capital.

This is especially critical for small and microcap companies, often more vulnerable to market manipulation and the volatility sparked by short selling. As a result, short selling can have far-reaching implications, from financial performance to corporate reputation.

Strategic Use of Preferred Stock to Counter Toxic Financings and Short Selling

In a strategic move, companies can engage in broker-sold best-efforts offerings of preferred stock. By using an approach that functions similarly to crowdfunding, companies can utilize Regulation A to create a new class of preferred stock, possibly with an attractive preferred dividend and either common equity conversion and/or common stock warrants at a market value above the current market price, that can be marketed to thousands of investors who believe in the prospects of the company rather than to one institution who is more concerned about structure rather than supporting the company.  In addition, utilizing Regulation A allows a company to market not only the securities offering but also to create awareness for its products and services, creating the ability for customers to become shareholders and shareholders to become customers.  By utilizing Regulation A to sell preferred stock that disconnects from a company’s common stock and common stock share price, a company can raise capital at a reasonable valuation, allowing the funds to be used to generate revenue and growth, which in turn would hopefully allow investors to recognize that the common stock is undervalued.

With this approach, a company can raise funds not at the depressed common stock price but at a true valuation point without having to worry about triggering common stock toxic structures, volatility and additional short selling.

Additionally, this strategy places short sellers in a precarious disadvantage: If the company’s common stock price climbs as a result of new capital being used to fuel organic growth and favorable corporate news, positive market sentiment, or broader economic uptrends, short sellers could be trapped in a short squeeze. This scenario forces them to repurchase shares at rising prices to close their short positions, inadvertently further increasing the common stock price. The type of preferred stock offering discussed herein has the potential to turn the tables on short selling, leveraging market dynamics to a company’s advantage.

Importance of Listing on a National Securities Exchanges

To be an effective strategy, the company must list the preferred stock on a major securities exchange, such as the Nasdaq National Market or the NYSE American, following completion of the Regulation A offering. Listing on one of these exchanges broadens the company’s exposure and appeal to a varied investor base of thousands, including retail traders and loyal fans.

The presence of a recognized exchange is key, as it enhances liquidity – vital for any offering’s success –  by facilitating the ease of trading these securities. Furthermore, these exchanges’ stringent regulatory standards and enhanced transparency and corporate governance requirements boost investor confidence. Collectively, these elements foster a suitable environment for the successful execution of the preferred stock strategy, empowering a company to effectively tackle toxic financings and short selling that result in low common stock valuations and to improve and maintain the stability of its common stock price.

Moving Forward

The preferred stock strategy pioneered by Digital Offering, LLC, marks a significant shift in combating the adverse effects of toxic financing and related short selling. The strategy represents a forward-thinking solution that will foster a market environment where stock prices more accurately reflect a company’s actual value and growth prospects. We expect to see further developments in this space in the coming years.

Mark Elenowitz, Managing Director of Digital Offering, LLC, a pioneer of this preferred stock offering strategy, and a leader in marketing crowd-financed offerings utilizing Regulation A, had the following to say about this strategy, “Wall Street has evolved to provide alternative structures to capital formation that are designed to provide capital for growth and expansion, allowing the executives to focus on providing shareholder value rather than being victims distracted by toxic structured financings that benefit no one but the professional investor.” Mark added, “Our preferred stock offering strategy makes it possible for public companies to work around the blockers established by toxic financiers and allows companies to raise capital based on fundamentals, comps, and a true reflection of enterprise value.  This enables companies to accept funding without toxic features.”

Conclusion

Microcap companies are increasingly leveraging Regulation A as a strategy for issuing preferred stock that can combat toxic financing and short selling and serve as a means to raise substantial capital. While offering significant advantages, the success of this strategy is contingent on various factors, including market dynamics, investor response, and a company’s overall financial health. This approach exemplifies how strategic thinking can be employed to navigate the complexities of modern financial markets to achieve financial objectives on the road to a company’s success.

If you want to learn more about our client Digital Offering’s preferred stock strategy or other capital financing methods, please reach out to Lou Bevilacqua at Lou@bevilacquapllc.com or (202) 869-0888 (ext. 100), Paul Levites at Paul@bevilacquapllc.com or (202) 869-0888 (ext. 103), or Patrick Costello at Patrick@bevilacquapllc.com or (202) 869-0888 (ext. 130). You can also contact us through our general information email at info@bevilacquapllc.com.

[1] “Crowd-financed Offering” means an equity financing effort under Regulation A of the Securities Act in which securities are sold to the “crowd,” or retail investors, rather than institutions. Crowd-financed Offerings should not be confused with what is commonly referred to as a “Crowdfunding Offering,” which is a securities offering conducted on a FINRA and SEC-registered funding portal under Regulation Crowdfunding of the Securities Act.