Small caps turn to debt, shelf offerings amid challenging capital markets – Roth Annual Conference

News Analysis 17 March

Small caps turn to debt, shelf offerings amid challenging capital markets – Roth Annual Conference

  • Structured arrangements with lucrative terms seek to entice investors
  • Lack of equity deals is forcing more companies to take on debt, warrants 
  • Investors exploring opportunities amid battered SPAC market

Small-cap technology firms are increasingly looking to structured capital and shelf offerings, along with a range of other creative arrangements to fund their businesses amid market volatility, according to a panel of sector bankers and investors. 

With pure-play equity deals tougher to come by and the IPO market expected to remain largely closed into at-least late 2023, more transactions require warrants with cashless exercise and other lucrative terms to induce investment, said David Enzer, managing director in charge of technology investment banking at Roth MKM.

Public companies with market caps under around USD 250m are increasingly discussing senior debt or convertible debt with warrants, he told a session on the state of capital markets during the 35th Annual Roth Conference in Dana Point, California, this week. 

“That seems to be where a lot of investors are right now,” Enzer said. “It’s a good thing to do…as long as you don’t get too over-levered.”

Lately, Roth MKM advisers have been encouraging clients to have an active shelf registration, as well as an ATM, to maximize their ability to tap markets on very short notice when stocks trade up, he said.

A Roth analysis found that more than 60% of companies with a market cap of USD 500m or less have active shelf registration statements on file, allowing for the rapid sale of stock should an unexpected buyer reach out, according to Enzer.

“That becomes very opportunistic,” he said. “You see these reverse inquiries all the time…I think we’re going to be in that kind of a market.” 

ATMs, which allow for the piecemeal sale of shares at prevailing market prices, offer an additional measure of flexibility for companies seeking to raise in volatile public markets, according to Enzer.

Shelf offerings are generally more advantageous for institutional investors since they result in less of a stock price decline at 180 days, compared to equity lines of credit (ELOC), he said, citing Roth data.

“The ELOC share price decline is four times as bad,” Enzer said.

He pointed to Indie Semiconductor [NASDAQ:INDI] as an example of a Roth client with an ATM that was ultimately converted to a private offering for nearly USD 160m in November.

PIPEs have fallen out of favor as fund managers balk at the notion of restricted stock for 90 days in a volatile market, he said.

All eyes remain on when the IPO market might meaningfully resume and how many companies will be able to squeeze through; Roth alone has a handful of semiconductor clients that have already filed for IPOs and are waiting for the market to open, Enzer said.

Roughly 200 companies are on file for NASDAQ IPOs, with some ready to quickly update financials and hit the window, while others’ filings were made years ago and are likely dormant and stale, said Andrew Hall, managing director with the new listings team at NASDAQ.

Though hopes for improvement during 1Q23 have thus far not materialized, 17 operating companies did go public on NASDAQ as of the start of this week – including six SPACs – raising about USD 1.7bn, he told the panel.  

Going forward, the index is easing its reverse-merger seasoning rules to make it easier for SPACs to remain listed on NASDAQ or quickly return from the over-the-counter market, despite high redemptions.

“We think the structures of the SPACs are more sophisticated now and we’re not seeing them as much as a reverse merger into a shell or classifying them as clearly as a shell as we did earlier,” Hall said.

The well-documented challenges of SPAC companies have created opportunities for investors, said Robert Johnston, managing director at UK-based Herald Investment Management, which has USD 1.5bn under management and has done multiple deals through Roth.

About 95% of Herald’s investments are in small caps and the firm prefers “clean,” straight equity investments, free of warrants or novel structures, he said.

Herald has a policy of avoiding companies that came out via SPAC until they’ve had at least two quarters as a public entity but it is clear that a lot of good companies have been “thrown out with the bathwater,” Johnston said.

“We definitely have been combing through them and finding some investments that look very interesting,” he said.

Dallas, Texas-based 272 Capital, which has about USD 300m under management, has worked with Roth in more “transactional,” structured deals.

They also have served as an anchor investor, sometimes writing a check for USD 10m or 15m for small caps seeking to raise USD 20-30m, CEO Wes Cummings said.

“Generally, it’s easy to build a book around that,” he said.  

Warrants can create an overhang on the stock price that 272 Capital tries to avoid, though the company has found success with structures in which the warrant effectively amounted to half a share of stock. “I thought that was a really good structure for the investors,” Cummings said.

They, too, see a chance to make money amid the difficulty of the SPAC market. Participants can negotiate better deals than in the past from a dilution standpoint, because SPAC promoters are “willing to give away a lot more,” Cummings said. 

“We’re looking at several of those where we can come in and kind of guarantee a certain amount of capital stays, and not do it in a PIPE format, which is much more attractive to me,” he said.