The dream of going public is almost universal among entrepreneurs. It seems to represent the Holy Grail of accomplishments, the culmination of years (or a lifetime) of sweat, blood and tears.
For the business owner it means a payday – finally. Loyal employees and stakeholders are rewarded for their support. The dream of being fully-funded, able to tackle new markets, offer new products and provide additional services will become a reality…
Or will it?
I’ve been in the public markets for many years now. Not as many as some, but enough to get a birds-eye view of not only the successes, but also the seedy underbelly that exists only to piggyback on the dreams of others, raping and pillaging with one goal in mind – making money for nothing.
I’m going to tell you a story. It’s a story of lies, of greed and corruption. Not every story starts out or ends the way the one I describe to you does. Some stories are happy, the people involved are honest, hard-working and ethical. Good exists. We don’t need to protect ourselves from those people, they’re the types Chris and I like to associate with.
Nonetheless, the waters are murky, and the barracudas exist. This is a story about barracudas.
First let’s be clear; I don’t have an Ivy League degree. I didn’t start out in a shiny, ivory tower office, donned in a Brooks Brothers suit peddling muni bonds or Blue Chip stocks to Richy Rich and his country club buddies. I started in a boiler room, surrounded by “meth heads” in wrinkled Hunt Club garb, wreaking of coffee and last night’s escapades. The guys who couldn’t make it at JP Morgan, or even JP Marlin for that matter; this was the bottom of the barrel, even for boiler rooms.
The typical conversation between a sales guy (I can’t call them brokers, because none were) and his “client” went something like this: “Look, you’ll never see a chance like this again. This company is about to sign a contract worth millions. I can’t give you the details, but you’re gonna wanna pick up as many shares as you can get your hands on. Whaddya mean you have to talk to your wife? Listen, pull off your pantyhose and screw your balls back on!”
Charming huh? If you haven’t seen the movie “Boiler Room” you really should.
Why was I there you ask? Who is this guy that we’re reading every week? Should I shut down my browser right now and un-subscribe? Not so fast. I wasn’t peddling penny stocks to granny like the guys around me, no, I was the “tech guy” empowered to keep these Neanderthals connected to the outside world. I lasted a few months until the disgust overcame me (coupled with the fear of an FBI raid at any moment). I wasn’t doing anything wrong, but you know what they say about the company you keep.
That experience, as morally repugnant as it was, showed me a business that I didn’t know existed. Sure I’d heard of the stock market, I had some experience speculating, but I had no idea that an entire industry existed around taking worthless companies public and pitching them to greed-driven, neophyte investors with more money than common sense.
The bacteria that inhabit this world of pump-and-dump actually believe that they are providing a service of value. They sell naïve CEO’s on the dream of “going public” and monetizing their life’s work. For the privilege of providing this service, they, the “promoters,” take a huge slice of the equity, and possibly some cash, if the company has any.
In exchange for their “blood money” these promoters will roll the company, via a reverse merger, into an OTC or Bulletin Board shell. Usually, and this is the key, this “shell” is under their control, with stock rat-holed everywhere they can put it. Rat-holed is a term that refers to hiding assets where they are unlikely to be found or identified.
The promoters introduce their friendly attorney to the deal, along with an audit firm to help get the deal done. Sort of like the ambulance chasing attorney with the chiropractor buddy – all for one and one for all. A few months of paper shuffling, comments from the 3 letter guys, some fees and some more paperwork and bang, the company is public.
Fast-forward a few weeks and volume in the stock is tremendous, despite very little, if any, material developments within the company. The “pump” is in high gear, and as the “dump” progresses, the stock quickly fades from it’s lofty float price to a more reasonable level, and then lower… lower… lower… endlessly lower, until the promoters are finally done selling their position.
Now what?
All of a sudden the daily phone calls to the CEO from said promoters stop. Calls to them aren’t returned. The investment bankers that they promised would be beating down the company’s door to shower the company with money and untold riches haven’t shown up.
Meanwhile the legal and accounting bills, not to mention the wire service, transfer agent, DTC and other “miscellaneous” expenses keep rolling in, to the tune of a couple hundred thousand per year, just for the privilege of being public.
The once optimistic CEO with more ideas than common sense now finds himself “orphaned.” With no funding in sight, bills stacking up and a stock price that would make any type of financing so dilutive as to possibly wipe out much of his stakeholders equity, he simply throws in the towel. He stops filing his Q’s and K’s and falls off to the Pink Sheets or de-lists, abandoned by the promoters, shunned by investors and hated by his own employees and stakeholders.
I’ve since seen this story repeated countless times. I’ve talked some of these CEO’s off the ledge, helped others, and simply had to say, “I’m sorry this happened to you…” to a few that were beyond rescue. It’s always painful to see, yet it keeps happening, despite more regulation and oversight than ever. Sarbannes-Oxley, Dodd-Frank… yada, yada… Whatever.
As investors, how do we protect ourselves from these unethical promoters and clueless CEO’s?
The first step, as we’ve said countless times, is to vet management. A businessperson worth their salt understands how, when and why they should “go public.” If their company is doing $100k in revenues they should not be contemplating a public listing – period.
Come on Mark, $100k in revenues, get real, nobody does that. Really? I know that sounds ridiculous, but I’ve seen it, many, many times. I’ve also seen ZERO revenue “opportunities.” Welcome to the OTC market. Do some due diligence on who’s running the show.
I can hear some of you asking the question, “Mark, are you saying never buy a business with zero revenues?” No, I’m not. Some businesses, including biotech, hi-tech and mining and resource companies, can, and often do, fall into the zero revenue genre. Many go public. Am I saying never buy an un-funded, zero revenue business that is publicly listed? Yes! The reasons are obvious.
Next, what is the business? Not to sound like Warren Buffet here, but you really should avoid businesses you don’t understand. If you’re attracted to an industry you aren’t familiar with, study up and learn all you can.
I have some good friends who decided they wanted to invest in gold mining companies. They didn’t know much, but they understood basic business and how to read a balance sheet. They aren’t geologists or engineers, yet they have a working knowledge of the industry after a couple years of casual study. Do they make mistakes, sure, but they have enough knowledge to avoid the obvious frauds and identify management with questionable competency.
Check out the shareholders list, if you can. Ask the CEO outright if there are promoters in the deal. Where did he get the shell? Who is handling legal and auditing? Do your due diligence on all these players. Bear in mind, not all promoters are bad.
Finally, listen to your gut. If you get a bad feeling, or even a feeling of uncertainty that borders on uncomfortable, just pass. There are ALWAYS new opportunities for those who are looking.
I’m sure a few of you could share some good stories on this topic. Drop us a comment below!
Enjoy your weekend!
- Mark
“Caveat emptor, caveat venditor”
(Let the buyer beware, let the seller beware)
Good post. The longer i trade the more i learn. We’ve been looking at doing a reverse merger, for reasons of visibility, transparency and ability to raise further finance and have been offered the chance to go with a clean cash shell.. will be doing further due diligence on the other companies that the firm who offered us, what their share patterns were etc. always a pleasure reading your posts
Thanks Shola. I think a cash shell is the only way to go, or better yet, a new registration or CPC (for the Canadian exchanges). The sharks will still circle once your public. Then the offers for convertible debentures roll in, lol. “We’ll fund you using your stock in a floor-less convert.” Gee, thanks…
Interesting commentary. I worked for an investment firm right out of college that was the broker dealer for a private independent oil producer. The owner of the oil producing company was also the owner of the brokerage firm. We owned salvaged oil fields that we raised money from investors to rework wells in those fields. We had cheezy graphs, pictures, and spreadsheets that showed the ROI potential from drilling the well on the property. These numbers were so highly inflated and fudged it was funny. We would even pitch the investment as conservative which in reality was more risky then betting on black in vegas. The goal was to cold call a potential investor and qualify him before sending out an investment package. We ultimately had to close the deal as soon as they received the package so that they wouldn’t’ take the time to thoroughly study it. Basically, you had to close a 50k minimum investment in one phone call.
This was my first job as a broker and it was similar to your boiler room experience. In fact, we used to have the Boiler Room movie playing while we cold called. We put together investment packages with massive mark-ups and sold units to each investor that would allow them percentage ownership in an oil well. If you were fairly sharp and actually read the investment prospectus, you would figure out quickly that the only people making money on the deal were the owners and the brokers. Not too mention, these types of investments were notoriously recognized as scams since so many firms raised money and drilled dry holes. Most investors wouldn’t even know if they actually drilled or not and would lose all their money. Because these types of investments offer tax incentives, investors would listen. The crazy part of this business is that most of these firms weren’t technically selling securities since they were presented as partnerships so FINRA and the SEC legally had a hard time going off the shady firms. It was a very interesting experience but I quit after 2 weeks. I couldn’t sacrifice my ethics and morals for 200k and more per year. I figured out the business after my second day on the job when I took home the prospectus and read it. It is unbelievable how stupid these brokers were that worked there. They knew nothing about economics or finance. They were snaky salesmen that would sell their mother for a dollar. I must admit they were very good at selling on the phone thought. They understood the psychology of selling to high net worth investors on the phone. It was funny to listen to them on the phone talk like they were millionaires.
High pressure, aggresive selling was not my style nor was bullshitting investors out of their money. I don’t know how they could sleep each night knowing that they lied and practically stole money from their investors. Like every experience you have in life, you always can gain wisdom from them regardless, if they were bad or good experiences. I thought I would share my story with you since I totally understood your experience at the boiler room firm.
Thanks for your story Jonathon, its appreciated. Investors need to be wary.
I passionately hate these guys and if I could I would lynch every single one of them!
I just watched a really great clip on spotting some frauds from two of the best guys in the business. For anyone interested in spotting shady deals take a look at http://www.youtube.com/watch?v=3rF5x20vNsY
Brent Cook is easily one of the most knowledgeable guys in the resource sector.