| > | | | | financing for a bloc ofstock is asking for trouble from |
| Venture vs. Vulture Capitalists | | | | the SEC. Without the stock incentive, thebridge loan is |
| By William Cate | | | | too risky. After all, only half the IPO's are underwritten. |
| Published July 1999 | | | | Unless you are the underwriter, you can't be certain |
| [ [ | | | | that the underwritingwill happen. |
| In the last issue of EFS (V3#10), my Venture Capital | | | | A Convertible Debenture (CD) is a loan that can be |
| articlereflected the current experiences of three small | | | | converted intoshares of the public company. If the |
| Silicon Valley companies. | | | | lender loans the public company amillion dollars at |
| My article generated comments from four Venture | | | | Prime plus 3, they will make a profit. A CD loan |
| Capitalists. In essence,there are Venture Capitalists and | | | | allowsthe lender to convert the loan into shares of the |
| there are Vulture Capitalists. | | | | company. If the CD allowsthe loan to be converted at |
| Venture Capitalists fund one company in every 2,500 | | | | $4/share and the company's share price goes to |
| companies thatquery them. Their preferred exit | | | | $10, the lender makes more money on the stock sale |
| strategy is the private sale of thecompany. They are | | | | than from theconventional loan. Convertible Debentures |
| willing to hold their equity in an investment for years. | | | | are popular in Canada because the stock issued is |
| They believe that they bring management and financial | | | | free trading. They haven't been popular in the |
| skills to the companythat will enhance the company's | | | | States,because the lender gets restricted (144) stock. |
| probability of success. If two-of-seveninvestments | | | | Toxic Convertibles are Convertible Debentures with an |
| (29%) succeed, they make money. | | | | unspecifiedexercise price for the shares. The lender |
| Vulture Capitalists fund one company in every 100 | | | | can convert the stock at thecurrent trading price of |
| companies thatquery them. Their preferred exit | | | | the shares. This allows the lender to sell shortthe stock |
| strategy is to take the company public. | | | | against the CD while recovering the loan and interest. |
| They intend to recover their risk capital quickly. They | | | | The shortsale of stock depresses the company's |
| bring sales skillsto the company. Their goal is to make | | | | share price. The lower share priceallows the lender to |
| money on every investment. | | | | sell short more stock. It's a downward cycle for |
| I've come across Vulture Capitalists offering toxic | | | | thepublic company's stock. The CD is used as |
| convertibles. | | | | insurance against an upward surgein the company's |
| They act as Merchant Bankers offering bridge | | | | share price. The Toxic Convertible lender can't lose. |
| financing. They offersecondary Private Placement | | | | If a public company does a toxic convertible, by the |
| financing to high flying, usually Hi-Techpublic companies. | | | | time theyrepay the loan, their stock is trading for |
| The Merchant Banking loans require the repayment of | | | | pennies a share. The publiccompany fails and the |
| the loan andinterest from the underwriting. The | | | | lender makes a multiple of the principal of theirloan. |
| Merchant Banker demands a large bloc offree stock | | | | The moral of this story is that public companies should |
| for making the loan. The Merchant Banker dumps the | | | | be wary of |
| stock quicklyinto the Market. About two years ago, the | | | | Vulture Capitalists. Read and understand every word |
| SEC moved to stop this practice. | | | | of every Agreement,before you sign it. |
| Any outside party considering doing Bridge Loan | | | | |