Negotiating with Hedge Funds

Monthly Webinar Series

presents

Negotiating With Hedge Funds: Five Ways to Save Time, Money, & Dilution

April 25, 2012

Panelists

Adam J. Epstein, Founder, Third Creek Advisors, LLC Sara LaFever, Account Manager, Sagient Research Systems Joseph A. Smith, Member, Ellenoff Grossman & Schole LLP

Moderator

Brett Goetschius, Editor and Publisher, Growth Capital Investor

Thank you for participating in “Negotiating With Hedge Funds: Five Ways to Save Time, Money, & Dilution.” This manual contains information you will need for this webinar.

CONFERENCE MANUAL

This manual contains:

•Dial-‐in/log-‐on instructions.

Speaker bio and contact information. •Tips for submitting questions. •Pertinent information from the pages of Growth Capital Investor.

CONFERENCE DETAILS

The webinar is scheduled for Thursday, April 25, 2013 at 2:00 p.m. EDT, 1:00 p.m. CDT, 12:00 p.m. MDT, and 11:00 a.m. PDT. It will last 90 minutes.

HOW TO JOIN THE WEBINAR

Online With Streaming Audio •Go to http://web.beaconlive.com •On the “Join a Meeting” side of the login page, enter meeting room: mnm2

•Enter your unique PIN (sent in your email confirmation). •Click on “Join Meeting” to access the presentation. •Make sure your computer speakers are turned on and at the correct volume. You can adjust the volume by using the up and down arrows above the presenter’s box.

Optional Telephone Access If you have trouble streaming the sound through your computer, please follow these instructions to listen by phone:

•Dial 1-‐877-‐533-‐4964 about 5-‐10 minutes before the start of the conference. •Enter your unique PIN (sent in your e-‐mail confirmation). •You will hear music on hold until the conference has started or be connected directly if it has already begun.

•If you have trouble with your PIN stay on the line and an operator will assist you. •If you are using a speakerphone, put the phone on MUTE for best sound quality. •If you are disconnected at any point, just repeat the processes above.

PLEASE NOTE: Only one dial in and one log on per PIN are allowed.

If you have problems accessing the webinar, please call 877-‐297-‐2901. HOW TO SUBMIT QUESTIONS

Questions may be submitted at any time during the call using the chat function on the web interface in the lower left corner of your screen. Just type in your question and send it to “Q&A session” in the drop-‐down menu.

Conference Manual Page 1

Sagient Research Systems

Sara LaFever


}  CCMMPPOO//OOvveerrnniigghhtt OOffffeerriinngg:: A confidentially marketed public offering (“CMPO”) is a hybrid structure between a Registered Direct and a traditional public follow-on. After registering shares on an S-3 shelf registration, transactions are typically marketed confidentially to institutional investors, then announced publicly and “flipped” to a public offering. Deals are announced after the close of US market trading, and the public selling process concludes prior to the market opening the following morning.

}  CCoommmmoonn SSttoocckk -- SShheellff SSaallee:: A sale of the Company's pre-registered common stock from an existing shelf registration statement (a.k.a. Registered Direct). The Registration allows the Company to sell the securities over a period of time. At PlacementTracker, a Common Stock - Shelf Sale is tracked when the registered Common Stock is sold in a private transaction to accredited investors.


}  CCoommmmoonn SSttoocckk ◦  Common Stock transaction may or may not include

purchase Warrants. Sometimes Common Stock with Purchase Warrants are sold together as a security called a "Unit".

}  CCoonnvveerrttiibblleess ◦  Convertible Debt (such as Debentures or Notes) and

Convertible Equity (Preferred Stock). A Convertible Note, Convertible Debenture or Convertible Preferred Stock can have one of four Conversion Features: 1) Fixed, 2) Floating, 3) Reset, or 4) Company Installment.


  From 1995-present   Convertibles: Fixed Conversion Premium/Discount at

Announcement Conference Manual Page 5

-‐40% -‐20% 0% 20% 40% 60%

Common Stock

Registered

Convertibles

2011

2012

2013

2010


-‐10.00% 0.00% 10.00% 20.00% 30.00% 40.00% 50.00%

100M-‐250M

1M-‐100M

ConvertiblesNon-‐registeredRegistered


-9%

4.00%

0.63%

-6.00%

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

Healthcare Energy Tech Financial


Registered

 45.1% have warrants  Average of 26.81%  1-100M:  Average 32.22%  51.9% have warrants

 100-250M:  Average14.91%  34% have warrants

Non registered

 51.5% have warrants  Average of 38.35%  1-100M:  Average 48.20%  60.93% have warrants

 100-250M:  Average 28.35%  39.2% have warrants


Registered  12.82

Non-Registered  15.59


}  PlacementTracker is the premier research, analysis, and reporting tool for private placements by public companies. Cataloging every private placement since January 1, 1995, PlacementTracker's interactive database includes over 29,000 transaction profiles, over 1,900 placement agent profiles, over 14,700 investor profiles, and over 1,200 legal counsel profiles. As a tool developed by investment professionals for investment professionals, PlacementTracker utilizes state-of-the-art web-based technology to provide subscribers with an easy to use, comprehensive means to evaluate PIPE transactions and investors, perform quick transaction pricing, identify potential issuers and investors, and compile comparable transaction, investor and agent statistics.


Nego�a�ng with Hedge Funds: Avoiding the Common Mistakes 5 Ways to Save Time, Money, and Dilu�on

Adam J. Epstein, Founder, Third Creek Advisors, LLC Joseph A. Smith, Partner, Ellenoff Grossman & Schole LLP

April 25, 2013

© 2013 TCA, LLC & EGS LLP


OVERVIEW

v  76% of all U.S. public companies have market capitaliza�ons less than $500 million

v  On senior U.S. stock exchanges, 40% of companies have market capitaliza�ons less than $250 million (majority of financings for these companies is restricted vs. registered)

v  The vast majority of public companies with market capitaliza�ons less than $500 million regularly access the equity capital markets for growth capital

v  Depending upon the year, hedge funds invest between $30 billion and $50 billion directly into micro-‐ and small-‐cap companies annually

v  Hedge funds are the primary source of growth capital for the vast majority of U.S. public companies

v  The focus of today’s program is to highlight various ways micro-‐ and small-‐cap companies can save �me, money, and dilu�on nego�a�ng with hedge funds for growth capital



HEDGE FUNDS START WITH AN ADVANTAGE THAT COMPANIES ACCENTUATE

v  Hedge funds write the checks; cash is king

v  This situa�on has been exacerbated post-‐2008 since there are fewer funds financing micro-‐ and small-‐cap companies – scarcity has created more leverage

v  But, the failure of most companies to adequately prepare for financings accentuates the buy-‐side’s advantage

v  Companies need to use the same three-‐step process for each financing, and should start prepara�ons six months before they need the capital

v  Only a�er the three-‐step process is any company in a posi�on to retain the right investment bank

v  The predominant reason why companies rou�nely select the wrong investment bank



MAJORITY OF COMPANIES ARE UNPREPARED FOR INVESTOR MEETINGS

v  Deference to investment banks should be replaced by data; singling out funds with whom to construc�vely meet is more science than art

v  Five cri�cal ques�ons that rarely get asked/answered:

1.  Is your company being brutally realis�c about macro/micro elements which might impact the financing

2.  For directors -‐-‐ does the management team have recent, relevant experience securing financing; has the board listened to management’s presenta�on

3.  Is management prepared to present the company extemporaneously (without handouts, iPads, or laptops)

4.  Does management know the five likeliest concerns that investors will have about financing your company

5.  Has management reviewed what has previously been promised to investors with respect to milestones and use of prior financing proceeds

v  Loose lips sink ships



NEGOTIATING/DOCUMENTATION – LEVELING THE PLAYING FIELD

v  Though not binding, recent financing terms received by substan�ally similar companies are proba�ve; companies must possess/analyze the data

v  “Anything you say, can and will be used against you…”

v  Prior to signing a term sheet, call the CFOs of the last few companies that the lead investor financed; in the case of registered offerings test alloca�ons by referencing 13F filings

v  Impossible to overstate the importance of deal documenta�on in restricted stock or

conver�ble instrument deals; cri�cal to understand that most corporate a�orneys don’t stand a chance nego�a�ng against hyper-‐specialized hedge fund a�orneys

v  Ask the investment banker to provide you with the expected deal documenta�on as soon as possible, so you and your a�orney actually have �me to read it and understand it. You cannot digest a conver�ble debt deal overnight

v  You almost always will have to give up SOME warrant coverage



POST-‐FINANCING MISTAKES ARE COSTLY… BUT AVOIDABLE

v  Penal�es in restricted stock/conver�ble deal documenta�on can cost a fortune, they are in the documents for good reasons, and they are rarely waived

v  Especially with structured financings, companies o�en fail to appreciate the complexi�es of complying with the terms

v  Understand whether the dilu�on protec�on in your warrants is limited to a downward adjustment of your price or also involves an increase in the number of warrant shares (an “exploding” warrant in hedge-‐speak)

v  Make sure the “purchase price” in the dilu�on provision does NOT deduct the Black-‐Scholes value of any warrant component in your subsequent deals, because you are likely going to issue warrants in the future

v  Make sure the CFO (or whoever interfaces with your transfer agent on a regular basis) is made aware of all deadlines for delivering shares on conversions or warrant exercises, and have a system in place for covering that chore when the CFO is out of the office

v  Don’t get cute with refusing to honor conversions. The courts are never going to rule in your favor



MAKING WORKOUTS LESS COSTLY, TIME-‐CONSUMING & FRUSTRATING

v  Companies need to be�er understand the business and psychology of the buy-‐side

v  Restricted stock/conver�ble deal documenta�on can’t be construc�vely amended without first understanding/evalua�ng the business ra�onale for the breached term(s)

v  Impact on hedge funds’ P&L is where the rubber meets the road

v  If you are dealing with mul�ple investors, understand that you have work through them one at a �me (or through the banker that arranged the deal) – the funds cannot meet you together or they may be ac�ng as a “group” for short-‐swing profit purposes

v  Beware of paying a banker to arrange a workout: this will eliminate the 3(a)(9) exemp�on that will at least allow the investors to “tack” their prior holding periods for Rule 144 purposes or maintain the registered status of a previously registered security

v  Don’t be bashful about asking the investor if they have wri�en off their investment in your

company. They may not say, but it cannot hurt to ask



FOUR SUCCINCT TAKEAWAYS

1.  In the aggregate, micro-‐ and small-‐cap companies would undertake faster, smarter, less-‐dilu�ve financings if they prepared further in advance, and u�lized deal data (vs. officer/director, third-‐party specula�on) to ascertain what financing structure and terms are most likely

2.  Far too many companies cede addi�onal advantage to the buy-‐side by making poor banking and deal a�orney choices; the rou�ne failure to undertake any diligence whatsoever on the hedge funds that are about to provide financing is icing on the cake

3.  Be prepared to give up a bigger discount to your market price in order to avoid having to give the investors too many of the “gotcha” provisions

4.  There is no free lunch! Every �me you go to market, you are compe�ng against dozens of similar deals being offered to a limited universe of poten�al investors that same week



SPEAKER BIOS AND CONTACT INFORMATION

Sara LaFever is an account manager at Sagient Research Systems in San Diego, where she works with three of Sagient’s capital markets research tools: PlacementTracker, BioMedTracker, and CatalystTracker. She received her BA from New York University and is pursuing a Master’s in Library and Information Sciences from San Jose State University. Ms. LaFever began her career with Sagient as an analyst.

CONTACT Sara LaFever Account Manager Sagient Research Systems 858-‐200-‐2357 [email protected]


Adam J. Epstein is a corporate director, and a special advisor to small-‐cap boards and investment funds through his firm, Third Creek Advisors, LLC (“TCA”). He is the author of The Perfect Corporate Board: A Handbook for Mastering the Unique Challenges of Small-‐Cap Companies (McGraw Hill, 2012).

Mr. Epstein is lead director of OCZ Technology Group, Inc., and a Board Leadership Fellow at the National Association of Corporate Directors, the highest level of credentialing for corporate directors and corporate governance professionals. Mr. Epstein is a regularly featured speaker at national corporate governance forums and investor conferences, and a regular contributor to Directorship magazine.

Prior to founding TCA, Mr. Epstein co-‐founded and was a principal of Enable Capital Management, LLC (“ECM”). During his tenure, ECM’s special situation hedge funds invested in more than 500 small-‐cap financings in the United States, the European Union, and Australasia. Mr. Epstein started his career as an attorney at Brobeck, Phleger & Harrison.

CONTACT Adam J. Epstein Founder Third Creek Advisors, LLC [email protected]


Joseph A. Smith, a member of the Firm, is widely recognized as the leading expert in the field of Private Investments in Public Equity (PIPEs) and Registered Direct offerings, where he developed and perfected many of the most commonly used transaction structures, including the intra-‐day and overnight shelf takedown, confidentially marketed public offerings (CMPOs), the self-‐liquidating convertible debenture and the equity line of credit.

Mr. Smith’s clients are mainly investment banks and institutional investment funds, where he and his team facilitate approximately 75 financing transactions each year. He has more than 25 years of experience representing small-‐ and mid-‐cap public and private companies in all phases of development, from formation through IPO and subsequent merger and acquisition activity; and broker-‐dealers with their regulatory issues. He also assists broker-‐dealers with regulatory issues. Under Mr. Smith’s leadership, Ellenoff Grossman & Schole has been ranked as the No. 1 legal adviser to placement agents every year since 2003.

Mr. Smith is a regular speaker on legal issues relating to the PIPE and RD markets at the PIPEs Conference and other venues. He has undergraduate and MBA degrees from the University of California, Berkeley and a law degree from UCLA.

CONTACT Joseph A. Smith Partner Ellenoff Grossman & Schole LLP 212-‐931-‐8719 [email protected]


Negotiating with Hedge Funds

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