How Digital Currency Innovation is Disrupting Equity Crowdfunding

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crowdfunding-8-24-16.pngIn July of 2014, Facebook acquired virtual reality headset company Oculus Rift for around $2 billion. One of the most successful crowdfunded companies of all time, Oculus raised nearly $2.4 billion on the popular crowdfunding platform, Kickstarter.

Sounds like a great success story in crowdfunding, but here’s the catch: Kickstarter investors saw barely a dime from the lucrative buyout.

That’s because traditional crowdfunding platforms like Kickstarter are middlemen, set up to reward Kickstarter participants with things like tiered promotional items, and in the case of Oculus, early access to or discounts on the product. As it stands now, crowdfunding a startup gets platform investors just about anything except an actual piece of the company.

But that’s all set to change this year. The federal Jumpstart Our Business Startups (JOBS) Act has provisions set to kick in that will allow crowdfunded startups to issue equity directly to their investors. Financial technology companies are ready to move quickly, seeking to leverage digital currencies and innovations like bitcoin and the blockchain to create completely digital stock offerings for investors. Simply put, they want to cut out intermediaries like Kickstarter to provide investor with direct access and greater returns.

Here’s a look at what some of the early leaders in the space are doing, and how digital currency could be a major game changer to equity crowdfunding in 2016 and beyond. […]

This content was originally written for FinXTech.com. For the complete article, please click here.

 

FAST Act Extends Popular JOBS Act Registration Threshold to S&Ls

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JOBS-Act-2-1-16.pngOn December 4, President Obama signed the Fixing America’s Surface Transportation Act, or the FAST Act, which included several amendments to federal securities laws. Among the changes, the law amended Section 12(g) of the Securities Exchange Act of 1934 so that savings and loan (S&L) holding companies will be treated in the same manner to banks and bank holding companies for the purposes of registration or suspension of their Exchange Act reporting obligations. Not too long ago, the Jumpstart Our Business Startups (JOBS) Act raised the threshold under which a bank or bank holding company may terminate its Securities and Exchange Commission (SEC) registration and reporting requirements to 1,200 shareholders of record from 300.

One thrift, Alpena, Michigan-based First Federal of Northern Michigan Bancorp, which has $338 million in assets, has already taken advantage of the new ruling and voluntarily deregistered and de-listed its stock from the NASDAQ stock market on December 18. The company’s stock now trades on the OTCQX market, the top tier of the over-the-counter markets operated by OTC Markets Group Inc.

In its press release about the rule change, the bank said that “the continuing increased costs and administrative burdens of public company status, including our reporting obligations with the SEC, outweigh the benefits of public reporting.”

The bank said it will continue to file quarterly interim financial statements and provide its shareholders with an annual report with audited financials, among other items, all of which are requirements on the OTCQX market.

The JOBS Act Deregistration and De-Listing Wave
Twenty banks and bank holding companies have deregistered and de-listed from a national stock exchange since the passage of the JOBS Act. Approximately half have moved to the OTCQX market.

Most banks have cited the high costs and regulatory compliance of being an SEC reporting company as the reason for their decision, as well as the ability to focus more of management’s time and resources on growing the business.

In a letter to shareholders following its de-listing, First Federal of Northern Michigan Bancorp said that deregistering and de-listing it shares would allow its management team to “spend more of its time focused on the core operations of the bank, including strategic planning and market expansion, thereby helping to create shareholder value.”

Wheeling, VA-based First West Virginia Bancorp, Inc., with $347 million in assets, said in an October 26 press release that deregistering and de-listing its securities from the New York Stock Exchange’s NYSE MKT market would allow its senior management “to devote more time and resources to focus on customers and profitable growth of the [c]ompany as opposed to the considerable time and effort necessary to manage compliance with SEC reporting requirements.”  The company’s stock now trades on the OTCQX market under its same symbol, FWVB.

Attorney’s fees, printing costs and exchange listing fees aren’t the only expenses banks stand to save from by de-listing from an exchange. Directors and officers (D&O) liability insurance is also higher for SEC-registered companies than for non-SEC reporting companies and can provide a significant cost savings to smaller banks.

Trading on the OTC Market Versus on a National Stock Exchange
The unique structure of the OTC market, which is based on a network of broker-dealers rather than a centralized matching engine, can also help reduce volatility in the trading of small bank stocks and provide better visibility into trading activity.

“For a very thinly traded bank on NASDAQ, a trader may not want to commit capital to inventory 20,000 shares of stock when those shares may represent six weeks’ worth of volume, and computers are changing the bid and ask every few minutes. Maybe that capital is better committed someplace else. Don’t get me wrong, NASDAQ is a fantastic place to be but maybe not for some of the more illiquid banks,” says Tom Dooley, senior vice president of Institutional Sales at Boenning & Scattergood.

On OTCQX, banks are required to appoint a FINRA-member broker-dealer who can provide guidance on the trading of their stock, as well as help facilitate relationships with institutional investors, investment bankers and other key market participants. OTCQX bank advisors can also help their clients handle changes in their shareholder base and correct imbalances between the number of buyers and sellers of their stock.

Small S&L companies that are interested in taking advantage of the new law should examine the various costs and benefits to their business and their shareholders. There is much to be gained from deregistering and de-listing your securities if you do it the right way.

Revival of the Bank IPO

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5-28-14-Hovde.pngAs U.S. equity markets climb higher—the S&P 500 has set a new record 10 times already this year—initial public offering (IPO) activity has returned to levels last witnessed during the tech boom. In 2013, 222 U.S. companies went public, raising $55 billion—the most activity since 2000. This IPO momentum has continued into 2014.

Now that the banking industry has returned to health and equity markets are on fire, IPOs have become viable options again for banks seeking fresh capital.

Disregarding mutual-to-thrift conversions, four banks completed IPOs in 2013, raising $335 million. Seven banks have already filed for IPOs in 2014, four of which have completed offerings and raised $254 million. As a result, 2014 is shaping up to be the most active year for bank IPOs in a decade.

What’s contributing to the revival of bank IPOs?
The banking industry is as healthy as it has been post-recession, but the extended low interest rate environment has changed the industry’s profitability playbook. Most banks have improved asset quality, returned to profitability and boosted capital ratios; however, net interest margin compression is overpowering those banks that lack sufficient loan growth. As a result, opportunistic banks capable of growing loans through acquisition or market expansion are attracting the most investor interest. Given the current market appetite for growth, access to capital is becoming a larger consideration for management and boards, especially if it gives them a public currency with which to acquire and expand. A bank’s ability to articulate its growth story remains critical to completing a successful IPO.

The same factors that are fueling IPOs in other industries are at play in the banking industry. Equity markets have recovered from the recession, and valuations have improved sufficiently for banks to consider an IPO. The SNL Bank & Thrift Index now trades at approximately 165 percent of tangible book value and 15 times trailing earnings.

Furthermore, many banks that recently completed IPOs have since outperformed the market. The four banks that went public in 2013 have returned 49 percent, on average, since their IPO dates, compared to 20 percent for the SNL Bank & Thrift Index and 21 percent for the S&P 500.

Private equity (PE) firms are also playing a pivotal role in the revival of bank IPOs. PE firms that entered the banking industry during the downturn now view the market as ripe for an exit. Valuations have increased and firms are nearing the end of their typical investment horizons. Five of the last six banks that went public were owned by PE firms. Private equity’s business model depends upon a successful investment exit, and an IPO exit may be preferable for those investors who want to take some money off the table, but still believe in the growth opportunities of their franchises.

Additionally, certain regulatory changes under the JOBS Act have made it less burdensome for companies to raise capital publicly. In particular, new issuers that qualify as “emerging growth companies” (i.e., those with less than $1 billion in gross revenues) can submit a draft registration statement to the SEC for confidential review, thus avoiding any public stigma associated with a failed IPO if they decide not to complete the offering. These changes may result in more IPOs in the pipeline than are publicly reported.

The confluence of factors leading to the revival of bank IPOs could also warrant investor caution. Banks that have completed IPOs in 2014 saw their stock drop 1.5 percent, on average, since their IPOs. The two most recent bank IPOs in 2014 had stock price declines of 6.6 percent and 2.2 percent, respectively, on their first trading days.

The market’s upward trajectory—fueled, in part, by the Federal Reserve—will not last forever. The S&P 500 now trades at about 25 times earnings—a level rarely reached over the past century. And while bank stocks trade at more reasonable multiples, a steep macro correction would stall the recent bank IPO momentum.

Furthermore, since loan growth is critical to shareholder returns in the current low interest rate environment, banks must remain prudent while executing their growth plans. Interest rate and credit risk monitoring is paramount to sustained, profitable growth—particularly at a time when it’s tempting to chase yield. PE firms have had mixed success investing in banks, and their aggressive roll-up strategies have not been time-tested in the banking sector.

Despite some warning signs on the horizon, the IPO window remains open, and bank investors are still captivated by unique growth stories. If the trend continues, 2014 should remain on pace as the most active year for bank IPOs in a decade.

The Changing Public Markets for Banks

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2-15-13_OTC_Markets.pngIn April of last year, Congress enacted the JOBS (Jumpstart Our Business Startups) Act with the purpose of easing the capital raising process for small and growing companies.  While only some of the provisions have been put into effect, many small banks have already taken advantage of the new registration and deregistration threshold. According to the latest numbers released by SNL Financial, more than 100 banks have deregistered with the Securities and Exchange Commission (SEC) following the passage of the enactment of the JOBS Act. Most of the attention has been placed on the amount of money and resources banks save as a result of deregistration, but what has not been addressed is the flip side, the new threshold that will require registration. Going forward, banks won’t need to register until they have 2,000 shareholders of record. This change opens the door for small to mid-sized banks that in the past were reluctant to raise capital or merge in fear of increasing their regulatory burdens. What’s important to note is that for non-bank and non-bank holding companies, the statutory shareholder threshold remains the same. In writing the new laws, Congress purposefully carved out banks, acknowledging not only the need for banks to access capital but also the highly regulated environment that banks already face.

SEC Registration Versus Public Markets

Even with this statutory easing, many banks still view the capital markets with caution and often the hesitation comes from a dearth of information and misunderstanding of how the public markets function for small companies.  The common perception is that a bank must undergo a costly and time-consuming process to become public, one that requires underwriting, SEC registration, and compliance with Sarbanes-Oxley. While that process still exists, it only applies to banks seeking to do an Initial Public Offering (IPO) and trade on a registered national securities exchange such as NASDAQ.  As long as there are freely tradable shares, banks can have broker-dealers quote and trade those shares on OTC Markets without filing with the SEC.

With greater demand and regulatory pressure to hold more capital, it is no longer efficient for banks to sell stocks by pulling out a list of interested buyers from desk drawers.  However, as a company enters the capital markets, the information gap also begins to widen and it becomes infeasible for companies to know each shareholder and conversely, investors become removed from the daily ins and outs of the companies they are investing in. The classical definition of markets assumes that information is widely available, allowing buyers to make informed decisions, and sellers to have access to the capital they need to grow and expand their businesses. Yet, information is not always widely accessible, or the information availability is asymmetric, meaning that one side has more information than the other, making a marketplace inefficient.

An Efficient Marketplace

There are three elements that make a stock market efficient:

  1. Access for investors with widespread pricing and the ability to easily trade through any broker
  2. Availability of publicly disclosed information to allow for fair valuation of the stock
  3. Confidence from investors that companies are reputable and information is trustworthy

All three elements above address the problem of asymmetric information in a marketplace by bridging the knowledge gap between company management and investors. Transparent pricing facilitates the assessment process, letting companies and investors determine whether the valuation is fair and actionable. Markets are self-regulating, and when information is widely available, prices will adjust to reflect a combination of company performance, investor demand, and overall economic conditions. Intrinsically, SEC filings are meant to eliminate the discrepancy of information between companies and their investors, yet the high cost associated with registration doesn’t always seem to match the intended benefits. Banks on a quarterly basis already produce call reports to their regulators, and many of them also publish additional financials and disclosures to their shareholders via public portals such as www.OTCMarkets.com, through SNL, or on their own shareholder relations page. For a small bank, the cost of SEC reporting typically ranges from $150,000 to $200,000 per year, and on annual net income of $1 million, that’s a very significant amount.

The Implication

In the U.S., there are roughly 7,000 banks, a majority of which are small community banks with under $1 billion in assets.  Of the 7,000, about 15 percent are publicly traded, around 450 on registered national securities exchanges such as New York Stock Exchange and NASDAQ, and 600 over-the-counter, primarily on the OTCQB marketplace operated by OTC Markets Group. Fifteen percent is a relatively small fraction, especially given the current economic climate and disposition towards mergers and acquisitions. In general, banks are viewed more favorably and are in better positions to be acquired when the bank’s stock is publicly traded. There is always going to be greater confidence in a deal when valuation is publicly derived (even if the price/book is less than 100 percent).

However, should banks become publicly traded solely for the fact that they would be “more attractive” in an acquisition? Without a doubt being traded on a public market exposes the company to potential market volatility, and there are inherent risks and costs associated with being publicly traded, even with the recent changes outlined in the JOBS Act. A common impediment delaying and preventing companies from going public is the fear that the public valuation will be less than the management’s internally perceived price.  A parent will believe that his or her child is the best, but unfortunately we live in society where individuals are subject to comparison and ability is often determined by some form of standardized testing or arbitrary measurements.  Public scrutiny is hard to swallow, but public acknowledgement can be equally, if not more, gratifying.

Since the financial crisis in 2008, markets have been perceived as the big bad wolf, the visible scapegoat for why companies go bankrupt and why shareholders lose millions of dollars in their investments. However, despite the recent ups and downs, they still remain the best indicator of good investments and the most efficient way to access capital. If the company has a sustainable and profitable business, if a bank’s loan portfolio has consistently provided high returns with minimal default risks, then the well-informed markets should adjust to reflect those successes. 

Being Public: Is It Worth It?

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Six months after the JOBS (Jumpstart our Business Startups) Act went into effect, making it easier for banks to remain private, we asked lawyers their opinion on the advantages and downsides of public ownership. Although all raise good points, many believe the expense is just not worth it for that size bank. But if the bank is looking at acquisitions and access to capital that the public markets provide, public ownership is a good idea.

Does it make sense for banks with less than $500 million in assets to be public companies? 

Mark-Nuccio.jpgWith increasing needs for capital and a desire to grow, some smaller banks may want to become or remain public companies, in spite of the significant burdens imposed on smaller public company issuers. Access to the public markets and shareholder liquidity, in the right situation, are worth the price of admission. Without a growth agenda, however, small, publicly held banks would be well-advised to privatize.

—Mark Nuccio, Ropes & Gray LLP 

Peter-Weinstock.jpgIt is hard to see many benefits for companies with less than $500 million in total assets to have their shares registered with the Securities and Exchange Commission (SEC) under the Exchange Act.  The accounting costs associated with public company status continue to increase, as do legal and regulatory check-the-box exercises. Perhaps it is worthwhile for boards to consider the issue again at $1 billion in assets, which is when the requirements for Federal Deposit Insurance Corp. Improvement Act certifications and the Federal Reserve’s enterprise risk assessments kick in. It is clear how smaller, publicly traded banking organizations view this issue. After the JOBS Act, the pace of such companies going dark has resembled Pamplona’s Running of the Bulls.

—Peter Weinstock, Hunton & Williams LLP 

Gregory-Lyons.jpgFor many banks with less than $500 million of assets, the burdens of operating as a public company likely outweigh the benefits. The reporting obligations themselves are substantial. Moreover, particularly as many community banks continue to feel the burdens of the financial crisis, the need to satisfy the short-term view of many investors can impede the pursuit of the long-term objective for a return to health. And the public markets often place a discount on the stock price of banks this size, thereby limiting the upside potential of an offering. Despite having said that, if a bank of this size is in comparatively good health, there are many opportunities for acquisitions in the marketplace now.  For these banks, the publicly traded stock can still be a useful currency in a growth strategy.  

—Greg Lyons, Debevoise & Plimpton LLP 

Schaefer_Kim.pngAfter the JOBS Act increased thresholds for registration from 500 shareholders to 2,000 and deregistration from 300 shareholders to 1,200, many banks have been closely examining the practicality of being a public company, especially considering the tremendous expense and additional regulation. However, the sensibility of that decision truly rests in the bank’s strategic plans for its future. How does the bank want to position itself? If a bank wants to expand its market or services, or if it wants (or needs) to raise capital, its prospects for doing so are much brighter as a public company. Some banks also enjoy the prestige and attention that they receive as a public company. Being a public reporting company may add significant expense, but the visibility and flexibility for raising capital is certainly enhanced for a public company, which may turn those expenses into a valuable investment for future growth.

—Kim Schaefer, Vorys, Sater, Seymour and Pease LLP               

John-Gorman.jpgThere is no one-size-fits all response to this question.  For the institution that sees itself generating enough capital to pay dividends and sustain growth and does not see itself expanding its footprint, then it should seriously consider deregistering with the SEC.  There is a unique ability for a bank or bank holding company (and a savings bank and savings and loan holding company) to continue to trade on the bulletin board without having to be registered with the SEC. This is not available for non-financial institutions.

For many small-cap banks, bulletin board trading may provide as much liquidity as NASDAQ OMX, and provides insiders with an outlet for their shares, which is one of the major downsides of deregistering (i.e., it is difficult for insiders to sell their shares).  For an institution that sees itself accessing the public markets for additional capital or expanding through mergers and acquisitions, continuing with an SEC registration could prove critical, despite the costs and burdens. And as the market cap of a bank/holding company increases, the need to maintain a trading alternative is also important for shareholders. 

—John Gorman, Luse Gorman Pomerenk & Schick PC

The Benefits and Drawbacks of Going Private

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The JOBS Act was about the only piece of bipartisan legislation to pass through Congress recently, according to Bruce Bennett, co-head of Covington & Burling LLP’s securities practice. It is supposed to facilitate job and capital formation by reducing disclosure rules for publicly traded companies with less than $1 billion in revenue, a new category deemed “emerging growth” companies. It also has a series of provisions to make it easier for banks and thrifts to stay privately held, enabling them to save costs. Bank Director magazine talked recently to Bennett about the impact of the JOBS Act on banks and thrifts.

What does the JOBS Act say about banks?

Previously, any company with more than 500 shareholders and $10 million in assets had to go public. Now, banks with fewer than 2,000 shareholders can stay private. The other trigger that was changed was the maximum number of shareholders you needed to deregister. Under the JOBS Act, banks no longer need to fall below 300 shareholders to deregister; the threshold is now 1,200 shareholders.

Other provisions apply to all “emerging growth” companies. The Act basically rewrites the rules for IPOs. It removes some fairly significant provisions. It reduces the duration of audited financial statements you need to go public from three years to two years. It allows for “test the waters” communications, so you can go out and talk to investors about whether they would want to make an investment in this company before you file your SEC (Securities and Exchange Commission) report. It reduces some of the public reporting requirements once the company goes public and the company gets the benefit of that for five years, unless it crosses the $1 billion annual revenue threshold sooner.

What impact do you think it will have on banks?

If a small bank is publicly traded, there is a cost to that. I’ve seen the cost estimate at $100,000 or more. If the bank doesn’t have to prepare SEC registration and reporting documents, it will probably save money. The investors who remain in the company will expect audited financial statements and most of the companies that have said they will deregister say they will continue to post those on their web sites.

If a bank is spending $100,000 to $125,000 per year to file SEC reports, and has 10 employees who could otherwise use their time more productively, then there is a benefit to that.

Are there drawbacks to deregistering?

The downside is this: What if in a few years the capital markets have changed and the bank wants to raise money in the public markets? If they have to do an IPO, that is more expensive than just staying public. It’s not good for companies to toddle in and out of public status. Investors would worry: Is this an investment I want to hold? It might make it harder to do the IPO. There also are some protections for a public company. If anyone wants to acquire more than five percent of a company’s stock, that person has to file with the SEC and the company knows who their large shareholders are. As a private company, you could have a large shareholder not aligned with your view as to how to manage the company and you don’t find out about it until that shareholder gets far more than five percent.

What size or type of bank do you think will be most interested in deregistering securities?

Small banks. We’re seeing an increase in stock-for-stock deals in mergers and acquisitions. If you’re a privately held bank, that sort of transaction is harder to do. If a bank is thinking of growing by acquisition, it would probably want to stay public. For a bank with assets in excess of $1 billion or $2 billion, I don’t see that category being interested in deregistering. I could also see regulators saying no, “If you do that, your access to capital is hurt from a safety and soundness perspective.”

Could deregistering hurt stock values?

If the standard metrics are strong, valuation will follow accordingly. If a bank has a compromised loan book and a lot of comprised real estate on the books, I don’t think being public would affect that. The way it would impact them is access to capital markets.

The JOBS Act has been billed as a way to create jobs. Will it?

I don’t think so from the banking perspective. The job creation could come from making IPOs easier to do. With that, you make it easier for small companies to grow or to do an IPO and they get better access to capital.

The Impact of the JOBS Act on Banks

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construction.jpgOn March 27th, the House of Representatives passed the Jumpstart Our Business Startups Act (the JOBS Act). The Senate approved the same legislation the prior week and and the bill was signed by President Obama yesterday.

In part, the JOBS Act changes the Securities and Exchange Commission (SEC) registration requirements under the Securities Exchange Act of 1934 (the Exchange Act) in two respects for banks and bank holding companies.  

First, the JOBS Act increases the threshold for Exchange Act registration with the SEC from 500 shareholders of record to 2,000 shareholders of record. This amends the current rule which requires registration for companies with more than $10 million in assets and 500 shareholders of record. Up to this time, many small banks with assets over $10 million have avoided SEC registration by keeping the number of shareholders below 500. The new threshold will now allow smaller banks to raise capital by selling stock to new shareholders without having to register with the SEC.

Second, the JOBS Act increases the threshold for deregistering securities with the SEC for banks and bank holding companies from 300 shareholders of record to 1,200 shareholders of record. Consequently, more publicly-held banks may explore deregistration in order to avoid the costs and aggravation of continued SEC registration. 

Exchange Act regulations subject a company to the SEC’s public disclosure and reporting requirements, including periodic financial reporting (Forms 10-Q and 10-K), detailed governance and compensation disclosures (proxy statements) and share ownership reporting (Forms 3, 4 and 5). (It is not clear that Congress intended for the legislation to exclude thrifts and thrift holding companies and it is possible that the SEC may include thrifts and thrift holding companies when it issues regulations on the new registration thresholds.)

In deciding whether to explore deregistration, companies should consider some of its advantages and disadvantages:

Advantages

Deregistration can provide a publicly held company with certain advantages, including:

Expense Reduction—Companies that deregister will save expenses in several areas, including costs associated with SEC filings, shareholder communications, professional fees, and, potentially, lower premiums for directors and officers liability insurance.

Increased Dividends—Companies that eliminate expenses associated with SEC registration may be able pass the savings to shareholders in the form of increased dividends.

Eliminate Personal Financial Disclosures—Deregistered companies would no longer be required to report transactions in the company’s stock and would also not be required to disclose detailed compensation information in the annual proxy statement of the company.

Reduce Pressure from Dissident Shareholders—Deregistered companies may be able to reduce certain pressures from dissident shareholders because those companies would no longer be required to comply with certain periodic reporting and disclosure obligations.  However, dissident shareholders would also not be required to publicly disclose their stock holdings.

Focus on Long-Term Goals—By eliminating certain reporting and disclosure obligations (quarterly reports, for example), deregistered companies may find it easier to focus on long-term business strategies rather than satisfying short-term shareholder expectations.

Disadvantages

When weighing the advantages of deregistering, companies should also keep in mind certain disadvantages, including:

Reduced Access to Public Equity Markets—Publicly traded companies generally have greater access to equity markets and, therefore, can often raise capital more quickly than private companies.

Reduced Market for Stock—Deregistered companies are ineligible to list their stock on the NASDAQ OMX or other stock exchange. Consequently, shareholders of deregistered companies, including officers and directors, may not be able to sell stock as quickly as they could with an actively traded security. However, many registered companies have small markets for their stock which already limits the ability of individuals to timely buy and sell. Further, some institutional shareholders may have policies that prevent them from holding securities of deregistered companies.

Reduced Ability to Use Stock in Acquisitions—Deregistered companies may find it more difficult to use stock in structuring acquisitions because issuing stock as acquisition consideration may not qualify for a private placement exemption and, thus, require SEC registration. However, deregistering should not affect the ability of the company to be acquired.

Loss of Public Company Status—Many companies believe that being a public company enhances the business reputation of the company.