AIM4Tech

Planning To Stay On The Shelf Thru 2013?

Last week I Chaired a Panel session at the Reverse Merger 2007 Conference in San Francisco.

Picture the scene - around 200 bankers, attorneys and other professional advisors spending 48 hours and a bunch of dollars exploring ways to take companies public without going through a straight IPO.

A sort of mass Nasdaq/SEC Escape Committee.

In a set of discussions that would have seemed more at home in a chapter of Alice In Wonderland, experts explained how to pick your way through the minefield created by the Four Horsemen of the Apocalypse - the SEC, SarBox, Nasdaq’s disinterest in small companies and the constant threat of litigation from just about everywhere.

I introduced our session – my co-panellists were Ken Koch of Mintz Levin Cohn Ferris Glovsky and Popeo and Gary Benton of Pillsbury Winthrop Shaw Pittman – by relating a story of my childhood.

Back in the early 60s when UK TV was limited to 2 really weedy B&W channels and the bad boys of pop music had names like Burt Bacharach and Mantovani we had to make our own entertainment.

At the forefront of bright young adolescent boys’ healthier attempts to occupy themselves was chess – the game of Kings. We played it often at school, both amicably and fiercely competitively. One day a new version hit the classroom and quickly established itself as the 1960s equivalent of Doom or Tomb Raider.
I can’t remember what its name was but, for reasons that will hopefully become apparent, I’ll call it 2.5D Chess.

The principle was simple. You set up the pieces on a board (A) as normal and placed a completely empty board (B) beside it.

It gets a little harder in a moment and so you might want to click the slide below to understand this graphically.

The games commenced as usual on Board A and play continued until a piece was taken, which triggered the unique characteristics of 2.5D Chess. Although the taken piece was consigned to the box as in the normal game, the taker moved to the destination square on the other board.

See the fate of the pawn and knight below.

When it was his turn (I attended a boys-only school) the next player decided on which board to make his move with the metaphysical transportation rules applying in reverse.

This second life opened up all kinds of exciting possibilities for the game – for example you could escape from what would ordinarily be checkmate simply by taking the attacking piece and transporting your King to the other board – subject only to not landing in check on the destination square. After only a couple of moves, the sheer enormity of the games’ possibilities became evident.

Why did I tell this story at the Reverse Merger Conference? What relevance could it possibly have to listing tech companies on the world’s capital markets?

The answer lies in the longevity of 2.5D’s appeal. About three weeks after the birth of the fever, all of we massively enthusiastic players simultaneously lost interest for all time and returned to the traditional game.

Why?

Simple – because we had come to the spontaneous collective realisation that playing normal chess and getting your opponent into checkmate was already damned difficult enough without adding needless layers of complexity to achieve the same objective.

And it’s the same with running businesses – it’s already hard enough to steer a growing company through the rapids of an IPO en route to becoming a global leader in your market, without having to add the value-sapping activities that accompany a SPAC, a super-SPAC, an AIMSPAC, a reverse merger, a PIPE, a clean reverse merger, a super-SPAC up a PIPE with a clean reverse and all the fixins, or any of the other exotic mechanisms explored during my two days in San Francisco’s Four Seasons.

That being said, the 2-days contortionistfest wasn’t wholly a waste of time. Amongst the complex gaming that characterized most of the material, there was one spectacularly illuminating presentation.
Brian Cooke of Keating Investments LLC, New York gave what qualifies as one of the best slides I have ever seen in a lifetime of enduring other peoples’ presentations- a lifetime that stretches back to the days of handwritten overhead foils.

Brian’s underlying point lays bare something that is screamingly obvious to any leader of a growing US VC-backed tech company today – namely that they aren’t going anywhere.

But unlike those who merely rant about the subject and wail about their misfortune – Brian analyses unimpeachable data to show the magnitude of their problem – and it’s very, very big.

His algebra is seductively simple. Calculate the size of the inventory of VC-backed companies, divide it by the current rate of exits – trade sales and Nasdaq IPOs – and the result is the time that it will take before all of today’s VC-backed companies can expect to escape from private hands.

Namely the length of the sentence that will see them starved of development capital and handicapped by a preference share structure that is guaranteed to piss off everybody involved.

I include the slide below, but to spare you the effort of double clicking, the answer is TWELVE YEARS!

So, if you assume a constant stream of escaping companies, the average time that each can expect to wait before either being sold or floated is SIX YEARS.

Or put more simply if you are normal you can expect to stay trapped in the status quo until some time in 2013.

So now you know.

And to test just how awful that prospect is if you are a tech company leader, rehearse the following speech on your way home tonight:

“Honey, I’ve got some bad news. You know how hard I’ve worked over the last [3, 4, 5, 6, 7, 8 – Delete as necessary] years, staying out late, skimping vacations, sharing my pain with you and the children? And you also know that the reason I did it was because I totally believe in my company and its potential to achieve global domination in our sector thus showering me with fame and us with riches beyond imagination. And you know how my CFO and VCs have always said that we were just [3 – 6, 6 – 12, 12- 18 – Delete as necessary] months away from an exit and that all we had to do was to wait for Nasdaq to open up a little? Well I’ve just discovered that I’m going to have to hunker down for a little longer. How long? Oh it definitely won’t be more than twelve years and hopefully it will only be [3,4,5,6,7,8,9,10,11 – Delete as necessary].”

Waiting For Godot

As, I suspect is the case for most of my readers, High School seems a very time ago.

I attended a now defunct institution – High Pavement Grammar in Nottingham, England. Founded in the 18th century it remained largely below the world’s radar screen until the conviction of alumnus Dr Harold Shipman. He notoriously broke with school tradition – motto "Virtus Sola Nobilitas” (Virtue is the only Nobility) – and more importantly with his Hippocratic Oath to become Britain’s top serial murderer by bumping off at least 200 of his elderly patients.

Although Shipman and I were there at the same time, he was 5 years older and so I guess I was too young to attract his developing geriatricidal attention.

However it’s likely that we did share the eccentric Drama teacher – Bert Brown – whose singular belief was that the system needed to be brought down – and at any cost.

As part of his lifelong campaign to develop an army dedicated to his cause, Bert taught us boys about philosophy, communism, anarchy and reinforced our budding revolutionary zeal by taking us to see seditious plays by men like Chekhov, Gorki and the like.

High on Bert’s list of must see plays was Waiting for Godot. Back then it was pretty avant-garde although now it has gone the way of all flesh and joined the mainstream. In it, five characters engage in apparently meaningless discussions while awaiting the arrival of the play’s eponymous figure – Godot – who never arrives.

Written by Samuel Beckett it was a prime example of the Theatre of the Absurd, a genre which Wikipedia describes as follows:

“Time, place and identity are ambiguous and fluid, and even basic causality frequently breaks down. Meaningless plots, repetitive or nonsensical dialogue and dramatic non-sequiturs are often used to create dream-like, or even nightmare-like moods.”

And for tech company leaders who are contemplating a Nasdaq float, I can guarantee that a world where everything is ambiguous, meaningless, repetitive or nonsensical will seem horribly familiar!

For example, just last month the WSJ carried a headline announcing a loosening of the SoX strictures “Sarbanes-Oxley Is Eased”

In the generally upbeat article, SEC Chairman Christopher Cox said the guidance

"is intended to right-size the evaluation and assessment efforts of managements, and it's intended to do that for companies of all sizes,". "Investors will benefit from reduced compliance costs."

The article went on to pray that:

“Regulators hope the management guidance and a companion measure that is expected to be approved by the Public Company Accounting Oversight Board today will reduce costs enough that they will at last feel comfortable requiring smaller public companies to comply with the internal-controls provision of the 2002 law.”

And exotically named SEC deputy chief accountant Zoe-Vonna Palmrose positively trilled:

“We do believe that it’s not only doable for smaller companies, but doable in 2007.”

Never mind the trill - the thrill didn’t last long.

On the same day, Senators Kerry and Snowe read a very different conclusion in the SEC’s smoke and the PCAOB’s silence.

In a joint press release the Chairman and Ranking Member of the Committee on Small Business and Entrepreneurship voiced:

“strong concern that the Securities and Exchange Commission (SEC) failed to provide an extension for small public companies to comply with Sarbanes-Oxley internal control regulations.”

More depressingly for business leaders but not at all of course for accountants and other fans of the Theatre of the Absurd, the Senators' release went on to point out that:

“According to a recent Government Accountability Office study, small public companies spend a disproportionately greater amount of time and money to comply with Sarbanes-Oxley regulations than large public companies. Firms worth $1 billion or more spend just 13 cents per $100 in revenue for audit fees, while small businesses are forced to spend more than $1 to comply with the same rules.”

Yes - small business spend $1 in evry $100 to meet compliance regulations!

The absurdity of this situation was reinforced by National Venture Capital Association (NVCA) President Mark Heesen who claimed in their release with the following headline:

“National Venture Capital Association Warns Congress that SEC and PCAOB SOX Reform Proposals Do Not Go Far Enough Venture Industry Cites Lack of Effort by Auditors to Reduce Costs”

"First, we are gravely concerned that the accounting profession will not change its high cost practices and the recent guidance provided by both the SEC and the PCAOB regarding materiality is not specific enough to compel them to do so," Mr. Heesen testified. "Second, the oligopoly that exists for 404 audits leaves no choice for small companies in terms of service providers. It does not provide any incentive for the Big 4 accounting firms to lower costs. Lastly, because of these first two concerns, it is imperative that prior to adoption, all proposed measures are fully field tested to confirm that they will indeed reduce costs."

All of which fell on deaf SEC ears as reported in the Deal with the headline

Cox Defends SOX for Small Firms, Donna Block wrote:

“Despite persistent criticism from top lawmakers and advocacy groups, Securities and Exchange Commission Chairman Christopher Cox is standing by his agency's decision to make small businesses begin complying this summer with the most controversial provision of the 2002 Sarbanes-Oxley law.“

(By the way, Bert would have given me bonus marks at school for including Cox, Block and Sox in the same sentence - ah the advantages of a classical education!)

So while non-US companies avoid having to pay anything for controls assurance, US public companies are massivley undermining their competitive position by paying a tax 1% of revenues for the privilege!

And if you don’t believe me or even the bi-partisan Senators Kerry and Snowe, check out the tear-jerking WSJ piece by Ken Wilcox - president and CEO of Nasdaq listed SVB Financial Group (SIVB) in which he laments:

“In 2006 we paid over $20 million to the Big Four for an average of about $17,000 per employee. This is more than five times as much as we paid them only three years ago.”

In Beckett’s play, the five characters - Vladimir, Estragon, Pozzo, Lucky and the Boy - waited in vain for Godot.

The play closes with the Boy arriving to announce that yet again, Godot will not be coming; followed by Beckett’s much-quoted lines:

Vladimir: Well? Shall we go?
Estragon: Yes, let's go.
They do not move

And let's face it - for those once-meteoric US tech companies starved of growth capital, Godot isn’t coming either.

(Mind you, compared to paying $17,000 for Sarbanes Oxley compliance it’s not clear who are the unfortunate ones!)

I never thought, back in my teens with a world-class mass murderer of tomorrow sitting in a nearby classroom and Bert ranting about the absurdity of our existence that Art could ever prepare me for life!

But even such a robust a classical education leaves me unable to answer the award winning absurd question of the 21st Century US capital markets –

If Nasdaq isn’t coming – why does no one move?

Perhaps the answer lies in the definition of US Regulation, aka the Theatre of the Absurd:

“Time, place and identity are ambiguous and fluid, and even basic causality frequently breaks down. Meaningless plots, repetitive or nonsensical dialogue and dramatic non-sequiturs are often used to create dream-like, or even nightmare-like moods.”