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Gregory P. Hanson

Expert Insights: Financing

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Gregory Hanson has more than 30 years of executive and financial management experience, and has completed approximately $1 billion in financing transactions, licensing arrangements, M&A activity and cost avoidance measures to fund operations.

Is there anything particularly unique about today's financing environment? How does the situation differ for startups and older companies? How do you see government policy affecting the financing environment?

From a government policy standpoint, the Obama administration is considering a plan to shift part of the bailout funds to small business. However, discussions are very preliminary and not something to be counted anytime soon, if at all. Questions arise as to whether there will be enough money in meaningful amounts to go around, who will qualify for lending and when will it be available, if any. Given the uncertainty of the plan at this point, our cash planning should assume none -- but be aware of the potential opportunity.

Gregory Hanson

Startup or venture-backed private entities will find that many of the venture funds have less capital today to invest in future rounds. Those that have funds prioritize where to make investments and who will win another round, as more companies are looking for funds.

For older companies that continue to need financing, they will face continuing pressure from the toughened economic outlook and financial markets. Older companies, more than ever, will have to make difficult strategic decisions to sustain their businesses to weather the length of the economic downturn. Tough decisions, if they have not already been made, include prioritizing the most valuable commercial opportunities and having well thought out operating and contingency plans with realistic market assumptions and expectations. Only after establishing a revised strategic and conservative-laden financial plan should one plan to approach the capital markets with any expectations for success in raising money.

Mega-deals, such as with major banks and automotive industries, may impact our industry locally, but these large deals are not typically seen in the other industries and in our local financial environment. The San Diego area is heavily laden with smaller, cash-hungry public and private companies within the life sciences and high-technology industries. The financial environment for these industries has a more direct impact on business in the greater San Diego area.

Types of financing transactions for public companies continue to include traditional forms, such as PIPEs (private investment in public entity), registered directs and public offerings. But the important distinction versus a year ago is that these types of financings seem to have steeper discounts and more warrants to purchase stock in the future as a sweetener to increase the attractiveness to investors.

For example, for the public life sciences companies including those in the greater San Diego area tracked by Brinson Patrick Securities Corp., the average size of a financing transaction in the second quarter of 2009 was 62.5 percent of what it was for the same period a year ago. And, overall transaction costs have doubled from a year ago.

Where/what are the creative financing opportunities?

For public companies to be able to meet financial needs and achieve sustainability, management will need more financial tools in their tool chest to ensure sustainability and to meet financial needs. Several creative and alternative financing strategies exist, such as continuous at-the-market offerings and use of equity line facilities. Both strategies have been around for years, but have not seen widespread use until more recently in our local industries. Both strategies require a reasonable amount of market liquidity to be effective.

An at-the-market offering (ATM), popular among major banks, public REITS, airlines, mining and auto industries, is the simplest and more flexible of the two. Further, ATM offerings are starting to reach other industries that continue to have cash needs, such as biotech and pharma. Total gross proceeds for ATM offerings since 1998 reached about $25 billion, the majority of which has occurred in the last 18 months. During the last 10 years, the number of ATM agreements put in place has grown to more than 200 but now appears to be growing exponentially.

In an ATM offering, a broker-dealer manages the sale of newly issued shares on behalf of the issuer directly into the trading market, if and when funds are needed and under terms designated by the issuer. The company must have a shelf registration statement on file with the SEC or be shelf eligible to conduct an ATM offering. Once an agreement is in place, an issuer can give instructions on a moment's notice, such as following a favorable news event, or more frequently, depending on the financing strategy. The broker-dealer uses a best efforts basis to sell the newly issued shares on terms provided by the issuer. Fees for mid-size companies typically range from 3 percent to 6 percent of dollar value of shares sold.

An equity line facility is an arrangement between the company and a specific investor -- often a hedge fund -- that commits to purchase up to a certain amount of the company's common stock over a period of time at a discount to a trailing pricing period. The share price is determined based on a discount formula that typically ranges from 5 percent to 12 percent depending on the share price itself, or can be fixed. In some cases, warrants to purchase stock may be part of the arrangement. The company has the ability to set a minimum acceptable price per share at the beginning of each pricing period. Shares must be registered with the SEC for resale, and a prospectus supplement is filed after each closing. The equity line gives the company an ability to draw on the facility from time to time, similar to an ATM. One drawback to the equity line is that there may be timing and volume restrictions for each pricing period.

Comparing the two facilities, an ATM offering arrangement with a broker-dealer gives issuers greater control and flexibility vs. other forms of financings, and typically has a lower cost of capital, particularly in the current economic climate. Further, an ATM offering can minimize the impact on stock price when used judiciously and strategically. Disclosures in financial statements at the end of the quarter are also straightforward for ATM offerings.

For private companies, management teams should think harder about partnering/collaborations with companies that have money and infrastructure. Deals can be structured with earn-outs on performance and reaching milestones without diluting ownership in the company. Financing through partners is non-dilutive in nature and likely preferred over a dilutive financing transaction. Perception of value of the company could vary depending on how much is received vs. given away in the partnership. In considering a partnering strategy, keep in mind it could take longer than anticipated to find and negotiate an acceptable deal while burning cash. Given how long it takes to find an attractive partner and terms in the life sciences industry, more consolidation, including reverse mergers, is likely. In a reverse merger, the private company seeks access to the public capital markets and any cash remaining from remnant companies -- shells from failed technologies and business endeavors -- and from clean shells.

How would you characterize a company's ability to get financing? What are some common assumptions/mistakes?

A company's ability to get working capital financing from traditional lending sources has become tougher to get in the amounts desired from a single lender. The good news is, traditional lenders such as Oxford Finance Corp., Silicon Valley Bank and Comerica Bank that traditionally have competed against each other for lending have shown a willingness to work together to participate on loans. Thus, it pays to get to know a variety of sources, not just the one you currently deal with.

Borrowers should expect well-defined financial covenants. Public companies seeking loans secured by general assets might have to give additional incentives such as a warrant to purchase stock. Pre-commercial companies -- ones without revenues -- would not likely have access to working capital loans but could get an equipment loan -- though not enough to build a business.

Three traditional factors, whether it's debt or equity financing, are as follows:

Favorable past performance -- Did the company achieve committed objectives and milestones on time or ahead of schedule, and was the outcome favorable? If the company's track record of success has been good, then statements about future performance become more reliable and believable to the investor.

Investor success from prior investments in company/management -- Did investors in the prior round make money? If they did, they should be more likely to make further investments in the company. If not, be prepared to explain what happened last time and what's different this time -- not an easy endeavor with a prior investor.

Prospects for the future -- A well-defined opportunity, documented with realistic assumptions backed by market information, rationale for expectations, management capability and a sound financial plan for achievement -- even with a few delays -- will be important decision criteria for the investor.

Given the worst market conditions in decades, other steps should be taken. Don't be surprised that investors may be timid right now or do not have sufficient funds to allocate to your opportunity. Current investor fears and expectations will translate into tougher investment criteria, more due diligence and scrutiny, and tougher deal terms to get a financing done.

Consider the following additional actions:

Tighten the operating and financial plan -- Company management has to make tough decisions in these market conditions to sustain the business. Be prepared for the worst economic and financial situation, and have a contingency plan, ready to be acted on if events do not take place in the timeframe and manner expected.

Take internal actions within your control -- Before seeking external financing, determine what can be done first to conserve funds as well as show fiscal responsibility to investors and financial institutions. That means prioritizing programs and cutting marginal programs.

It's never too late to plan ahead -- It's better to raise capital before your back is against the wall when everybody knows you need to raise capital. Financial terms get worse the more you need the capital. And if you are a public company and the market anticipates you will be raising capital, you should expect some downward pressure on your stock.

Common mistakes made by companies regarding financings include:

Lack of planning far enough in advance -- It typically takes longer to obtain funds and partnering arrangements on attractive terms. Waiting too long to take action under an operating and financial plan could have undesirable consequences: terms become tougher and markets begin to anticipate your need for raising capital. Planning further ahead could help avoid a catastrophe.

Lack of contingency plan -- Being flexible and adaptive is a key to survival in tough economic times, and with uncertainty about one's own business prospects. Risks should be addressed, together with a contingency plan with triggers for taking action if performance is not up to expectations or events do not happen according to plan.

Unrealistic predictions -- Management needs to be realistic in its predictions about future events and assumptions.


-- Compiled by Rebecca Go

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