It’s an efficient and low-cost method of raising money which, if used judiciously, can help plug a liquidity shortfall. But there are risks for the retail investors on whom the shares might ultimately be foisted.
These deals tend to be arranged by comparatively unknown hedge funds, rather than bulge-bracket investment banks, and the funds have the right to re-sell the shares immediately, if desired. Receiving this type of funding isn’t necessarily an endorsement of a company’s long-term financial health: At least half a dozen recent ELOC recipients have warned about their ability to remain going concerns, including “smart window” maker View Inc., flying taxi firm Lilium NV and electric vehicle manufacturer Lordstown Motors Corp.
ELOCs — sometimes referred to as committed equity facilities or standby equity purchase agreements — have exploded in popularity in the past 12 months, mainly because many neophyte public companies have less cash than they were anticipating and few other options to raise more.
Investors in SPACs are demanding their money back rather than funding mergers, while the supplementary institutional money that once backstopped blank-check deals, known as private investment in public equity, has also dried up. Newly listed startups either don’t have much (or any) revenue yet, or they’re burning prodigious amounts of cash, making it difficult for them to borrow. Raising equity the regular way via an underwritten offering is difficult due to a paucity of institutional demand.
Businesses that have been subject to SEC financial reporting requirements for more than a year might be able to do an at-the-market offering, the posh name for trickling shares into the market via a sales agent. SPAC-listed electric vehicle makers Canoo Inc. and Arrival SA and have both announced ATM programs this month, for example, after going public in December 2020 and March 2021, respectively.
ELOCs are similar, and suitable for those with shorter track records as public companies. The recipient gets the right to “put” new shares to an investor whenever it wants over a roughly three-year period, at a slight discount to the recent average market price, often 3%. In return, the investor earns the spread, plus a small upfront fee. For emergency funding, the cost of capital is pretty low. The company also doesn’t have to disclose how many shares it has sold until weeks later, making it harder for short-sellers to take advantage.
There are some restrictions. The volume or value of shares transacted can’t exceed an agreed daily limit, nor can the aggregate total sold exceed 20% of equity outstanding without shareholder approval. But provided the company has filed a registration statement, the hedge fund is normally free to flip the shares for a quick profit, a likely outcome given the weak finances of some of these companies.
One big advantage for the firm is it can discretely dribble the shares into the market rather than dumping a lot of stock in one go at a fixed price. So it can take advantage of periods of improved market sentiment, as has happened lately with stock markets rallying and meme-stocks resurgent. Investor Michael Burry, of “The Big Short” fame, has warned that “silliness is back.” But silly markets are great if you have an ELOC.
Of course, the downside is that many former SPACs are still trading at depressed levels and stock sales are therefore highly dilutive. If their share price keeps falling, a company might become unable to access its entire ELOC without breaching the 20% cap.
ELOCs are often provided by little known investment funds, rather than large investment banks. While admittedly these clients are often small fry, another explanation for Wall Street’s hesitance might be that ELOC investors are deemed “underwriters” under securities law. Investment banks have been reluctant to take on legal liability for SPACs.
One New Jersey hedge fund has been particularly active in this market. By my count, Yorkville Advisors Global has arranged around a dozen of these transactions, including for Lordstown Motors, Virgin Orbit Holdings Inc. and Eos Enterprises Inc. Tumim Stone Capital has also been busy: Its ELOC clients include Lilium, electric truck maker Nikola Corp. and cybersecurity firm IronNet Inc. Larger financial institutions are, though, starting to spot a financial opportunity, with Cantor Fitzgerald LP and B. Riley Financial Inc. frequently involved in these transactions.
Ordinary investors shouldn’t lose sight of financial fundamentals. Announcing a $100 million committed equity facility last week, loss-making smart glass maker View — whose SPAC deal I impolitely described as one of the worst ever — warned of substantial doubt about its ability to remain a going concern beyond November.
A money-printing machine can be a great safety net for a former SPAC in a tight financial spot. But it might serve only to delay the inevitable financial reckoning — by which time retail investors may be left holding the bag.
More From Bloomberg Opinion:
• Lordstown Motors Is Selling Some Stock: Matt Levine
• Why a $33 Billion SPAC Deal Couldn’t Pay Its Bankers: Chris Bryant
• Tiger Global’s Day of Reckoning May Never Come: Shuli Ren
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Chris Bryant is a Bloomberg Opinion columnist covering industrial companies in Europe. Previously, he was a reporter for the Financial Times.
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