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How can the OTCBB be used as a Stepping Stone to the AMEX and NASDAQ?
Daily news articles report that it is becoming increasingly difficult for early stage companies to raise capital.
Capital market conditions indicate that this status may continue. Overcoming this condition will require companies to execute a new approach by designing their business plan so it can succeed through raising small rounds of capital in planned follow-on offerings. This process envisions harmonizing a continuous capital-raising effort that begins by funding the company with a small initial round of founders capital, to raising a small private round to raising a larger interim round (PP, 504, Reg. S or bridge loan) to preparing, filing and funding a small SB-2 offering and making the company a publicly traded entity by listing it on NASDAQ’s tier three market, the OTC Bulletin Board and in 2003, transitioning to the BBX. This is a model that will allow companies to create a capital structure that is Wall Street-acceptable and then maximizes the company’s market cap value by making its early milestone becoming publicly traded. The OTCBB, as just one of the OTC programs, can provide companies with the experience needed to fully engage greater exchange entities such as the NASDAQ and AMEX proving to bring a most lucrative growth transition.
INTRODUCTION
There are two trading systems that are separate from the National Market: the Over the Counter Bulletin Board (OTCBB) and the National Quotation Service Bureau (NQS), commonly known as the Pink Sheets. Together, the OTCBB and Pink Sheets make up the OTC market in the United States. The OTCBB and the Pink Sheets are quotation mediums, rather than stock exchanges. OTC securities are traded by a community of market makers who enter quotes and trade reports through a sophisticated, closed computer network. In the last ten years, there has been a dramatic increase in trading using the OTCBB as a critical “stepping stone” to create capital structure and maximize the companies market cap value creating improved business metrics that are worthy of an outstanding NASDAQ or AMEX listing. In this paper, the significance of trading on the OTC Bulletin Board, its potential to move companies into greater exchange possibilities and the fluidity of this process will be explored.
WHAT IS THE OTCBB
The OTC Bulletin Board (OTCBB) is a regulated quotation service that displays real-time quotes, last-sale prices and volume information for approximately 3,800 companies. The OTCBB has grown from a daily volume of 29MM shares with $100MM market volume since its introduction in 1990 to more than 40MM shares and $400MM market volume today. Currently the 3,800 companies are traded by nearly 300 market makers, quoting an average of 39,000 positions daily.
All Market Makers subscribing to NASDAQ Level 3 service and in compliance with SEC Rule 15c2-11 are eligible to “voluntarily” participate in the OTCBB and may enter or exit at will. A further breakdown shows 475 banks, 28 insurance companies and 3,265 companies trading; although 25% of the OTC companies have financial SIC codes.
The largest company on the OTCBB is Publix Super Markets with a $9B market cap and $15B in revenues.
Heroes, Inc., as of November 2001, was the smallest, with a $302k market cap and revenues of $6.5m.
Some 2,000 OTCBB companies have an average market cap of $1m or less. OTCBB data is now fed into more than 450,000 Level I terminals. Since 1993, all trades have been reported in real-time, and since January 1999, every company trading on the OTCBB must be a reporting entity.
On Feb. 8, 2001, the SEC approved a proposal prohibiting member firms from trading ahead of customer limit orders. The new issues market in the U. S. is the largest in the world. As such, it has various sectors that appeal to many companies unsuccessful in attracting funds from other markets and/or sources.
This is especially true of firms in high-technology industries. For example, a high-technology company in Asia often prefers to issue securities in the U.S. public markets rather than in its domestic market. There is a venue that even companies in relatively early stages of development can issue securities to the public: the Over-The-Counter Bulletin Board. Biotechnology firms and firms specializing in computers, communications, and related areas have actively participated in this market in the past few years.
Now, the attractiveness of the OTCBB market is causing momentum to build among development stage companies in other industries. Comparing the Bulletin Board with its larger NASDAQ counterparts, one can see the inherent magnetism. Although the OTCBB like NASDAQ does have real-time electronic quotes for domestic issues and does have requirements for issuers to remain listed, it is unlike the NASDAQ in the following important ways. It does not:
•
impose listing standards therefore it has no minimum quantitative listing requirements;
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assess listing and maintenance fees to issuers;
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maintain relationships with quoted issuers; and
•
have the same obligations for Market Makers. Because of these material distinctions, the OTCBB is a terrific alternative to venture capital or the traditional underwritten initial public offering of a private company.
HISTORICAL POSITION OF THE OTCBB
As good a fit as the OTCBB is for development stage companies, many issuers wonder why the technique is not more widely used. There are several reasons, chief among which are:
1. The OTCBB’s historic position among other trading platforms.
2. The pervading misconception within the corporate finance community.
3. The media focuses on sound bite size sensationalism. The OTCBB “step-child” image has led to a lack of understanding among issuers and some investors. An important reason why this venue is not more often utilized is simply a lack of education among executives about the process and its benefits. The pervading viewpoint among executives is probably that the OTC market is simply composed of the Bulletin Board and Pink Sheets, the latter still burdened with a less than sterling reputation as an obscure corner of the securities market.
This however, is not true. It’s important to realize what the over-the-counter market really is and just how prevalent it is in the mainstream investment community.
The financial definition of over-the-counter securities refers to securities, which are not
traded on an exchange. For such securities, broker/dealers negotiate directly with one another over computer networks and by phone, and the NASD monitors their activities.
The Bulletin Board is but a small part of the OTC environment; there are several components of the OTC widely used by institutions as well as individuals:
•
Pink Sheets:
A daily listing of bid and ask prices for over-the-counter stocks not included in the daily NASDAQ over-the-counter listings, published by the National Quotation Bureau and used by brokerages.
•
Forex:
An over-the-counter market where buyers and sellers conduct foreign exchange transactions.
•
Intrastate Offering:
An over-the-counter securities offering limited to investors residing within one specific state.
•
Third Market:
Over-the-counter trading of listed securities among institutional investors and broker/dealers for their own accounts, rather than as agents for investors.
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Pink Sheets, giving rise to the name “the Pink Sheet market.” The origins of the Pink Sheets go back to 1904, when the National Quotation Bureau began as a paper-based, inter-dealer quotation service linking competing market makers in OTC securities across the country. Since that time, the Pink Sheets and the Yellow Sheets (another version of same) have been a central resource for trading information in non-NASDAQ OTC stocks and bonds.
Recently, Pink Sheets has been transformed to utilize the power of the Internet and the advances in web based technology to increase the timeliness of information. In September of 1999, Pink Sheets introduced the Electronic Quotation Service, an Internet-based, real-time quotation service for OTC equities and bonds for market makers and brokers but the Pink Sheets remain outside the purview of the NASDAQ primarily because they are owned and operated by Pink Sheets LLC, a privately owned company.
The NASDAQ National Market is where the big boys, the Intels, Microsofts and Dells of the world trade.
During the first three months of 2000, the percentage of companies with 100% gains raced to over 40% (the average first-day gain was a little over 112%) and fully 16% of deals exceeded 200% gains on day one! These spectacular first day advances attracted an enormous amount of media attention. Unfortunately for the issuing companies, this type of “branding event” is arguably the most expensive marketing a company could ever endure. However, the high initial valuation doesn’t often last, a quick look at the tape now reveals that many of these “high flyers are either no longer in existence or have floundered leaving their management teams and founders with virtually worthless equity and sometime stratospheric tax bills related to options exercise strategies gone awry.
A second factor that attracts headlines is market volatility. The media loves a sound bite and it’s hard to ignore events like the more than $300 billion in wealth that evaporated during the week of April 14 due to the big board nosedive. In addition, this downturn stimulated extensive margin calls that supplied even more fodder for reporters. Although first-day runs and wide swings contribute to the notoriety of select companies, it can also produce the potential for unhappy shareholders. OTCBB companies do not have the market cap to attract the kind of attention that companies trading on exchanges do, which can be advantageous during periods of extreme volatility prevalent in today’s market environment.
Although listing on the OTCBB hasn’t been a popular strategy in the past, it probably will be more broadly utilized in the near future because of the changing dynamics of the securities business and the advent of the BBXSM .
CFOs want a high-valued currency created when share price trends upward but they also want the cash balance that a fairly priced offering provides. OTCBB listing can offer the best of both worlds.
HOW DOES THIS PROCESS WORK?
NASDAQ Listing Requirements:
For initial listing, a company must satisfy one of the following to be in compliance: the stockholders’ equity requirement, the market value of listed securities requirement or the net income requirement. Under Marketplace Rule 4200(a)(19), listed securities is defined as “securities quoted on NASDAQ or listed on a national securities exchange.” Seasoned companies (those companies already listed or quoted on another marketplace) qualifying only under market value of listed securities requirement must meet the market value of listed securities and the bid price requirements for 90 consecutive trading days prior to applying for listing.
Publicly held shares is defined as total shares outstanding less any shares held by officers, directors or beneficial owners of 10% or more.
NASDAQ Market Requirements
NASDAQ National Market
(Entry Standards) Market Alternative
Qualitative Standards:
In evaluating listing eligibility, the Exchange also considers qualitative factors such as the nature of a company’s business, market for its products, reputation of its management, historical record and pattern of growth, financial integrity, demonstrated earnings power and future outlook.
Public shareholders and public float do not include shareholders or shares held directly or indirectly by any officer, director, controlling shareholder or other concentrated (10 percent of greater) affiliated or family holdings.
AMEX Market Requirements
Registration Under the Securities Exchange Act of 1934
Full registration required Form 20-F)
THE SUCCESS OF THE OTCBB
The OTCBB is an excellent spring board for becoming a fully reporting company and is an important step towards getting on the NASDAQ SC exchange as exemplified by the number of companies that have gone from the OTCBB to listed exchanges in the past 18 months as opposed to the number of IPOs during 2003.
Until June 18, 2003 Wall Street investment bankers say they had priced either five or seven IPOs in 2003; that’s according to whom you wish to believe. With such a small number of companies going public, it’s hard to believe how the financial press and various financial reporting services can get so confused. The number is now either 6 or 8 for the year! Compare that with the number of companies moving from OTCBB to larger exchanges.
According the AMEX March 31, 2003 weekly activity report, there were 12 companies that listed on AMEX in the first quarter verses 9 in the same period last year. An astounding 75% were upgrades from the OTC Bulletin Board
The NASDAQ had 21 for the same period verses 23 the prior year, while it too had a large
percentage of OTC Bulletin Board listings showing 15 having switched verses 13 from the prior year, or a 15% increase.
The bottom line for candidates is that listing on a bigger exchange is more than ever from OTCBB source.
Additionally, the key to the success of the OTCBB as a stepping-stone to NASDAQ and AMEX is its propensity to ensure a company’s continued growth with a relatively short transition time into a larger exchange program. Here are some personal testimonies from companies who used the OTC Bulletin Board and are now trading on the NASDAQ or AMEX: I. Decorize Inc., (AMEX: DCZ) a home-furnishings importer, went public with a listing on the over-the-counter bulletin board
on July 5, 2001 -- just 16 months after CEO Jon Baker cofounded the company in his horse barn in Springfield, Mo. In December, Baker, 49, applied for the company to make the leap to the
American Stock Exchange which -- with its more rigorous listing requirements -- would increase the likelihood that investment firms like Merrill Lynch and Morgan Stanley would recommend the company’s stock to their institutional and individual clients. Three months later, on March 5 2002, Baker walked into his office and found the Amex approval letter waiting for him. “Getting on the Amex, that changes the world for us,” says Baker.
DECORIZE INC
(AMEX:DCZ) Quote data by Reuters
II. On April 29, 1999, E. David Gable’s improbable dream came true. Carnegie International Corp., a small Internet support and computer telephony holding company he took over three years earlier, graduated from the OTC Bulletin Board to a listing on the American Stock Exchange.
Gable, a former car dealer, even rang the opening bell in honor of the listing for the company he had initially run out of his attic. “This was everything I’d ever worked for,” says the 54-year-old Baltimore native. After he took over in 1996, he took Carnegie public via a so-called reverse merger with Electronic Card Acceptance Corp. (ECAC) and DAR Products Corp. two bulletin-board companies in very different businesses: credit-card transactions and grip technology.
III. Swissray International (SRYL), a Swiss digital x-ray equipment manufacturer, took only 3 months to take Swissray (initially quoted on OTCBB and moved to NASDAQ after 9 months) public via a reverse merger. Afterwards, the company placed two follow-on equity offerings, raising a total of $10 million and thus quickly recouping the initial reverse-merger. During the ensuing three years, Swissray increased its sales 3.5-fold and successfully launched a number of new products. With the total annual sales of $13.2 million, total assets of $24.4 million and equity of $6.6 million, Swissray’s market capitalization reached about $27 million. The shares became actively traded around just 6 months after the reverse merger was completed. At this favorable valuation, the average daily volume was around 2.5 million shares or $3 million. Therefore, Swissray’s entire capitalization turned around in only 9 weeks.
SWISSRAY INTL
(Other OTC:SRYI.PK) Quote data by Reuters
IV. Nutrisystem.com Inc. of Horsham, Pa., which specializes in weight loss programs, completed a reverse merger at the same time it got an infusion of $7.6 million in private money. (Its assets totaled $8.4 million.) “It was early enough in our evolution that private placement was preferable to an IPO,” said Chief Financial Officer James Brown. The stock now trades on the OTC Bulletin Board, but it moved up to the NASDAQ. The NASDAQ application and approval process took about six weeks. The company decided THIN, its new stock symbol, is in and NSCI, the old one, is out; it retained that symbol when it lost its NASDAQ listing. Brown has taken part in an IPO but says the reverse merger “definitely was easier
NUTRI/SYSTEM INC
(OTC BB:THIN.OB) Quote data by Reuters
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