Standby Equity Purchase Agreements Explained
Standby Equity Purchase Agreements, often referred to simply as "Standby Equity Purchase Agreements", are financial instruments that provide a company with pre-arranged infusions of capital on demand. They essentially promise to sell a certain amount of the company’s stock to a specific investor at predetermined rates over a designated period. Companies facing the need for future capital, perhaps to backstop risky projects or shore up operational expenses, benefit from these agreements by having a dedicated source of funding. Standby Equity Purchase Agreements function broadly by allowing businesses to better manage their liquidity , ensuring that cash is available in times of need.
Once a Standby Equity Purchase Agreement is in place, investors agree to purchase, at their own discretion, shares in the public company at a discount and a fixed price. The agreement also lays out that the company will register the purchased shares at the investor’s request (possibly including a commitment that such registration occur within a specified period of time). A Standby Equity Purchase Agreement is a particularly useful financial tool for public companies looking to ensure capital raises for the future.
The Parts of Standby Equity Purchase Agreements
Standby equity purchase agreements typically contain the following key components:
The Parties
The parties to a standby equity purchase agreement typically are the purchaser and the issuer. The purchaser is often (but not always) an existing shareholder or investor in the issuer. If the issuer is a public company, the purchaser may be a fund or account associated with an activist or other institutional investor that has recently accumulated a significant position in the issuer. If the issuer is a private company, the purchaser may be a venture capital or institutional investor that has made prior investments in the issuer. Regulators may request information regarding the identity of the purchaser if the issuer is a public company and to whom the funds will be distributed if the issuer is a private company. As a result, it is important for issuers to know the identities of the investors to whom the proceeds from a standby equity purchase agreement will be paid and where those funds will ultimately go.
Purchase Price
The purchase price in a standalone standby equity purchase agreement is usually equal to the current market price of the issuer’s common stock (and typically is expressed as a combination of existing market prices and market averages over a period of time), discounted by the number of shares purchased. While the purchase price is typically fixed in a standalone standby equity purchase agreement, in a recapitalization, the price may be adjusted based on an agreed formula.
The Price Participation Right
In most situations, the price participation right is a right exercisable by the purchaser to participate in any capital that the issuer raises after the date of the standby equity purchase agreement. The price participation right is tied to the amount of capital that the issuer raises. It is not tied to the share price at which the capital is raised. Instead, it is tied to the aggregate per-share price of the newly issued capital (regardless of the number of shares issued) and the predetermined aggregate sale price of the shares subject to the standby equity purchase agreement.
The Overallotment Option
Many standby equity purchase agreements also provide for an overallotment option pursuant to which the purchaser (or other designated party) can purchase additional shares in the same offering or generally in the same terms and conditions as the original standby equity rights.
The Standby Right
The standby right entitles the purchaser to purchase the issuer’s shares at a set percentage (usually between 20% and 50%) of the aggregate cash proceeds raised by the issuer in connection with private equity placements and other transactions. The amount of cash proceeds will typically exclude any underwriting discounts/commission and other related selling expenses. The eligibility of such cash proceeds to be included in the amount of cash available for purposes of the applicable percentage will be limited by the agreement to cash proceeds received after the effective date of the related registration statement and prior to the termination date set forth in the standby equity purchase agreement.
The Eligibility of Standby Capital
The eligibility criteria for the type of offerings that are eligible for the standby right varies. In many situations, only public offerings will be eligible. In some situations, only public offerings for cash can be eligible. The availability of the standby right for private placements also varies.
Why Use Standby Equity Purchase Agreements?
The primary benefit of a standby equity purchase agreement is liquidity. It provides the ability to access the capital markets for virtually any amount. Additionally, each time share are purchased and sold in the capital markets, there will be a slight upward tick in the share price, as the company will be able to use proceeds for operating expenses which can help to reduce any financial distress the company may be facing.
Likewise, the corporation will be able to access this liquidity quickly. A standby equity purchase agreement requires no underwriting or book-running, and the agreement is put in place when liquidity is most needed. Other forms of financing generally require long due diligence periods, during which the need for liquidity may well have passed.
The visibility of a publicly traded corporation may be enhanced through the accessibility of capital by registering an at-the-market shelf registration statement with the SEC. Final sale price of the shares is susceptible to market price fluctuations, which goes both ways; prices may be too low for the corporation to sell if prices move up prior to closing, but this is desirable from the perspective of investors. This is more of a risk to smaller companies than larger ones.
A standby equity purchase agreement allows the company the flexibility to draw only what it needs, and can be drawn up to the maximum amount within the designated period of time. A company may not know in advance how much liquidity it will need for the next 20 months, nor what the state of the capital markets will be at that time. In other words, a standby equity purchase agreement allows a lower degree of specificity when drawing liquidity.
A standby equity purchase agreement allows a publicly traded corporation to draw upon a large source of liquidity at once, due to its accessible price point, with minimal conditions, while predicting with some accuracy that it will receive that liquidity once the conditions precedent are fulfilled.
Concerns and Risks
When considering whether to enter into a Standby Equity Purchase Agreement ("SEPA"), companies should be aware of a number of risks and considerations.
Market Risk
A SEPA allows a company to receive cash when it is needed, but the market for its shares may not be receptive. If the market for the shares is weak, the selling price under the SEPA may be reduced by a discount to the then-current market price. In addition, if the company’s shares are illiquid, it may only be able to sell a limited number of shares every three or four trading days, because the sale of larger amounts may drive the market price down substantially.
Dilution
Entering into a SEPA will result in some dilution to existing shareholders. The amount of dilution will depend upon the number of shares issuable, the market price of the company’s shares and the extent to which the company draws down on the SEPA. If the maximum amount of shares that can be sold under the SEPA (including any shares that need to be registered to satisfy the registration right described below) is fully drawn down, the dilution may be severe.
Regulatory
Companies that have previously completed registered offerings may be kept out of the marketplace even though the company could use cash. The SEC has regulations that limit the amount of securities that can be registered on a Form S-3 registration statement by a company that has already registered securities on a Form S-3 in the prior 12 months. SEPA’s, however, are typically registered on a Form S-3 registration statement where the S-3 is not subject to the 12-month restriction (as the registration statement is being used only for resale by selling stockholders). Accordingly, if a company has used an S-3 previously, the company can still use an S-3 registration statement to register a SEPA. In addition, if the Company is subject to the reporting requirements of the Exchange Act, the SEPA will not be integrated with another transaction such as a firm commitment underwriting, which significantly reduces SEC consideration of the the "integration" of the two transactions. Further, an investor that commits to a SEPA may not be able to condition its first capital contribution under the SEPA on the Company obtaining derivative coverage from brokers or hedge funds in an amount equal to the amount of the first capital contribution. This is due to the fact that the SEC raised concerns about investment banks entering into similar pre-offering derivative transactions that may have created pressure on the underlying stock.
Standby Equity Purchase Agreements and Alternatives
Standby equity purchase agreements offer distinct advantages and considerations when compared to other financing alternatives such as traditional bank loans, public offerings of securities, or private placements of equity or debt. The right financing choice depends on the specific needs and strategic objectives of the issuer.
For companies in the early stages of growth or facing uncertainties that make traditional lending difficult, equity-linked financing through a standby equity purchase agreement can be an attractive option. In contrast to standard equity issuances, these agreements provide greater certainty regarding pricing and volume while at the same time significantly decreasing the risk of down-round financings (see The Downside of Down Rounds).
While public offerings of equity may raise more money than a standby equity purchase agreement, these offerings typically require a fully functional business model and track record . Because equity sells at a discount to market or intraday prices, this discount creates a valuation risk that does not exist with a traditional bank loan. In addition, a registered public offering will often cause share price dilution, an outcome that companies, generally, avoid.
Unlike public offerings, private placements of equity securities are exempt from registration requirements under the Securities Act of 1934. However, the financing process can take substantially longer, and the ultimate cost of a private placement may be higher since issuers, seeking to entice investors, typically offer a larger discount to the market price. On the other hand, private placements, by nature, keep financial information regarding the issuer out of the public domain, but an issuer may find it more challenging to place securities in the current economic environment.
Laws and Regulations
Standby equity purchase agreements (SEPAs) are governed by a patchwork of federal and state securities laws, regulations, and industry best practices. One of the most prominent regulatory authorities for SEPAs is the Securities and Exchange Commission (SEC) in the United States. The SEC imposes certain securities laws compliance obligations on companies that enter into SEPAs, particularly when shares are offered and sold pursuant to the SEPA.
Examples and Analysis
The use of Standby Equity Purchase Agreements (SEPAs) has increased in recent years, as more companies, particularly those listed on public exchanges, look to these types of agreements as an alternative means of financing. In this context, several case studies and real-world examples can provide a useful insight into the practical application of these agreements.
In June 2013, Raptor Networks Technology, Inc., a publicly traded provider of cloud and mobile managed services, entered into a SEPA with two firms, Standby Equity Corporation (SEC) and Exeter Holding, LLC, each an affiliate of privately held Cornell Capital LLC. SEC agreed to invest up to $75 million in Raptor by acquiring newly issued shares of Raptor common stock. In September 2013, Raptor drew down $2 million from SEC through the issuance of 800,000 shares of common stock in accordance with its SEPA with SEC. Raptor used the proceeds from this draw down for general corporate purposes.
Investment Kinetics Corp., a publicly traded Florida Corporation, is the latest company to enter into a SEPA. The company, which provides "real time" information and data to clients in the operations and business management sectors, entered into a SEPA with Ajaxo, Inc., a closely held practice management organization. Ajaxo has agreed to purchase a total of up to $7 million in newly issued Investment Kinetics common stock, subject to a maximum purchase price of $3.00 per share. The transaction agreed to by Investment Kinetics allows for a "volume weighted average pricing" purchase option. This purchase option allows Ajaxo to buy stock at a volume weighted average price during a specified period of time. In this way, given that the market price for the common stock may vary during the specified period of time, Ajaxo may buy shares of Investment Kinetics common stock at a lower price , while the company is likely still able to secure the necessary working capital it requires. The pricing structure agreed to by the parties is unusual but not unprecedented, and demonstrates the flexibility of SEPT.
An interesting example of a foreign SPAC and SEPA can be seen in the case of Pan Asia Mining Ltd., a company incorporated in Australia, which entered into a SEPA withote Energy Inc., a Canadian exploration stage mining company, in June 2011. Pan Asia Mining agreed to purchase a total of $50 million in Titan common stock. Titan is a publicly traded company established to pursue mineral exploration and production interests in the mineral rich Água Branca Region of Brazil. The total consideration, representing 25 percent of the minimum market capitalization, was to be payable in installments. The first installment of $20 million was to occur after the closing of the reverse acquisition transaction. After the Acquisitions, Titan was a foreign private issuer and filed a Form 6-K with the SEC reporting on the SEPA agreement. Pan Asia Mining received Titan stock pursuant to the SEPA, which closed shortly after the reverse acquisition transaction. Pan Asia Mining subsequently financed its commitment under the SEPA by offering and selling Pan Asia Mining shares to institutional investors and Bachar LLC, a Singapore fund vehicle for a group of Asian investors.
While the above case studies are examples of SEPA agreements with public companies, many private companies also enter into SEPA agreements with private sources of funding. In these instances, private companies typically use the proceeds from a SEPA transaction for general corporate purposes only. However, SEOAs are often entered into by private companies in order to finance future acquisitions or wholly owned subsidiary purchases, as was the case for GEI Industrial Systems, a privately held company based in Oakville, Ontario, which secured an agreement with Shenye Technologies Inc. in August 2011 for future acquisition funding.