It’s an effective and inexpensive method of raising funds that, if used wisely, can help bridge a cash crunch. But there are risks for retail investors on whom the shares could ultimately be taxed.
These deals tend to be arranged by relatively unknown hedge funds, rather than top-notch investment banks, and the funds have the right to resell the shares immediately, if they wish. Receiving this kind of funding is not necessarily an endorsement of a company’s long-term financial health: at least half a dozen recent ELOC recipients have warned of their ability to stay in business, including “smart window” maker View Inc., flying taxi company Lilium NV and electric vehicle maker Lordstown Motors Corp.
ELOCs – sometimes called committed capital facilities or reserve capital purchase agreements – have exploded in popularity over the past 12 months, mainly because many greenfield public companies have less cash than they expected and little other options to raise more.
Investors in SPACs are asking for their money rather than funding mergers, while the extra institutional money that once supported blank check deals, known as private investment in public stocks, 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. It is difficult to raise equity on a regular basis via a subscribed offer due to the scarcity of institutional demand.
Companies that have been subject to SEC financial reporting requirements for more than a year might be able to bid on the market, the fancy name to inject stock into the market via a sales agent. SPAC-listed electric vehicle makers Canoo Inc. and Arrival SA 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 histories as public companies. The beneficiary obtains the right to “put” new shares to an investor whenever they wish over a period of approximately three years, at a slight discount to the recent average market price, often 3%. In return, the investor earns the spread, plus a small upfront commission. For emergency financing, the cost of capital is quite low. The company also does not 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 traded cannot exceed an agreed daily limit, and the total total sold cannot exceed 20% of outstanding equity 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.
A big advantage for the company is that it can quietly dribble shares into the market rather than selling a lot of shares at one time at a fixed price. It can therefore take advantage of periods of improving market sentiment, as has happened recently with the rally in stock markets and the resurgence of meme stocks. Investor Michael Burry, of ‘The Big Short’ fame, has warned that “the stupidity is back”. But silly markets are great if you have an ELOC.
Of course, the downside is that many old SPACs are still trading at depressed levels and so stock sales are very dilutive. If their share price continues to decline, a company could become unable to access its full ELOC without breaching the 20% cap.
ELOCs are often provided by little-known investment funds, rather than large investment banks. While it’s true that these clients are often small fry, another explanation for Wall Street’s reluctance could be that ELOC investors are considered “underwriters” under securities law. Investment banks have been reluctant to take legal responsibility for SPACs.
A New Jersey hedge fund has been particularly active in this market. By my count, Yorkville Advisors Global has arranged a dozen such deals, 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 builder Nikola Corp. and cybersecurity firm IronNet Inc. Major financial institutions are beginning to spot a financial opportunity, however, with Cantor Fitzgerald LP and B. Riley Financial Inc. frequently implicated in such deals.
Ordinary investors should not lose sight of financial fundamentals. In announcing a $100 million committed equity facility last week, loss-making smart glass maker View — whose SPAC deal I rudely described as one of the worst ever — warned against substantial doubt as to 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 tough financial situation. But that might only serve to delay the inevitable financial toll – at which point retail investors might end up with the bag.
More from Bloomberg Opinion:
• Lordstown Motors Sells Stock: Matt Levine
• Why a $33 billion SPAC deal couldn’t pay its bankers: Chris Bryant
• Tiger Global’s Judgment Day May Never Happen: Shuli Ren
This column does not necessarily reflect the opinion of the Editorial Board or of 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.
More stories like this are available at bloomberg.com/opinion