Raising capital for an alternative energy company? Consider a Standby Equity Distribution Agreement, or SEDA

Please Take Your SEDA During this Turbulence

Richard Brand | Yorkville Advisors LLC


The 2008 election results were supposed to herald a new era of capital availability for alternative energy companies. However, the impact of the market down-draft overwhelmed the positive governmental backdrop and traditional means of raising capital remained largely unavailable to companies. Public companies engaged in conventional secondary offerings lost over one-quarter (1) of their market value during the period in which their deals were marketed. This loss of market capitalization in connection with traditional capital raises is a temporary phenomenon that exists in markets where the ability of expansion companies to raise growth capital is malfunctioning.

While these market conditions persist, many companies are relying on equity lines to raise capital. Equity line products, which are sometimes referred to as ATM (“At The Market”) Offerings or equity dribbles, have been around for decades and are especially useful to public issuers during periods of economic dislocation (such as the present). In brief, equity lines are a type of at-the-market offering in which public issuers periodically sell stock at prevailing market prices.

Companies who have recently entered into equity lines include Bank of America Corporation; Ener1, Inc.; Martin Marietta Materials, Inc.; FPL Group, Inc. (parent company of Florida Power & Light Company); KeyCorp (KeyBank’s parent); Wilmington Trust Corporation; Chesapeake Energy Corporation; Zions Bancorporation; AMR Corporation (parent of American Airlines); Continental Airlines, Inc. and Delta Air Lines, Inc. Some issuers treat equity lines like “just-in-time” inventory management, drawing off of the line “just-in-time” to meet their capital needs. This “just-in-time” approach can be used by a skillful CFO to minimize dilution. The company can sell a small amount of stock if the price is down due to economic and market conditions. As the capital is put to good use, conditions improve and trading volume in the issuer’s stock increases the issuer can subsequently sell more stock at higher prices.

Alternatively some companies consider the equity line product as a back-up plan to be available to fund project cost over-runs or needs arising from a hurricane’s impact. Other companies may utilize a SEDA opportunistically, selling modest amounts of stock when the price is elevated due to general market conditions, to investors’ flow of funds into the industry from sector rotation or to investor recognition of the specific company’s prospects.

How it works - generally
 
In an equity line, a public issuer sells, through an intermediary, new equity into the market at prevailing market prices. In a rising market, equity lines often result in equity being sold at increasing prices. The effect is less dilution than in traditional equity raises conducted at a single time and single price.

Traditional equity raises for public companies are commonly referred to as “follow-on” or secondary offerings. Such offerings are marketed by means of senior management presenting to potential buyers. Stock prices often decline during such marketing periods. Some advantages of equity lines compared to traditional equity raises are:
  • Issuers maintain control of the timing and amount of new equity sold and therefore dilution. Issuers only sell equity if they like the market price of the stock. There is generally no obligation to sell stock if the market price is insufficient.
  • Equity lines typically have a lower cost of capital as management can time the market to coincide with, for example, favorable public announcements.
  • Equity lines reduce the risk of stock price declines that often accompany traditional marketed secondary offerings. Traditional secondaries require much more advance disclosure, giving investors a chance to short stock ahead of the capital raise.
  • Equity lines minimize management time allocated to marketing new equity offerings in road shows or otherwise.
  • Equity lines reduce the uncertainty inherent in follow-on offerings that the required capital will not be raised.
 
Equity lines are not suited for all situations. For example, issuers would most likely opt for traditional follow-on offerings to raise capital to complete significant acquisitions. Equity lines are useful, however, in situations in which capital needs are somewhat predictable over a period of time. Some industries whose needs are particularly suited to equity lines are: alternative energy, natural resources, financial, healthcare, REITS, technology, and transportation.
 

How it works – some specifics
 
Equity lines are available in at least two forms. They can be identified by the efforts undertaken by the counterparty in an equity line. One type is an agency transaction. In these transactions, the contracting party acts as a “placement agent” and agrees to use its best efforts to sell an issuer’s stock to others in the public market. Many banks including Merrill, Morgan Stanley, UBS, Citi, Deutsche Bank, Cantor, Jefferies, Thomas Weisel, and Credit Suisse (First Boston) offer agency-type equity lines. The major disadvantage of these equity lines is that the contracting party is only obligated to sell the issuer’s stock on a best efforts basis. As such, the issuer may not raise the required amount of capital as and when needed.

The second type of equity line is a principal transaction. In these transactions, the contracting party is an investor acting as a principal and therefore is the buyer of the issuer’s stock. As such, the investor bears the market risk because it is obligated to purchase the stock regardless of the market demand. An important innovator of principal-type equity line is New Jersey-based hedge fund Yorkville Advisors through its form of equity line called a Standby Equity Distribution Agreement, or SEDA. This type of equity line has certain advantages, including:
  • The investor is contractually bound to buy the stock and is not merely acting as an agent on a best efforts basis. This provides issuers more certainty in raising capital that cannot be matched in an agency-type equity line.
  • The investor bears the market risk. The investor commits its own capital in the transaction and has the option to hold its investment while not relying solely on the liquidity profile of the issuer. This potentially reduces or spreads out the distribution of the issuer’s stock in the market and is less likely to add downward pressure on the stock price. A placement agent does not commit its own capital and does not take ownership risk but merely acts as a conduit to place the stock in the public market.
  • The investor may have wider distribution channels than a single placement agent because it is covered by many firms so the issuer’s stock is introduced to new investors, potentially increasing its liquidity. In contrast, a placement agent can only use its internal distribution channel and not those of other brokerage firms.
 
Conclusion
Issuers in need of raising capital should give serious consideration to equity lines. They offer advantages to traditional follow-on offerings, such as greater flexibility and a lower cost of capital. The principal-type transaction offers even more flexibility and certainty than an agency-type equity line in that the investor bears all the risk, is legally obligated to purchase the issuer’s stock, has a wider distribution network to get better execution, and certainty in raising capital. Yorkville, a main innovator of the principal transaction called the SEDA, has completed SEDA transactions in 15 countries.

1 Source: Google Finance


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