03 August 2015
A discounted Rights Issue can force the hand of reluctant shareholders.
This case is not unusual: we’ve been talking to a dynamic
young CEO with reluctant investors. The company in question raised some money
from angels and a VC and is facing resistance from the existing investors to
invest more, even though the company may well fail without an urgent injection
of €500k. The business is sound, but it developed more slowly than expected;
some investors are impatient and others are now outside their investment
window. Cash is so tight that the poor founder CEO has not been paid for a few
months.
Only one shareholder has expressed interest in investing
more; the others are either unwilling or unable. The shareholders have agreed
that the company is worth €5 million but, surprise surprise, no-one is actually
prepared to invest at that valuation (which of course means it’s not worth €5
million).
One option the CEO should consider is a heavily discounted
Rights Issue. Here all shareholders may invest in proportion to their holding.
Here’s what a Rights Issue would look like, to raise €500k with a valuation of
€5 million:
Here is what it looks like if, for example, if only the CEO and
Shareholder 4 take up their rights and Shareholder 4 also taking up everyone else’s:
No wonder no-one wants to reinvest at this point of crisis:
there is minimal dilution for quite a large risk.
But what about saying the company is worth just €50k? It
sounds farfetched, but if the company’s future is at risk, the company is
flirting with a zero valuation. The effect on the cap table is dramatic, with
the CEO and the investing shareholder becoming the dominant owners:
Won’t the shareholders just resist it? They may not like it,
but such a Rights Issue is hard to resist: the company demonstrably needs the
funds and all the shareholders are being treated equally.
How does the CEO find her share of the money? By converting
the debt in the form of unpaid salary into shares (tax and social security
costs will need to be found, of course).
So this would certainly get the shareholders’ attention, and
may be a route to a solution. Just be careful: a discounted Rights Issue does
not of course work if any of the shareholders have liquidation preferences.
# posted by DavidF @ 16:27 
