Raising Cash At Shareholders’ Expense
Have you ever noticed that some people are always successful? They must have been born under a lucky star. You know ‘em. They’re the ones with the beautiful girlfriend or wife. They have perfect kids, make great money, and were just nominated by Time magazine as the person of the year. By the way they just got a promotion . . . and a big raise.
I’m sure you know the type of people I’m talking about.
For some people its luck that brings success. For others it’s hard work and skill – especially when it comes to making money in business.
Let me give you an example. In business there’s a famous saying, “He who has the gold makes the rules.” Now I have no idea who said this. I don’t even know when it was said. But this statement couldn’t be more true. In business and in investing having the gold really does allow you to make the rules. If you’re smart those rules will be in your favor.
Some people call it stacking the deck. Others call it cheating. I call it savvy negotiating.
The big money does it all the time.
I know. I saw it with my own eyes on more than one occasion. As an investment banker we would raise money for companies. Sometimes these companies needed emergency funding. If you were desperate and looking for money the investors knew it. The more dire the situation, the tougher the terms investors would cut.
These companies negotiated as best they could, but the terms were tough. I read about penalty clauses, anti-dilution provisions, ratchets, make whole agreements, and milestone payments just to name a few. You don’t need to know what each of those called for, but trust me it wasn’t good.
These terms became so common lawyers gave them a nickname – Frankenstein clauses.
The terms were like Frankenstein – ugly, ugly, ugly. I’d often see these clauses in Venture Capital financing. Then they started showing up in public financing, initially for small companies. It wasn’t long before the big money was putting these terms into financing for big companies.
Now I know what you’re thinking. “How does this impact me?”
Let me give you a perfect example. Ever hear of a big bank named Washington Mutual (WM)? Of course you have. They are one of the bigger nationwide banks. You might even have an account there. Or heaven forbid own their stock.
A few months back Washington Mutual was struggling. With all of the problems in the credit markets they were over leveraged. They needed to raise money . . . and fast.
Management went out and talked to a few people. A few days later investing giant TPG agreed to give the company a really big slug of money. A bunch of other big investors threw in money as well.
This was a good move on the part of management. They really needed the capital and their businesses practically demanded it. But there was a catch. Because Washington Mutual was desperate TPG had them over a barrel. So along with the big money TPG tossed in some big conditions.
The devil is in the details.
TPG agreed to buy notes from Washington Mutual. This is smart because if WaMu were to go bankrupt the notes get paid back first – ahead of the common stock. Now for the twist. These notes could convert into common stock at a discount. So if the stock stays flat or starts to run up, TPG can convert the notes and make money.
But that’s not all.
TPG likes to protect their investment. So they inserted another Frankenstein clause in the deal. TPG essentially invested in WaMu at $8.75 per share. But if the company raises more money below the $8.75 level TPG gets made whole.
This is a little complicated but here’s the nickel tour. If WaMu raises money at $6 (or any point below $8.75) the company would have to pay TPG. They’d have to fork over the difference between the $6 and the $8.75.
What a deal.
But wait, there’s more.
This is my favorite clause. Shareholders get to vote on the TPG deal. That’s great. But of course there’s a catch – there always is. If shareholders turn down the deal they have to pay TPG a penalty.
So any way you slice this deal TPG will make a profit. And that’s why big money always makes money.
They get to set the rules, and the rules are always in their favor. So if you own stock in a company that’s getting money from these big funds, read the deal very closely. You might not want to own that stock.
Category: Stocks
