A hold expiration period for private placements can mean big-time selling pressure as well as potential buying opportunities
SmallCapPower | June 16, 2017: A company raises money for all kinds of purposes: growth, ‘working capital’, paying off debt/liabilities, as well as taking advantage of hot market (marijuana companies, we’re looking at you). Capital raises are great, because they show that there are intelligent investors backing a business/idea. However, the capital raised also usually comes from money managers whose sole intention is to try and make a ‘killing’ in the market.
That said, within the Canadian capital markets, when a company raises money, they tend to incentivise fund managers to participate in a raise by offering them “warrants” (warrants are given to you in addition to the shares that you are buying, as a bonus, and they entitle you to purchase additional shares of the company at some prescribed “exercise price”).
Now, savvy asset managers tend to participate in a raise, blow out the stock thereafter, and hold onto the warrants. This theoretically protects your capital, and gives you the upside if the stock appreciates in value over the next few years. However, there is just one caveat: when you participate in the raise or private placement, you have to hold the stock for a minimum of 4 months and 1 day. The regulatory bodies created this specific rule to eliminate the fluency in the exact investing strategy that we just described.
You might be somewhat confused now, but in short: every time a company raises money, fund managers and others who participated in the raise are not allowed to sell that stock for a minimum of 4 months and 1 day. Now you may ask: But what happens when the hold period expires? Short answer – big-time selling pressure. Okay, maybe not that bad, but it does create a lot of downward pressure on the stock. With the hold coming off, there is a lot more stock that is now able to trade hands, and most fund managers (as I explained) would rather sell the stock, protect their capital, and just hold on to the warrants for potential upside.
A really good recent example of this is Emblem Corp. (TSXV: EMC).
Emblem announced the closing of $15.9mm financing round on January 31, 2017, issuing 4.4 million shares as well as 2.2 million warrants. Four months and one day later is June 1st, 2017, which is the day where the hold expiry comes off, and participants in this financing can effectively begin trading that stock. The red box that we outlined in the performance chart above indicates the effect of that hold expiry.
With a hold expiry, there are three stages:
Stage 1: Investors who have shares in the stock start to pre-sell before the hold comes off, in order to hedge their risk from a big blow up in stock price due to the negative pressure of selling that is about to come.
Stage 2: Hold expiry comes off, and investors blow out the stock in the market, usually causing a large spike in volume (as can be seen by the tallest black column – this was the ~2 million shares that were sold in the market on June 1st).
Stage 3: Lastly, additional heavy trading volume persists after the hold expiry date, due to a number of factors: some investors delay their selling, some selling is spread out over a number of days, and trading persists amongst many new investors due to the large turnover of ownership.
Overall, these three stages create negative pressure on the stock price, as shown by the 30% drop in Emblem’s stock over this short period. And no, this selling wasn’t induced by any outside negative news. In fact, a couple brokerage firms even vouched for the company’s long-term potential, saying the stock is undervalued.
Now how can we, as SmallCapPower, help you, the investor, make money off of these types of trading opportunities? Well first and foremost, we are excited to announce that we will be beginning keeping tabs on private placements, and store this data (when a company does a funding round, at what price, and when this hold expiry comes off). Next, we plan to give notice to you a week or so in advance to a hold expiry coming off. Imagine you were an Emblem stock holder and had no idea there were 4.4 million shares that are about to hit the markets. You would get out of your position, wait until the dust settled, and then re-enter at a better price (if you stay put on the investment thesis that originally got you into the stock).
That said, please stay tuned for our next installments of this series, and if you have any questions, feel free to reach out to Alex Cutulenco via email at firstname.lastname@example.org.
Disclosure: Neither the author nor any of the principals at Small Cap Power, or their family members, own shares in any of the companies mentioned above.
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