The insiders guide to uplisting from OTC to Nasdaq/NYSE
September 21, 2023
We’ve already covered one of Wall Street’s favorite financing formats – Private Investments in Public Equities (or “PIPE”) – which produce “abnormal returns” of ~19%, and probably do so at the expense of the Issuer and other common shareholders…
We’ve talked about what we refer to as the Retail PIPE + Uplisting Strategy – designed to both, provide capital to the company to pursue corporate milestones, as well as build a stock that has sustained trading volume.
We’ve also talked at about how Regulation A+ can be used to construct the actual financing vehicle that allows retail investors to participate in this normally “Insiders Only” investment…
But what we haven’t talked much about are some of the mechanics behind how the different stock exchanges work…
The requirements to move up from the Over-The-Counter or ‘OTC’ markets to the Nasdaq or New York Stock Exchanges…
And some of the cost considerations that can influence strategy along the way.
That’s the topic of today’s issue of Private Capital Insider.
-Jake Hoffberg
P.S. This issue will serve as “Part 1” of this series on uplisting. Today, we’ll talk more nuts-and-bolts about how the stock market works, the cost behind going (and staying) public, and why companies may want to uplist.
This Saturday, the Weekend Edition will dive into some of the trends and data I’ve been digging into about the performance of uplisted stocks, post uplisting.
As usual, be sure to send in any questions you have about the article’s content, and I’ll answer those in a future newsletter.
P.P.S. As you may already know, Nevada Canyon Gold – a small, publicly traded gold royalty and streaming company – is raising capital via a Regulation A+ offering (i.e., a Retail PIPE).
Their offering closes on Wednesday, Sept 27th @ midnight EST. If you’re interested in learning more about the company, go here to read their offering page.
As usual, any investments in Regulation A+ securities should be considered high risk and speculative in nature. Please do not invest funds you need immediate access to, or cannot afford to lose.
A Brief Introduction to How the Stock Market ACTUALLY Works
I think it’s safe to say that a large percentage of our readers – and people who are investing in private companies in general – are interested in the answer to one question…
“When are you going public?”
Which, in reality, may be an extension of a different question, ”When can I sell?”
Statistically speaking, it is more likely that such a company will be acquired, than it is to go public…
It’s important to understand how the whole “going public” thing works, if that’s what you’re hoping to participate in.
This means knowing the requirements for going public and staying public!
But here’s the weird thing about the majority of investors I’ve talked to, who want to know when their investment is going public…
The stock market is not some non-profit infrastructure run by magic elves where you can cash out your shares.
In reality, the “stock market” is a broad term used to describe a variety of different trading venues (ie Exchanges) where investors can go to buy and sell different securities.
For investors, getting access to these trading venues is as simple as opening up an account with a broker who has access to that venue.
Once upon a time, these venues were the “Open Outcry” trading floors you’ve seen in movies where people are shouting “Buy! Sell!” with fistfuls of tickets…
Source: Wikipedia, Public Domain
But today, pretty much everything is handled electronically, or by phone.
In order to get access to that venue directly, you would typically need to become a Member of that exchange.
Members and member firms are regulated by the Financial Industry Regulatory Authority (FINRA), whereas the exchanges themselves are regulated by the Securities and Exchange Commission (SEC)
Owning an exchange membership was once a matter of prestige – and still is to a lesser degree – as it indicated financial power, wealth, and influence.
Being an exchange member meant that you were either a floor broker or trader, who could directly buy and sell securities listed on the exchange.
It also came with the responsibility of maintaining order on the exchange’s trading floor, by providing both buy prices and sell prices (called a “Market Maker”).
A market maker refers to a financial entity that performs transactions, and ensures there is liquidity in the market. The market maker exchanges securities for their own account (principal trade) or their customer’s account (agency trade).
However, just like any other “network effects” business, the more buyers and sellers that participate in each venue…
The easier it is to match buy orders (the “bid”) and sell orders (the “ask”) at the price people want to pay…
And the more likely it is that more buyers and sellers will want to participate in that market (called “market participants”).
This increase in volume or “liquidity” has the benefit of decreasing the space, or “spread”, between the bid price (buyers) and the asking price (sellers). Without getting too technical, when this spread distance decreases, it draws more parties to the table and generates more interest in the stock itself, which may lead to better price appreciation over the long run.
This, in a nutshell, is the primary purpose of ANY market – bringing together market participants to facilitate transactions.
But what types of securities are market participants allowed to trade?
Only the securities of companies (or fund managers) who’ve paid the exchange a listing fee, of course!
We’ll ignore this obvious conflict of interest when an intermediary has perverse incentives to increase trading activity (cough, ROBINHOOD, cough).
But for now, let’s just focus on the fact that if a company wants to go public, they have a variety of different venues – each with their own listing requirements, costs, and rules – to choose from.
These rules can include how long the company has existed, how many shares are held publicly, how many shareholders the company has, and how much net income the company reports.
For example: In order to pursue a public listing on the lowest listing tier of Nasdaq or the NYSE – the Nasdaq Capital Market and the NYSE American – the company needs at a minimum between 300 – 800 shareholders and ~$4m-5m in stockholder equity (depending on what criteria is used).
Source: Nasdaq
Source: NYSE
At the same time, each exchange must follow rules set by a larger governing body—in the United States, that would be the SEC.
In the U.S., the stock market can be largely divided into two categories: Senior Exchanges – like the New York Stock Exchange and Nasdaq – to Over The Counter (OTC) markets.
In turn, this dynamic often creates what is called Liquidity Risk – a seller may be willing to sell, but there might not be any buyers willing to buy (or buy at the price they want to sell), and therefore a large spread.
While both the NYSE and Nasdaq are considered Senior Exchanges, there are a few key differences that investors should be aware of.
The NYSE is an Auction Market, while the Nasdaq is a Dealer Market.
In an auction market, buyers and sellers come together to publicly announce their bid and ask prices through open outcry or electronic systems.
This allows for price discovery based on supply and demand dynamics in a transparent environment, with prices largely determined by the market participants themselves (known as an order driven market).
Also, the NYSE still has actual humans on the trading floor, whereas the Nasdaq is fully electronic.
In a dealer market, participants buy and sell securities through intermediaries called “dealers.”
The dealers maintain an inventory of securities and stand ready to buy or sell them to or for clients from their own account at whatever price they want (known as a quote driven market).
Source: Corporate Finance Institute
If you’ve ever been to a car dealership where they have a buy (or trade-in) price and sell price, it’s kinda like that.
To make a long, technical, and complicated story about how the stock market works, short… larger companies seeking to go public will typically choose between the NYSE and Nasdaq.
Why would a company choose one over the other?
Most often, the answer is a combination of price, minimum listing requirements, and status/prestige.
At first glance, the listing fees for going public might not sound like a lot…
But once you factor in all the costs associated with going public – most notably, underwriting, accounting, and legal – it gets expensive.
Underwriting makes up the largest component of IPO costs, by far. This includes fees associated with an investment bank that underwrites the stock and helps bring the company public. These fees generally amount to 4% to 7% of the gross proceeds of the IPO.
Accounting covers a wide variety of expenses, and falls into two main categories: external auditor fees and financial reporting advisor fees. Costs increase significantly for larger companies that may face additional complexities in preparing for an IPO.
Source: PWC
Legal includes fees from the securities counsel to draft the registration statement and prospectus, and provide other advice directly related to the offering.
Legal costs may also include the fee for the underwriters counsel to undertake legal due diligence during the offering process, and subsequently review the registration statement and prospectus.
The road to becoming a public company can be long and costly. In PwC’s recent survey of US firms that have gone public in the last several years, almost 83% of CFOs participating in the survey indicated that their firms spent more than $1 million on one-time costs associated with the initial public offering.
To make things worse, CFOs often underestimate the ongoing costs associated with being a public company.
Source: PWC
Two-thirds of the CFOs surveyed estimated spending between $1.0-$1.9 million annually on the costs of being public, while one out of 10 estimated spending more than $2 million.
Originally, “over the counter” referred to any trading that happened “off exchange,” directly between two parties, with little to no regulatory oversight to speak of.
Historically, these stocks were listed on pink sheets of paper posted at dealer network trading desks, which is why they are still occasionally referred to as “pink sheets” or just “pink”.
Source: The Tokenist
Today, the OTC Markets are home to more than 10,000 companies – both domestic and foreign – who want to get access to the U.S. capital markets for a significantly lower cost than a Senior Exchange, and with substantially fewer reporting and disclosure requirements.
Today, over the counter markets – which are largely managed by a company called OTC Markets Group – are regulated by the SEC and trade on an Alternative Trading System (or “ATS”) called OTC Link.
On one hand, these loosely regulated markets provide an opportunity for companies who do not meet the listing requirements of larger exchanges, to provide liquidity for their shareholders…
On the other hand, because there is a severe lack of reporting and disclosure requirements in PINKS-listed stocks, and to some extent, those listed on the OTCQB, there is a lot more risk in these types of transactions for buyers and sellers.
In turn, this creates what is commonly referred to as Liquidity Risk – while there may be a willing seller, there may not be a willing buyer (or at least not at the desired price), and vice-versa.
Researchers have found that this illiquidity of small company public stocks – sometimes called penny stocks – has driven large investment funds away from them since the late 1990s.
This creates a rather substantial problem as small public companies typically need to continue raising capital.
Today, nearly 80% of U.S. public companies have market capitalizations below $500 million, and the vast majority of them periodically require infusions of outside capital to fuel growth, to the tune of $25 billion to $50 billion per year in aggregate!
However, if companies don’t have enough trading volume, they likely won’t be able to raise capital on attractive terms.
Irrespective of whether they like your company and believe it’s a good value, most institutional investors are mathematically [reluctant] from buying stocks in the open market that don’t trade a few hundred thousand dollars of stock per day.
For example, if an investor has minimum position sizes of $1 million, and will characteristically not take more than 20 trading days to build such a position, then they need to buy an average of $50,000 of your stock per day.
But investors can rarely be more than 15 – 20 percent of the daily dollar volume without pushing up the price of the stock.
Accordingly, if a stock doesn’t trade $250,000+ per day, the fund would be functionally excluded from buying the stock.
Conversely, if an investor has to sell a large amount of shares where there are few buyers, it is going to drive the price down and hurt the profit margin, and potentially end up being a loss.
Furthermore, should a stock lack sufficient trading volume, analysts have no incentive to provide coverage of the stock; equity analysts are compensated, in large part, through transaction fees generated by research clients executing trades through their desk.
And this, in a nutshell, creates what we call…
The Small Cap Death Zone
This brings us to one of the most important questions public companies will likely have to face…
How do Issuers not only build their business… but also build a stock that people want to own and trade?
One answer is simple: get more analyst coverage.
In fact, the necessity to attract analyst coverage has traditionally been one of the key hurdles for private companies considering a move to the public markets.
Less coverage means a smaller pool of investors will even consider the stock, both in the lead-up to the IPO, and once the company is public.
The average level of coverage decreases from around 10 analysts for the largest companies in the index to just two analysts for the smallest companies.
Research shows that 60% of the 1,171 companies with market capitalization below $100 million listed on Senior Exchanges receive no analyst coverage!
It also suggests that a lack of coverage corresponds to lower stock liquidity…
Which, in turn, continues to put pressure on small public companies looking for financing.
The problem only gets worse for companies NOT listed on a major U.S. exchange (like the Nasdaq and NYSE), and instead, trading OTC. This is true for several reasons:
- Lower Visibility: OTC-listed companies typically do not have the same level of visibility or recognition as those listed on more prominent exchanges, (again, such as the NYSE or the Nasdaq).
- Lack of Financial Information: OTC-listed companies are often not required to disclose as much financial information as companies listed on larger exchanges. This makes it more difficult for analysts to conduct in-depth financial analyses and forecasting.
- Lower Trading Volumes: Many OTC-listed companies have lower trading volumes, which can make their stock prices more volatile and potentially riskier to invest in. This can deter analysts, who typically focus on companies with very broad investor bases.
- Size of the Company: Many OTC-listed companies are often quite small, may not have reached profitability, and thus, may not generate the same level of interest as larger, exchange-listed companies.
Analysts, particularly those at larger firms, often focus on larger companies with more significant market capitalizations.
- Regulatory Oversight: Companies listed on major exchanges are subject to strict regulatory oversight, which can provide analysts and investors with more confidence in their financial reports. Most OTC-listed companies do not face the same level of scrutiny, which can deter analyst coverage.
- Limited Institutional Interest: Given the above factors, many institutional investors, such as mutual funds and pension funds, often avoid investing in OTC-listed companies. As a result, analysts, whose work often caters to these institutional investors, may be less likely to cover these companies.
Added to those reasons, we also note that many, if not most institutional investors, cannot participate in lower-priced stock due to how their charters are written.
In many cases, they have strict limitations regarding the minimum share price the company is trading at. These prices can vary, but usually breakpoints of nothing under $5, though some are higher, and in the $10 – $15 range.
Additionally, with many OTC-listed companies, and even some smaller Nasdaq and NYSE listings, we find another issue – not enough float!
Floating stock is the number of public shares a company has available for trading on the open market. It’s not the total shares a company offers, as it excludes closely held and restricted stocks.
A stock’s float just tells you how many shares can be bought or sold at the present time
In these cases, the minimum buy-in appetite of an institutional account can be far greater than the float would reasonably allow.
Even if there was sufficient float, a large order can cause significant volatility in the price of the stock.
In this regard, we might picture stepping in a puddle, which would cause the water (stock price) to immediately – and artificially – rocket sharply upward.
But eventually, gravity takes hold and the water comes crashing back down.
In the stock market, “gravity” is trading volume. Should the stock price be significantly driven up, that doesn’t mean there is a market participant willing to buy at that price.
As the law of supply and demand dictates, this means the stock will simply drop right back down again. This can create a disorderly market – something regulators rightly frown upon.
Without getting into too much detail, this type of scenario can push a market maker into issues with dominance and control – a very bad situation.
So, we find that as most institutional-sized accounts cannot trade in these smaller issues, analysts associated with the larger broker dealers have no rationale to cover these companies.
And while independent analysts can and certainly do cover select OTC-traded (and smaller Nasdaq- and NYSE-traded) companies, they usually do not do so unless for a fee.
Finally, this brings us to point out that sometimes these small “orphaned” stocks may potentially offer solid investment opportunities for the retail investor…
That is, if the investor were willing to perform their own research.
As well, if that investor were willing to accumulate shares over a longer period of time, perhaps weeks or months.
For this reason, OTC-listed companies may decide to “Uplist” to a Senior Exchange to get access to (potentially) more analyst coverage, more trading volume, and cheaper costs of capital
Uplisting a stock from the OTC to a Senior Exchange is relatively straightforward. You just need to meet the listing requirements of the exchange you want to uplist to and pay the associated fees.
However, as part of this uplisting process, it also means the company will likely need to build out its Governance functions to maintain ongoing compliance requirements – especially around the audit committee, compensation committee, and board of directors.
But to be clear, uplisting a stock from the OTC to a Senior Exchange doesn’t magically create analyst coverage, build sustainable trading volume, and unlock capital all on its own.
Just like any other product or service, the stock needs to be marketed to the right audience in the right way.
For small public companies, this overwhelmingly means retail investors. And for better or worse, building a retail investor base often comes down to storytelling.
One of the anomalies of the small-cap ecosystem is that you can have two similar companies with similar products and financial metrics, yet one of them trades $75,000 of stock per day and the other trades $1 million of stock per day.
More times than not, the more liquid company is simply better at storytelling.
There is an old adage that “Investors don’t buy small-cap stocks… you have to sell it to them.”
Selling small-cap stock, particularly to retail investors, is about accurate, efficacious storytelling.
But like many things in life, there is no shortcut to building sustainable trading volume in a stock.
Instead, it often comes down to rather simple business principles – develop a track record of consistently achieving your forecasts on time and on (or under) budget.
While we won’t go into the nitty gritty details on how the investor relations industry works in this issue…
At Equifund, we see the Regulation A+ Retail PIPE as a promising mechanism to accomplishing these objectives.
