New York, Oct. 10 (Bloomberg) -- Atlantic Technology
Ventures Inc. had less than a year of cash left. Rejected by
banks, the medical technology investment company turned to
Chicago-based hedge fund Fusion Capital LLC for a $6 million
credit line in exchange for discounted stock.
Atlantic Technology paid $664,000 in stock and a finder's
fee to Fusion Capital in March. It never got any money because
its shares fell 65 percent to below a minimum specified in the
loan agreement. They were removed from trading on the Nasdaq
Stock Market in August.
The loan, known as an equity credit line, is an
increasingly prevalent form of finance for desperate
businesses. Sales of equity and junk bonds have slumped and
banks curbed lending as loans at risk of default almost
doubled last year to $192.8 billion. Critics say the credit
lines drive borrowers deeper into the hole and securities
regulators say the risks are sometimes not fully disclosed.
Investors say the transactions attract short sellers who push
down the shares.
``This was a real trial by fire in the harsh aspects of
corporate finance,'' Atlantic Technology Chief Executive
Frederic Zotos said. ``I wouldn't recommend them unless you
really know what you're doing.''
The loans, pioneered in the last two years by hedge funds
and used by some investment banks including Societe Generale
and CIBC World Markets, give the lenders quick up-front fees.
Lenders can also profit by selling short, or betting against,
the stock of a company that wants to tap its equity line, then
using the shares it receives at a discount to profit from the
The loans are the latest manifestation of so-called ``death
spiral loans'' that are structured by investors to profit by
driving down a company's stock through short sales.
``It's like jumping in a pool of sharks,'' said John
Nelson, a portfolio manager for the Wisconsin Investment
Board, the 10th- largest U.S. public pension fund with $67
billion in assets. Nelson warns companies it invests in
against equity lines.
The loans continue to gain in popularity as typical sources
of capital for risky businesses -- stock and junk-bond sales
and bank loans -- dry up, especially after the Sept. 11
With just 64 initial public stock offerings have been
completed this year, the U.S. is on track for its worst year
in at least a decade. There have been three junk-bond sales
since Sept. 11 as the default rate reached a 10-year high.
Conversely, in 2000, there were 136 equity line loans
totaling about $538 million, from 11 equity lines for $35
million in 1999, according to PlacementTracker.com. Through
Sept. 24 of this year, 115 equity lines were issued and
companies received $386 million.
New York-based Acqua Wellington Asset Management and its
affiliates are the largest issuers of equity lines. Acqua
funds arranged $198 million in loans for at least 24 companies
the past two years, according to PlacementTracker.com, a
database compiled by DirectPlacement Inc., a San Diego
Some investors oppose the loans, and in at least one case,
blocked loans by CIBC World Markets to DMC Stratex Inc., a
maker of wireless-networking products. USInternetworking Inc.
and Leap Wireless International Inc. were forced by regulators
to restructure loans from Acqua Wellington.
``We warn (companies) against doing equity lines or other
financings which we consider to be toxic,'' said the Wisconsin
Investment Board's Nelson. ``They attract shorts, and they
also repel savvy buyers who know what this type of instrument
can do to these stocks.''
On average, companies have received only 15 percent of
announced lines, after paying hundreds of thousands of dollars
in fees, PlacementTracker.com data shows. Some loan agreements
contain provisions that prohibit companies from accessing the
line if their stock drops. Other companies find that not
enough of their shares trade daily to enable them to tap much
of the line.
Lenders deny that they are investing for short-term
profits. They say they are investing in companies whose
prospects they say are bright.
``I'm not telling you every share is held forever, but when
we take an investment our intent isn't flipping it,'' said
Acqua Chief Investment Officer Isser Elishis, who formed the
fund in January 2000 after leaving Hong Kong Shanghai Banking
While the Sept. 11 terrorist attacks curbed junk-bond sales
and bank lending amid concern the economy is tipping into
recession, they have had little effect on the market for
equity credit lines. At least four companies announced
agreements since the attacks.
Cornell Capital Management, which was based in the World
Trade Center, provided a $20 million equity line to
Continental Energy Corp. even after Cornell's offices were
destroyed, Continental Chief Executive Gary Schell said.
Schell said he finalized the loan in cell phone calls with
Cornell banker Robert Farrell. Cornell did not respond to
messages seeking comment.
In a typical equity line, the company and the issuer
negotiate a maximum amount the company can borrow. The
companies tap the lines at their discretion. In return, the
lender buys the shares at a discount of between 5 and 10
percent to the stock's current price.
Critics say that the investors begin shorting the company's
stock when notified that the company wants to tap the line. In
a short sale, an investor borrows shares and sells them in a
bet the stock will drop and can be repurchased for a profit.
In equity lines, the investors use the discounted shares they
receive from the company to repay the shorted stock.
``We are concerned that these hedge funds may be acting as
an underwriter, getting securities at a discount with the
intention of flipping them, generally pretty quickly and in
large blocks,'' said Michael McAlevey, the deputy director of
corporation finance at the SEC.
The SEC in March tightened rules governing how the loans
are issued, and the agency has forced at least three
transactions to be restructured. Regulators questioned whether
the companies were adequately capitalized to complete the
borrowings, and they forced the loan sizes to be reduced. They
also compelled the lenders to assume liability if they
misrepresented the investment when they resold the stock.
``As a shareholder or a bondholder, this is not the
financing you'd like to see,'' said Dmitry Khaykin, a
telecommunications analyst with Gabelli Asset Management Co.,
a mutual fund family with $25.6 billion under management.