Dow deva: this is the one

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There are in today's financial world many new and exciting products outside of the giant brokerages and traditional buy-sell relationships. These have been growing in popularity over the last few years, helped along especially by the dot.com bubble burst and the more erratic nature of the market in recent years.

I have been involved in two types of transactions that have touched on these products. One is a Structured Equity Line of Credit for a company, and the other is a non-recourse stock loan with an annuity feature. The company I did these with was HedgeLender (www.hedgelender.com) and Emerging Money Corporation (www.emergingmoney.com).

Basically, with the Structured Equity Line of Credit (ELOC), the company needed financing to the tune of US$8 million for modernization of an aluminum factory. The company (I will not give ticker publicly as we are not allowed to do so) was listed on NASDAQ and shares sold for about US$4.00 per share. The average 22 day volume was about 500,000.

The ELOC provides financing at 90% of average lowest traded price during the previous 22-day period. This stock was fairly stable so we financed at 90% X $4.50 = $4.05. The financing is for 200% of the average 22-day volume, thus, 500,000 X 2 = 1,000,000. They needed US$8 million, and we could thus do that in two weeks, with one million shares per week.

The choices we had were to either require the company to issue 2 million newly registered shares, or to have an insider or other large stock holder(s) pool their shares and utilize them in the same way. In this case, the company wanted to preserve the current ratio of ownership and so they issued 2 million shares new, which was only about 4 percent of total float.

The system was simple: A very clearly written contract was sent to them, which included Commitment Fees to be deducted from first drawdown, of 3 percent of total funding, or $240,000 dollars. Once signed, the client issued a Put notice for the first one million shares by Monday morning (9AM). Settlement occurred on Friday (we offered a Wednesday settlement too, at 120 percent, but they wanted to do this in two pieces rather than 3-4). Stocks moved and cash at 90% of $4.05 was exchanged simultaneously, broker-to-broker. This was repeated the next week, and the funding was completed.

The contract included a "3 percent trigger" -- basically a proviso that if the stock's price declined over the previous week's lowest traded average price by 3 percent or more, the investor would have the option of taking few shares. This was designed to ensure that if some outside shareholder got wind of the ELOC and for some reason panicked and started dumping shares, that our activity could be adjusted a bit to help stabilize price. (Since I began brokering these, I have never had that experience, but its a nice safety feature to have). As the Investor unwinds the stocks over a long period of time, he doesn't not take any kind of ownership role in the company, and this has allowed not only the ownership ratios to remain, but also the size of the transactions to be much larger than would normally occur during a private placement (the investor we use is former VP of First Union Securities in charge of multibillion unrolls and stock investment portfolios... so he's a true pro at this).

Now, is there a downside? Well, there are always SOME risks. The main one is that if we do this using one insider's stock, there is always the danger that some politics between insiders will throw a monkey wrench into things and cause the stock price to plummet. It has never happened to me with this investor, but I understand a company in Asia not long ago had a running feud going between two brothers, both large shareholders of a company, and that they had agreed never to pledge or sell their stock without consulting the other; one apparently did undertake a stock loan with Morgan Stanley, and the other "got revenge" by dumping every last share they had, tanking the stock. Thus, I do not recommend this type of financing if the source of the stocks is an insider's portfolio. But this problem does not exist if a new issue of registered shares is used. This is the only caution I have on this and having done 32 of these over the past two years, I can say that for those companies needing a low-profile means to raise cash in private placement configuration, it works very well.

The other type of financing that fits the "non-affiliated" broker profile is the hedge loan. I use HedgeLender/Emerging Money Corporation (see above) but I heard there are some other good ones out there too, so look around. Basically, these are for individual stock owners and they can go to a portfolio as small as US$100,000. Stocks need to trade at least at the US$3 a share rate with an averag 22-day volume of at least 100,000 (same with ELOCs above). The proceeds of the loan can be put into an annuities product customized to cut taxes or produce income while preserving asset value.

Basically, hedge loan gives the borrower 90% of the value of his portfolio today. In exchange, the client receives two things: 1) Full upside protection, so that if his portfolio rises in value, after the loan is paid off at maturity he (the borrower) receives the full profit and 2) Freedom to walk away from repayment if the portfolio value falls at loan maturity (what is known as "non-recourse to lender" or "non-recourse" loans). The ones I do come in terms of as few as 2 years up to 20 years, with no interest or principal payment due until loan maturity date. Interest is competitive, but the effective interest can be brought down to as low as 3 percent because all dividends are credited against interest.

For my clients who want income or tax reduction, I propose the Stock to Cash program of Emerging Money because they have the largest number of top-line insurance company affiliates and can work the best deal for my clients. I just finished a US$4 million deal for an elderly couple owning Motorola and Intel, who were worried that their stock assets would be cut in half when the old man passed away under death tax rules. And they needed income for his wife if she survived him while preserving the portfolio for the kids. We were able to do it all -- the non-recourse loan, which allows the client and his descendants to get the portfolio back if they pay it off, allowed us to craft a produce where the wife had an annuity stream and the grandkids had a large portfolio of stocks that would be theirs when the annuity was cashed at wife's death and the proceeds used to pay off the hedge loan. Amazing.

Anyway, those are two of my experiences as a non-affiliated broker and RIA. I am open and welcome any comments, thoughts, discussions, etc. on my experience or on related experiences. I think that for stock owners, these types of innovative financial tools are the way the future is going.

Regards,

Bonzo