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Microcaps, Macro Goals

When David Lee took his tiny Santa Clarita solar tech company public, it was without fanfare. At a whopping 10 cents a share, BioSolar Inc. raised about $2.65 million in its 2007 initial public offering. But for Lee, there weren’t many options for his two-employee firm trying to make photovoltaic panels greener by replacing the conventional backing with bio-based materials. “There are many ways to raise money, but at that particular time, venture capital was very difficult,” he said. “Now I kind of regret going public a little bit, but it is worthwhile to keep this structure.” One major reason Lee partially regrets going public is all the extra work, and money, that goes into being listed. The costs associated with being a public company, from filings with the Securities and Exchange Commission to audits, can be more than $500,000 on an annual basis even for an over-the-counter stock like BioSolar. And once a small company is public, the shares usually aren’t traded at any serious volume nor do they garner analyst research or reporting on company prospects. The greater Valley region has about a dozen of these thinly-traded microcap firms with share prices of less than $1 operating in a variety of industries. They include Thousand Oaks energy crop developer Ceres Inc., Van Nuys blood products and services firm HemaCare Corp. and one of the world’s largest zipper company’s, Talon International Inc. of Woodland Hills. Others operate in the burgeoning marijuana industry, advertising and even inventory liquidation. And while many investors and bankers won’t touch these firms, sometimes the lure of initial financing is enough to convince management to put them on the public markets. “The reason a company goes public in a microcap situation is to have access to capital. That’s it,” said Marc Anthony Indeglia, founder and senior partner at Indeglia & Carney LLP in Los Angeles, a law firm focused on securities. “Venture capital and angel investors have high standards and want to hit home runs with every investment. They’re often just not interested in these companies.” ‘Fiscally conservative’ Another problem for microcap companies, many of which are startups seeking to develop or refine a novel technology or product, is retaining what money is raised. BioSolar was founded to work on products and materials that reduce the cost of photovoltaic solar panels. Lee claims the company’s biomaterial back sheet is less expensive and more durable. However, the company has yet to record any revenue from the technology, registering its first commercial order only about a year ago. Lee said the product was shipped and the company will record its first revenue this quarter, though he declined to state amounts or the identity of the client. In its first quarter earnings released earlier this month, BioSolar reported no revenue and a net loss of about $175,000. Lee and his partner and Chief Technology Officer Stanley B. Levy keep the firm afloat through personal investments in exchange for additional stock. The stock trades at about 25 cents a share with a volume of around 17,000 shares traded daily. BioSolar’s market cap is $2.2 million. And with limited cash on hand, about $95,000 as of March 31, the firm operates well outside the traditional norm. Lee has a small office in Santa Clarita; Levy works out of Delaware; the firm partners with a lab in Concord, N.C.; and when production is needed, the firm uses a contract manufacturer in East Hampton, Mass. “The only way to have potential future success is to be fiscally conservative,” Lee said. “We’re operating as efficiently as humanly possible.” But a company like BioSolar is only one iteration of what a penny stock looks like. Take Talon International, which was founded as the Universal Fastener Co. in 1893 making a more rudimentary version of the zipper we use today. After the company bounced around through the decades under several different ownerships, it went public in its current form in 1997. But the Woodland Hills company got hammered by the retail manufacturing industry shift to Asia. And instead of moving its operations oversees, Talon bet on a U.S. plant, which didn’t work out and left it about $22 million in debt. Talon’s shares, which had traded at more than $5 in 2005, plummeted to less than $1. In 2007, Talon was dropped from the American Stock Exchange and began trading over-the-counter. “We were basically forced to restart,” said Chief Executive Lonnie Schnell. “We’ve had a lot of investors ask why we’re still public.” But Schnell has recovery plans for the zipper maker, including a coming reverse stock split and an application for Nasdaq listing later this year. The reverse stock split would help grow the company’s stock price, as the 25 cents or so it currently trades at isn’t sufficient for listing. Talon will need to get its price up to about $4. What’s more, Talon will have to increase its trading volume and market cap. Talon trades about 28,000 shares a day and the company has a market cap of about $24 million. In its first quarter filing released last week, Talon reported a 12 percent bump in total sales compared to the first quarter last year. What’s more, net income was $17.3 million (0 cents a share) as compared to a loss of nearly $620,000 a year ago. The company attributed the turnaround to the liquidation of its Series B Preferred Stock, which increased shareholder equity and was one of the first steps toward applying for Nasdaq listing. Despite the growing top line sales, Indeglia, the securities attorney, is still unsure the company should conduct its planned reverse stock split. “A reverse stock split is an effective technique to raise the stock price, and if the other requirements are met and a company wants to ‘uplist,’ it is usually worth pursuing,” he said. “Overall, however, it is really a cosmetic adjustment to capital.” Stock currency Despite the complications, most companies that go public don’t return to a private structure. “None of them go public to stay at the small market caps,” Indeglia said. “They typically feel that they have a business that is susceptible to high rates of growth.” Another motivation to remain public is the acquisition market. Even microcaps use stock in lieu of cash to pay for some purchases, with the acquired business owner taking a bet he or she is getting in on the ground floor of what may be a big thing. GrowLife Inc., a Woodland Hills-based seller of marijuana growing supplies, issued stock last year for everything from business acquisitions to wages and salaries and even paying rent on its corporate headquarters. Earlier this year, the Securities and Exchange Commission halted trading of the stock to investigate suspicious stock transactions. It resumed trading two weeks later on April 25. And CrowdGather Inc. of Woodland Hills announced earlier this month a merger with Plaor, a Boston startup run by former Microsoft, Disney and Sony employees that develops mobile and social-media games. The merger is being financed with about $5 million in CrowdGather stock, which is trading at about 8 cents a share. The move represents a major shift for the firm, which was focused on the potential for advertising in online forums. Chief Executive Sanjay Sabnani said being public gave CrowdGather the ability to make the acquisition. (See profile page 10.) “It has given us access to capital and deals. Having public stock makes it easier to issue more,” he said. “As a private company, your stock might have value, but how do you know if you can’t really sell it? It has given us leverage.” Schnell at Talon also sees using stock for growth as a strong possibility. “Our long-term growth strategy includes roll-ups and acquisitions using stock as currency,” he said. “Bringing businesses into our fold would allow us to significantly increase revenue.” Still, Chris Kiper, managing director of Beverly Hills asset management firm Legion Partners Asset Management LLC, said he believes some managers at microcap companies just love being public executives even if there is no financial gain in it. “If you have a company with a small market cap and not a lot of shares are being traded, it doesn’t make sense,” he said. “But some management teams are just wedded to the idea of being a public company.” But that is not how Lee of BioSolar sees it. He’s searching for a way to cash out, perhaps an acquisition by a private equity firm or a larger tech company. “The only difficult thing is to choose the right time,” he said. “But you need to reach certain milestones and we’re not there yet. We’re certainly looking for our exit strategy.”

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