To Will Mullin's way of thinking, his company's high-frequency portable scanner is technological silly putty. "Everyone who comes in contact with our product envisions a new use for it," says the 31-year-old president of Swarthmore, Pennsylvania-based Longport Inc.
Initially, Mullin says, Longport developed its scanner in the early 1990s for the wound-care market. "The underlying technology gave us several competitive advantages," says Mullin. "For instance, with a 20 MHz frequency, we were able to scan much clearer images than were possible at lower ends of the spectrum." Unlike the ultrasound technology used in obstetrics and gynecology, Mullin adds, Longport's device is portable and digital, meaning the equipment can be taken to the patients and the images can be sent via e-mail to achieve true telemedicine.
These attributes have created excitement beyond Longport's initial target market. Oncologists have used the scanner to measure the effects of radiology treatments on cancer patients. Sports medicine professionals want scanners on the field, and veterinarians see uses in barns, paddocks and pens.
After several years of development and one lawsuit, Longport finally began rolling out products in October. Because of limited marketing resources, the company's initial focus is on the wound-management market. But investors who bet on the company when it sold shares in a private placement in late 1993 and then began trading on the Over-The-Counter (OTC) Bulletin Board in 1994, have enjoyed pretty good returns. Initially traded at 35 cents per share, Longport's common stock has climbed to a price of about $3. Based on fundamentals such as future sales, Jim McGonigle, Longport's founder and CEO, thinks the company can eventually be a $50 stock...perhaps.
McGonigle's doubt stems not from the potential of the product or its markets but from Longport's trading venue, the OTC Bulletin Board. "Initially," says McGonigle, "I wanted to go all the way on the Bulletin Board, to blaze a trail for others and to show it could be done. But now I'm not so sure we can pull it off."
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Tiers For Fears
McGonigle's quandary raises a good question for others considering public ownership: Should you wait until you meet the requirements of the Nasdaq's so-called SmallCap Market or National Market System before going public? Or can you survive and prosper on the OTC Bulletin Board?
The answer is that the Bulletin Board might be an ideal proving ground, but ultimately, entrepreneurs who want to create an embarrassing horde of riches will have to move up in the world.
To understand why this is so, entrepreneurs must first understand a little bit more about the structure of the Over-The-Counter market. In general, it's divided into four tiers. The first three tiers--the Nasdaq National Market, the Nasdaq SmallCap Market and the OTC Bulletin Board--have automated quotation (the "aq" in Nasdaq) and execution systems that are owned and operated by The Nasdaq Stock Market Inc. Nasdaq, in turn, is owned by the National Association of Securities Dealers Inc. (NASD), which is the self-regulating body established by the securities industry to avoid direct regulation by the feds. Got that? (The fourth tier of the Over-The-Counter market has no automated distribution of quotes, and trading information for companies that trade at that level can be found only in a publication known as the Pink Sheets, giving rise to the name "the Pink Sheet market.")
The Nasdaq National Market is where the Intels, Microsofts and Ciscos of the world trade. The SmallCap market attracts up-and-comers--all of whom are grooming themselves to move up to the Nasdaq National Market. The OTC Bulletin Board was formed in 1990 to give companies that could not trade on the SmallCap Market or the National Market (because of their size or because their shares were not registered under certain U.S. Securities and Exchange Commission laws) a market to trade on with automated quotation, trading and visibility among investors, according to Nasdaq's Wayne Lee.
It shouldn't be surprising that the major brokerage firms focus most of their attention on the upper tiers of the OTC market. This reality creates significant challenges for the denizens of the lower tiers, as described below.
Perks Of Being Public
It was the OTC Bulletin Board trading venue that Longport ascended to in 1994, having completed a private offering of shares the year before. In several ways, trading on the OTC Bulletin Board accounts for the success, past and future, of Longport.
"Being public and offering investors some form of liquidity or exit strategy played a big role in our ability to raise additional funds and commercialize our technology," says McGonigle. He estimates that Longport has raised an additional $4 million since the company's first offering in 1993. Some of this fund-raising has been plain vanilla, such as the sale of additional shares of common stock to new investors. Many companies are able to accomplish this because they price the common stock they are selling privately at a slight discount to the prevailing prices in the public market, thus enticing potential new investors with an immediate gain.
In addition, Longport has been able to enjoy a fairly robust valuation. With 17.5 million shares outstanding at a prevailing price of $3 per share, Longport is valued at more than $52 million--not bad for a development-stage company with four employees. And of course the stakes owned by Longport employees have made them wealthy, at least on paper, and perhaps someday for real.
Another benefit to Longport being public is that the company already has its exit strategy in place--meaning a way for investors and founders to cash out if the company succeeds. Many companies face the real risk of building a successful enterprise and then having the market melt down on them when they decide to go public, scuttling their dreams for public ownership. Companies that come very close to doing an IPO only to have the IPO window close on them may never be able to get back, even when market conditions improve. They're perceived as damaged goods. "The way we did it means that regardless of what the IPO window does, we're already public," says McGonigle. "If the company does well, we hope it causes the price of the stock and the value of the company to go up."
The Dark Theatre
But it's this latter point that has McGonigle, Mullin and the rest of the Longport staff worked up. "We're not sure that trading on the OTC Bulletin Board will allow the company to achieve its full valuation," says McGonigle. For instance, the company's first-quarter profit of $1.01 million on revenues of $1.23 million, a revenue jump of more than 1,700 percent from the comparable period a year ago, pushed the stock up nicely but not commensurately with revenues or earnings.
The problem, says McGonigle, is that as an OTC Bulletin Board stock, investors can look at you, but they can't touch. Many of the major wirehouses have a policy against buying and selling Bulletin Board stocks. This means their brokers can't pitch these companies to their clients, and their research staffs can't write research on them. "The vast majority of retail investors are diverted from even looking at Bulletin Board companies," says McGonigle. Meanwhile, most institutional investors are too big to profitably invest in Longport. While there are still independent investors and brokers out there who can buy and sell whatever stock they want, there are not nearly enough to provide an active, liquid trading market for all the Longports of the world.
About the only way to overcome this second-class--sometimes referred to as "designated"--status is to graduate to the SmallCap tier of the market. But in one of the great Catch-22s of all time, the inability to develop the kind of sponsorship on the Bulletin Board that opens the company up to more investors, and hopefully a higher stock price, is also what keeps companies from reaching the minimum $4-per-share price that is required for a SmallCap listing.
There are several other requirements to getting listed on the SmallCap market, but if share price is the only outstanding issue for a company, sometimes management will reverse-split the stock--that is, instead of having 4 million shares outstanding at $2.50, the company will "recapitalize," causing only 2 million shares to be outstanding, but at a price of $5 each. This can be dangerous, however, because if no new interest is generated for the stock, it can drift down to its old level--in effect halving the value of the company.
The way out for many companies is to hire an investment banking firm. Because most firms don't want to work with Bulletin Board companies, an investment banker's priority will be restructuring the company and bringing in new investors so it can trade on Nasdaq's upper tiers.
Mullin and McGonigle are contemplating such a move but aren't sold on its merits yet. Says McGonigle, "I still think the markets should be a democracy. If we succeed, the investors should be able to share our success no matter where we trade."
Visit http://www.otcbb.com and http://www.nasdaq.com to review the listing requirements for each trading venue. Try to determine how long it will be before your company meets the requirements of the upper tiers of the market, and consider whether you can wait that long for public ownership.
Longport Inc., (800) 289-6863, http://www.longportinc.com