” Equity For Punks : Whether they are punks or not, this certainly isn’t equity.”
Beer Insider has previously raised concerns about crowd-funding and the activities of Brewdog. In particular, it related to some of the brewers’ actions that could potentially reduce the value of the equity (shares) held by thousands of small shareholders who took part in its various fund-raisings.
However, after yesterday’s press release (https://www.brewdog.com/GM290317LTR_Chairman-BrewDog-PLC_13-MAR-17.2.pdf), we can categorically say that those who participated in the Equity for Punks (EfP) scheme did not receive proper equity.
Brewdog announced that they are looking for a new, outside investor, but crucially they are not allowing the original EfP to participate at the same terms. This means that they do not have full pre-emption rights, which would be illegal if EfP was genuinely equity. This not unusual practice in the crowd-funding industry for B-class shares, but they are therefore not equity and should be named accordingly.
There is still room for such arrangements where loyal consumers contribute funds, in advance, for a souped-up membership scheme with generous benefits and discounts. However, it should be named accordingly. Section 561 (1) of the 2006 Companies Act, on existing shareholders’ right of pre-emption, (http://www.legislation.gov.uk/ukpga/2006/46/part/17/chapter/3/crossheading/existing-shareholders-right-of-preemption) is very clear:
It states: “A company must not allot equity securities to a person on any terms unless—(a) it has made an offer to each person who holds ordinary shares in the company to allot to him on the same or more favourable terms a proportion of those securities that is as nearly as practicable equal to the proportion in nominal value held by him of the ordinary share capital of the company, and (b) the period during which any such offer may be accepted has expired or the company has received notice of the acceptance or refusal of every offer so made.”
This means that if you think the Board is issuing new shares too cheaply, and, consequently, undervaluing your present investment, then you have the right to also buy at that price, thereby ensuring that the value of your investment is not reduced.
Even in a perfectly honest world, this process is important as we all have different opinions of the value of a stock that is not actively traded. It is absolutely and fundamentally vital in the real world, as it is a crucial guard against malpractice.
Without it, there is nothing to stop a Board massively undervaluing a company when selling to a new investor, who then gets it too cheap at the expense of the original providers of equity. This illegal profit can then be split with the Board, cheating the first round of equity investors.
Let me be crystal clear – I am not suggesting that Brewdog’s issuance is in any way fraudulent. However, it is basic text-book corporate finance that this structure could, in the future, be exploited fraudulently by a different issuer.
Others have commentated that the new terms look very generous. Indeed, I agree, that by giving the new investor a preferred return preference of 18% per annum, they essentially get the rights of debt to be paid first, whilst befitting from the equity value of any outperformance. However, we don’t know the price they are paying. Crucially, it only becomes a real issue as the present investors don’t get the opportunity to participate in the same deal.
To summarise, I do not know the terms of this deal. Indeed it is possible that the investor is paying too much, which actually creates value for the existing investors. However, they do not know the price and without pre-emption rights there is no way of them acting.
Pre-emption rights are a crucial safeguard against an original equity investor being defrauded. In corporate finance terms, they are a necessary, legal condition for the definition of equity.
Crowd-funding is being marketed to very small investors who probably do not have much finance experience. They think they are buying ‘shares’ but if their pre-emption rights are being widely removed as an original condition, then they are not getting what any reasonable person would view as equity.
Many of these crowdfunding ventures are a potentially mutually beneficial customer loyalty schemes. On that basis they must not be marketed as equity and I strongly suspect that the FCA (Financial Conduct Authority) will be along shortly to inform BrewDog, CrowdCube et al of this very fact.
Amateur drinker, serious investor