Competitive hedge

The liquidity crisis plaguing the U.S., especially middle-market companies, threatens the backbone of our economy -- tens of thousands of jobs in the short term and the viability of emerging and existing companies, the future of our economy, in the long run.

The $750 billion "rescue" plan promises to start the ball rolling to unfreeze credit markets. But it will be too little
too late.

Small to midsized private companies are cash starved. Even with goods ordered and promised contracts with customers, they need capital immediately to meet production demands. These companies rely on revolving lines of credit with banks but in this liquidity crisis, such credit is unavailable. We need action now, while these companies are still in business.

There is a way out, but the answer lies not with the current rescue plan (nowhere close to implementation), or with traditional lending practices (all but evaporated, for now) but, rather, with hedge funds.

Continue reading below

Many hedge funds have billions ready to deploy under appropriate circumstances. They want to provide financing for midsized companies that require growth capital, but because hedge funds must offer near-term liquidity to investors, they need to invest in public companies. And given the volatility in the markets, funds need economic incentives they can explain to investors.

Hedge funds would be motivated to provide this much-needed capital if they had favorable tax treatment (that is, eliminate the capital gains tax) and protection against the downside or the freedom to take any loss as a business loss (against ordinary income).

For their part, small to midsized private companies that need cash would happily take the financing terms and go public but for the extraordinary cost of Sarbanes-Oxley compliance, which makes no sense for the middle market, where companies can't spread out the fixed expense. So why not suspend Sarbanes-Oxley for these companies?

Here's a scenario: A midmarket company, unable to tap credit lines with traditional lenders, would approach a hedge fund for investment. The hedge fund would be willing to provide financing but would say its investors need short-term liquidity. In other words: "You need to be publicly traded."

Going public is far too time-consuming, so the investor would enter into a private investment in public equity, providing the company did an immediate or simultaneous reverse merger into a U.S. public shell.

This would make perfect sense for a privately held midsized company, but for the incredible expense of Sarbanes-Oxley compliance. The government could eliminate Sarbanes-Oxley for companies going public by reverse shell mergers, raising $30 million, or less, through PIPE deals.

In this market, the hedge fund would still have incredible risk. Accordingly, the government could agree to suspend capital gains tax for PIPE investments of $30 million or less, provided the fund is not a short term-investor (that is, the fund remains in the position for six months or more). As an added incentive in such volatile markets, the government could let the hedge fund treat any loss within the first year of the investment as an ordinary business loss.

The government does not need to spend billions of dollars in taxpayer money to jump-start and restore liquidity to the capital markets. Authorities do not need to trust to chance that by buying $750 billion of toxic debt off public companies' or financial institutions' balance sheets, the banks would immediately begin writing new loans (rather than hoarding money until they gain confidence in the market).

All the federal government needs to do is to relax Sarbanes-Oxley on middle-market companies and create tax incentives for hedge fund investment. It makes good sense in this market. It's small business that creates and provides the vast majority of jobs in the U.S. Such a plan is essential as our unemployment rate balloons and threatens to land us in a depression.

Best of all, this plan would enable small businesses to raise capital in the form of equity and not as an onerous bank loan or debt to be repaid. It is a way to secure much-needed financing without expending billions in taxpayer dollars. We need the government to implement such a program now, before it is too late to do any good.

Perrie M. Weiner is a partner and the international co-chair of securities litigation at DLA Piper.

Comments

Post a comment

Name:

Email Address:

URL:

Remember personal info?

Comments: (you may use HTML tags for style)

Please only click "Post" once. It may take a few moments to process.