Public-equity options let restaurants cash in: over-the-counter trading and reverse mergers help companies raise capital and sidestep costly reporting requirements

Nation's Restaurant News, Oct 16, 2006 by Gregg Cebrzynski

Trading over the counter doesn't have the glamour of being listed on the New York Stock Exchange or Nasdaq, but a number of restaurant chains have found that it's an efficient way to raise capital and avoid dealing with stiff Sarbanes-Oxley reporting requirements.

Reverse mergers--in which a corporate identity is transferred to an already public, usually dormant company--are relatively rare in the restaurant industry, though they allow formerly private businesses to sidestep the tremendous amount of time and money involved in registering for an initial public stock offering.

Pink Sheets is the largest over-the-counter stock quotation system in the United States, and it's where some restaurant chains are listed, either by necessity or as an alternative to trading on the larger exchanges, explains Tim Ryan, Pink Sheets' director of sales and marketing.

Companies that are delisted from the major exchanges because they don't meet share price requirements often end up on Pink Sheets because they still need to raise capital, Ryan says. In other cases, a broker requests permission to post equities on the system.

Either way, trading on Pink Sheets does not require companies to register with the Securities and Exchange Commission.

Those companies also do not have to comply with the auditing requirements of the federal Sarbanes-Oxley Act, which Ryan says can cost between $1 million and $1.4 million annually. For a company with a market capitalization of $100 million or less, he says, "that's a pretty large expense."

Almost 5,000 securities are quoted on Pink Sheets, and trading volume for the first quarter of 2006 reached $25 billion.

Pink Sheets dates back to the early 1900s, and its history has been troubled from time to time. It was considered the "Wild West of the securities industry," where scam artists pretending to be legitimate companies ran "pump-and-dump schemes," Ryan says.

Now, however, Pink Sheets requires disclosure to a certain degree and has begun a premium listing service called OTCQX, which lists the top 15 percent to 20 percent of securities trading over the counter to separate them from "speculative" companies, Ryan says.

Companies listed on the OTCQX undergo background checks of their management and must have operating businesses. They cannot be shells, nominal businesses or bankruptcies.

The OTCQX is designed to provide alternative disclosure to SEC regulations, Ryan says, "taking what makes sense for smaller companies from SEC reporting requirements and taking out those that are burdensome."

The burdensome requirements of Sarbanes-Oxley were factors in Tumbleweed Southwest Grill's decision to go private two years ago, according to president and chief executive Terry Smith.

"We discussed it with our auditors, and it was very clear to us that the price to live by that legislation was exorbitant, and the benefit in our opinion was nonexistent," Smith says.

Tumbleweed, which is based in Louisville, Ky., would have had to hire additional staff just to meet the requirements of Sarbanes-Oxley, he says, and the company was reluctant to do that "when we believed our controls were good."

Since going private and being listed on Pink Sheets, Tumbleweed has cut expenses related to being a public company by $300,000 and has attracted investors eager to put money into the company, Smith says.

"I get a knock on the door every day from people who want to invest," he says.

Even though it's private now, Tumbleweed continues to operate as if it were a public company, publishing audited financial statements and holding shareholder meetings, Smith says.

Being free of the burdens of SEC regulations actually has allowed Tumbleweed to be more open with shareholders about its financial state, he says.

"They can call me at any time, and I tell them anything," Smith says. "Everyone has open and equal access."

For most companies that want to remain private but have access to public capital, Pink Sheets "mostly becomes a necessity," says Joseph Quinones, president of Genesis Corporate Advisors of Orlando, Fla.

Such companies usually don't have the financial resources to hire investment bankers to attract investors, he says, yet they have a product they believe investors would be interested in.

Pink Sheets is a good starting point for them to raise capital, Quinones says, and as they grow financially they can always upgrade to the larger public exchanges.

He acknowledges, though, that some companies are troubled by Pink Sheets' past.

"For years it was associated with scams, but now they're trying to make it more legitimate and provide more transparency," he says.

Like Tumbleweed, Meritage Hospitality Group Inc., the Grand Rapids, Mich.-based franchise operator of 53 Wendy's and O'Charley's restaurants, believes it can do better as a private company than as a publicly traded one because of the costs associated with Sarbanes-Oxley compliance.

Meritage is the nation's only publicly traded Wendy's franchisee and the first O'Charley's franchisee. It trades on the American Stock Exchange.