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

In June it announced that it had asked Donnelly Penman & Partners to act as exclusive financial adviser to the company's board of directors on going private or being listed on Pink Sheets.

Meritage is considering a reverse stock split that would reduce the number of shareholders to a level that would allow it to deregister from the SEC.

The cost to remain a publicly traded company is "becoming increasingly high as a result of Sarbanes-Oxley," says James R. Saalfeld, Meritage's chief administrative officer and general counsel. "This is especially true of smaller public companies."

If and when Meritage goes private, it would still have to undergo yearly financial audits to obtain financing, Saalfeld says, but the audit would be much less expensive. Because Pink Sheets requires minimal reporting, it's up to companies listed there to decide if they want to put out more than what's required, he says. Disclosure depends on a company's strategy for raising capital. That Pink Sheets is not as widely recognized a trading system as the American Stock Exchange is not a problem from Meritage's perspective. "I don't see a drawback from where we are today because of the cost factor [of Sarbanes-Oxley]," Saalfeld says.

Elephant & Castle, a British-style pub chain based in Vancouver, British Columbia, has 23 units in Canada and the United States and is one of the companies trading over the counter by necessity. It had been listed on the Nasdaq Small Cap Market but fell below minimum share-price requirements. It now trades on the Over-The-Counter Bulletin Board.

"We have to provide a trading environment for our shareholders," says Rick Bryant, president and chief executive of Elephant & Castle. But some investors have the wrong idea about what being traded on the OTCBB means, he adds.

"The perception is stronger than the reality," Bryant says. "Investors believe that if you trade on Over-The-Counter Bulletin Board, there must be a market in your securities. In reality, the actual trading volumes are extremely low. Price fluctuation is quite significant on small volumes."

Still, Bryant says that with the costs associated with Sarbanes-Oxley "the threshold to get value from being a public company continues to increase."

He recommends that restaurant companies with anything less than a $100 million-plus market capitalization avoid being publicly traded.

Another option for raising capital is the reverse merger. Ultimate Franchise Systems Inc., a publicly traded franchisor with investments in nearly 600 restaurants and numerous brands, spun off its Obee's sandwich brand in a reverse merger two years ago. More recently, Jamba Juice Co. agreed to be acquired in a reverse merger with publicly traded Services Acquisition Corp.

Typically, a reverse merger melds a private entity and a "public shell" company that has few if any assets or operations but still holds value.

When UFSI spun off Obee's it created a new company, Obee's Franchise Systems Inc., which is traded on Pink Sheets. Divestitures and spinoffs are common among restaurant holding companies, but it's rare for those deals to include the creation of a new public company.