Owners of small companies in search of financing have no doubt been as depressed in recent months as the equity market itself. Some businesses have been forced to postpone their fund-raising; others have accepted less attractive deals.But there are always exceptions, as shown by CVD Inc. of Woburn, Mass. Last fall, the $3.3-million company pulled off what may have been one of the financing coups of the year. The company's founder went all the way to London to do the initial public offering, and found, to his delight, that the transatlantic voyage was well worth the trip.
CVD, a producer of advanced materials for defense and industrial applications, was started in 1980 by two ex-employees of Raytheon Co., Robert N. Donadio, a research scientist, and his associate, Joseph F. Connolly. Donadio had borrowed $35,000 against his house, and he and Connolly had raised an additional $46,000 from relatives and friends. Within a few months, CVD got approval for a $275,000 bank loan guaranteed by the Small Business Administration. By that time, demand for the company's two main products -- zinc selenide and zinc sulfide -- had started to heat up, and CVD suddenly began to feel pressure to expand.
In 1982 and '83, the company's production capacity doubled, then doubled again. By the end of the fiscal year ending May 31, 1983, it had earned $393,000 (before taxes) on sales of $2.7 million. Meantime, however, its growth was being mirrored in soaring levels of debt. New furnaces were financed with new bank borrowings (also backed with SBA guarantees), and much of the raw-material purchases were being funded by a key supplier. Indeed, by early 1984, CVD's debt-to-equity ratio was up around eight to one.
So last April, Donadio, 49, began exploring ways to expand CVD's equity base. The idea was to raise about $2 million either privately from venture capitalists or in an initial public offering, enough to pay off debt and finance additional plant and equipment. The more Donadio and his attorney learned of the sour market conditions, though, the more pressimistic they became. Selling an initial public offering would be dubious, they concluded, and the climate for raising venture capital wasn't a lot better. "The venture guys wanted nearly 40% of the business for $2 million," Donadio notes. That made for a total valuation of around $5 million, barely eight times net income.
In the meantime, Donadio began hearing some intriguing news from a London-based consultant he had hired to investigate financing possibilities in England. It seemed that CVD was a very plausible candidate for going public on London's Unlisted Securities Market of The Stock Exchange -- its version of the U.S. over-the-counter market. The fact that CVD had a number of customers in the United Kingdom certainly didn't hurt.
In July, Donadio flew to London with his wife, Felicia, who is secretary of the corporation; Edward Crowley, CVD's chief financial officer; and general counsel Dennis O'Connor. After a week of meetings with investment bankers and underwriters, it appeared that British investors were willing to value CVD significantly higher than U.S. venture funds. Not only were the prevailing market multiples generally higher in Britain for technology-oriented businesses, notes Donadio, but "they were also willing to use our projected earnings as a base." It appeared that such factors could give the company a market valuation of at least double and maybe triple the $5-million figure quoted by U.S. venture investors.
Within a few days after returning from London, CVD signed a letter of intent with Phillips & Drew, one of the most prestigious investment firms in Britain. This marked the beginning of a frenetic three-month period of gearing up for an October offering. While there is no regulatory agency in Britain analogous to the Securities and Exchange Commission, the process leading up to a public offering can be every bit as rigorous.
In order to comply with The Stock Exchange's disclosure requirements, for example, CVD's accounting firm, Touche Ross & Co., had to assign auditors from both sides of the Atlantic to prepare a 150-page report documenting the company's well-being. The auditors verified the accuracy of the company's financial records, but they also had to testify to the veracity of CVD's business forecasts through the fiscal year ending May 31, 1985. In contrast to what happens in the United States, says attorney O'Connor, "Those projections are key to the pricing of an offering, and they are examined very carefully." Much of the due diligence process thus involved scrutinizing of CVD's production costs and extensive cross-checks with customers.
The countdown began in the fourth week of October, when Donadio returned to London for a string of dog and pony shows for British institutional investors. During the week preceding Impact Day, the day of the public offering in Britain, the precise terms of the underwriting were pinned down. As it turned out, CVD ended up selling just 22% of its common shares for ?3 million -- which converted into $3.7 million at the time. The market value of the total company was $16.7 million or 51 times net income for fiscal-year 1984.
As with any offering, the company didn't keep all of the money. Nearly $400,000 -- or about 11% -- went for auditing, legal, and underwriting expenses. In addition, some $1.6 million was paid out to a handful of selling shareholders (including Donadio) -- a feature that is frowned upon by U.S. investors. But even after these payouts, the company is well ahead of where it might be if it had stayed at home. "Last spring I didn't even know it was possible to do an offering in the U.K.," Donadio says. "I guess I just didn't know."