Letter to Shareholders August 19, 2010

Subject: "Are You Sitting Down?"

Dear Shareholders and Managers of Any Entrepreneurial Over-The-Counter Quoted Company:

I am writing to you today in a single letter to discuss the ongoing conflict I find that often exists between the managers and shareholders of  over-the-counter quoted companies.  That conflict usually surrounds a mutual dissatisfaction between managers and shareholders regarding long-term share price performance.  Though neither managers nor shareholders are usually happy with over-the-counter long-term share price performance, little collaboration between shareholders and managers exists today to address the issue.  Shareholders and managers otherwise often find themselves locked in argument with topics ranging from shareholder dilution and stock shorting to insinuations of share price manipulation and alleged Sarbanes-Oxley violations.  I think the prevailing conflict between managers and shareholders is rooted in a gross misunderstanding of how the over-the-counter market really works to provide a source of investment for early stage companies and a return on investment opportunity for shareholders.  I have been both a manager and a shareholder of multiple over-the-counter quoted companies and I firmly believe the  over-the-counter market can provide the world’s best opportunity for consistent small business finance and small investor returns.  However, to realize the full potential of the over-the-counter market both investors and the entrepreneurial managers of over-the-counter quoted companies will have to better communicate with each other and together, substantially reset their expectations of how the over-the-counter market really works.

On August 5th, I published a letter titled “Sex, Lies and PIPEs” that presented a different picture of how the  over-the-counter market really works than many may had ever before considered (link to “Sex, Lies and PIPEs” letter.  My “Are You Sitting Down?” letter today continues to elaborate upon that difference and emphasize the importance of a collaboration between the entrepreneurs seeking early stage business plan financing and the small investors seeking meaningful returns through over-the-counter investments.  As one of the objectives of my letters is to begin a dialogue between the managers and shareholders of over-the-counter quoted companies, I am pleased with the amount of feedback I received in reaction to “Sex, Lies and PIPEs.”   As expected, knowing my different picture would be difficult to accept all at once for some, not all of the feedback was flattering.  That’s ok.  At least a dialogue has begun.  “Are You Sitting Down?” will address some of the feedback that I received in response to “Sex, Lies and PIPEs,” and expand upon the different picture of the over-the-counter market.

In both my letters I am focusing my discussions on start-up and early stage Over-The-Counter Bulletin Board (OTCBB) and Over-The-Counter Pink Sheets (OTC) quoted companies.  While the OTC and OTCBB today include large, multinational corporations and many of the topics I discuss may apply to some of the large, multinational corporations, I am primarily focused on the start-up and early stage over-the-counter market.  I am focusing on this market for two reasons.  One, I am a shareholder of multiple  over-the-counter quoted companies, some where I serve as a manager or director and some where I am only a shareholder.  Any improvement to the  over-the-counter market and related PIPE financing market could in turn enhance the value of the companies I help manage or am a shareholder of.  Two, access to investment for entrepreneurial small businesses worldwide is in grave trouble and desperately in need of help.  Both reasons are big motivators for me to make a contribution to the overall improvement of the  over-the-counter market.

Freedom Isn’t Free

We have all heard the slogan “freedom isn’t free.”  It is a recurring theme that often surrounds a call to arms to defend against an attack on individual liberty and basic human rights.  In my letter today, I want to recast the slogan to emphasize the economic aspect of individual liberty and basic human rights.  Even when a prevailing government philosophically supports an unalienable right to life, liberty and the pursuit of happiness, most aspects of such freedom have a price tag attached.  Food, clean water and shelter have an associated cost.  Philosophy is important, but economic infrastructure is the real weight bearing cornerstone of a free society.  We may have to take up arms from time to time to defend against political tyranny, but every day we have to take up shovels and hammers and all matter of tools of trade to earn our living and purchase even the basic fruits of freedom. Freedom, is indeed, not free.

The world's population is over 6 billion people. Just over 1 billion people live within the world's developed economies. The rest of the world's 5 billion some odd people live on $10 a day or less.  Approximately half of that 5 billion live on two dollars a day or less.  No diplomatically empowered or militarily enforced philosophical  commitment to basic human rights by any sovereign nation will alone make a meaningful advance of individual liberty for those 5 billion living on $10 a day or less.  A corresponding economic initiative is imperative.

I contend that access to start-up, early stage and small business financing in general is an essential building block of that economic imperative and the key to a practical advance of individual liberty and basic human rights.  The small business economy is already the largest segment of the overall global economy.  Small businesses produce most of the world’s gross domestic product (GDP) and provide most of the world’s employment.  Start-up and early stage finance is the fuel the small business economy needs to grow. Start-up and early stage investment is the fuel the world needs to advance individual liberty and basic human rights. 

Yes, I am proposing that the over-the-counter market can actually be an institution that supports the advance of individual liberty and basic human rights.  No, this is not the part of my letter that I think you might want to sit down for.  Stand if you’d like. My point here is that the global economy is not currently providing the basic food, clean water and shelter necessities for the majority of the world’s population.  Facilitating the growth of the small business sector is the best way to make a dent in the global economy’s current shortfall (by the way, small businesses are bigger than micro-businesses funded by $250 micro loans – I am not discussing micro businesses in this letter).  As an individual that has raised money for start-ups and early stage business operations all over the world sourcing funds from angel investors, venture capitalists and through the PIPE investment market available to over-the-counter quoted companies, it is my belief that the early stage investment financing available within the  over-the-counter market is the best and most consistent source of early stage capital.  It can be an even better source of early stage capital if the managers of over-the-counter quoted companies and their investors can improve their mutual understanding of how they can benefit each other.

Regardless of my moving testament for the importance of improving the global economy for the worldwide advance of individual liberty and human rights, some of you might not care.  Please keep reading.  While you might think individual liberty and human rights are not important to you, let me briefly make two more appeals as to why it is worth your time to learn more about the over-the-counter markets and participate in an improved collaboration between management and investors.

While you may not feel an individual motivation to improve the plight of the world's impoverished, let me present the poverty issue from a different perspective.  Poverty breeds disease and social unrest.  Through the advent of modern technology, the world is smaller than ever, more mobile than ever, and getting smaller and even more mobile every day.  Disease and social unrest no longer remains resident at its point of origin. It gets on airplanes.  Do we need more than 9/11, H1N1 or HIV-AIDS to emphasize the mobility of disease and social unrest?  If global poverty is not addressed, life, liberty and the pursuit of happiness cannot be perpetually guaranteed for those that enjoy it today.

Ok, you’re still not moved. In your way of thinking, someone else can take on the mission of reducing global poverty.  That’s ok.  Even if your only interest is your own personal return on investment, it is still worth your time to take part in the collaboration between investors and managers to improve the over-the-counter market as a source of early stage financing and return on investment. As I have said from the onset of this letter writing campaign, I firmly believe the over-the-counter market can provide the world’s best opportunity for consistent small business finance and small investor returns. Right before I began the “Freedom Isn’t Free” appeal within this letter, I even said my first reason for wanting to see an improved  over-the-counter market is because I currently make my own living through the serial introduction of entrepreneurial new products and services through the financing facilities available in the over-the-counter market.  The only reason the over-the-counter market can be a good source of early stage funding to the global small business sector is because it can provide meaningful returns to investors. 

If you’re an investor and your only interest in the over-the-counter market is a meaningful return on investment, then that is just fine by me.  You don’t have to join my “Freedom Isn’t Free” parade.  You do need to take the time to collaborate with managers of over-the-counter quoted companies and learn how this market really works.  If you are an entrepreneur and your only interest is funding your business plan, that is also just fine by me. No marching with the band required.  However, you also need to take the time to collaborate with investors to learn how this market really works.

A New Understanding of the Over-The-Counter Market

My recent “Sex, Lies and PIPEs” letter  extended to over eight pages long in its presentation of a new perspective on how the over-the-counter market really works.  I am trying to keep this one shorter by not repeating information that is available in “Sex, Lies and PIPEs.” 

In summary, the key messages in my letter were:

1.  Over-the-counter investors and managers have a mutually beneficial opportunity.
2. Investors have a consistent and meaningful return on investment opportunity, but it’s not going to be realized through a traditional long-term return on investment strategy.
3.  Over-the-counter quoted companies can get consistent access to early stage financing, but it’s going to require the company to issue a lot of common stock.
4. Call it dilution if you want to, but all that stock issued by the over-the-counter quoted company does not get in the way of investors having a meaningful return.

In “Sex, Lies and PIPEs” I pointed out that publicly-listed or not, approximately seventy percent of start-ups do not reach sustainability within the first three years.   Accordingly, I suggested that no matter what the circumstances, a long-term investment strategy in general is probably not the best approach to investing in an early stage company. Alternatively, investors in early stage over-the-counter quoted companies should look for short term returns that can be achieved when an early stage over-the-counter operation meets one of its forecasted milestones that can in turn trigger dramatic, though probably temporary, share price increases.  Temporary because while a milestone success may shed optimism on the long-term prospects of a company, a single milestone success does not necessarily mean the company will reach sustainability.  Inevitably, at least some market pessimism will likely creep back in following a milestone success and the share price increases will be retraced to previous levels.  Share price volatility driven by competing milestone optimism and sustainability pessimism can create multiple short term return on investment opportunities within a single over-the-counter quoted company over the course of several years.

How Can All The Investment Experts Be Wrong?

Much of the feedback I received from “Sex, Lies and PIPEs” generally demonstrated a difficulty with letting go of a long-term investment strategy and otherwise looking for multiple periodic short term return opportunities resulting from a company’s achievement of forecasted milestones.  High on the list of comments from those providing feedback was resistance to the idea that an increase in the number of shares issued and outstanding was not necessarily related to the return on investment opportunity.  The responses expressing opposition to the ideas presented in my first letter expressed a resolute expectation that a wisely selected purchase of common stock issued by an OTC or OTCBB company should create a return on investment opportunity through a continuously increasing share price that reflects the company’s continuously improving fundamental financial performance. I am trying to break OTC and OTCBB investors from that expectation.

Countless volumes of stock investment advice recommend a "buy and hold" long-term strategy.    My suggestion that price per share and fundamental financial performance are disconnected when it comes to OTC and OTCBB quoted companies runs counter to almost everything you might read on stock investing or hear on television.  Nothing Warren Buffet has said or written would likely endorse my claim that an increase in issued and outstanding is irrelevant to a shareholders return on investment potential.  I recognize the over-the-counter market picture I am presenting is dramatically different from most investors’ and entrepreneurs’ current expectations and that those expectations are rooted in years and volumes of advice from credible experts.  I am asking a lot by suggesting that you listen to me instead of the years and volumes of expert advice to the contrary… or am I?

Warren Buffet does not invest in OTC or OTCBB quoted companies and not many (if any) stock investing books include an OTC or OTCBB quoted company as a demonstrative example illustrating the book’s investment advice.  I am certainly not suggesting that Warren Buffet’s stock investing advice is wrong, nor am I necessarily suggesting any of the other published stock investing advice is wrong.  I am merely saying that it does not apply to the OTC or OTCBB markets.  In fact, I think OTC and OTCBB relevant publication is sparse and in need of attention.  I find that most OTC and OTCBB related information is either suspiciously focused on motivating the purchase or sale of a particular stock or otherwise advising investors to stay away from the OTC and OTCBB market all together.  I don’t think I am asking a lot by suggesting that you consider the picture I am presenting of the over-the-counter market.  Not much of the currently published stock investing expert advice actually applies to the over-the-counter market, let alone counters the picture I am presenting.

If You Are Not Already, This Is The Part Where You Might Want To Sit Down

In my last letter I attempted to separate investors and entrepreneurs from existing long-term return on investment expectations by highlighting some of the overall OTC and OTCBB market statistics.  I pointed out that the 2009 average OTCBB price per share weighted by trading volume was $0.04.  To further illustrate the difference between common long-term return on investment expectations and the way the over-the-counter market really works I also provided weighted average share price performance statistics for the top 100 most actively traded stocks on the OTC and OTCBB from a recent and randomly selected trading day.  The weighted average share price for the top 100 most actively traded OTCBB securities on Friday, July 31, 2010 was just less than $0.01 per share.  The weighted average share price of the top 100 most actively traded OTC securities on that same day was approximately $0.0026 per share.  The combined trading volume value of the top 100 most actively traded OTC and OTCBB securities on Friday, July 31, 2010 amounted to over $40 million.

I frequently communicate with OTC and OTCBB investors and managers that expect an over-the-counter quoted company of particular interest to perform in dramatic exception to the prevailing market trends.  My experience in these conversations has been that the individual to whom I am speaking is simply unaware of the OTC and OTCBB market trends.  Much of the market trend information is readily available on the OTC and OTCBB websites.  However, the OTC and OTCBB market trend information is not widely discussed on any investment news website or news channel the way NASDAQ and NYSE market trend information is discussed.  OTC and OTCBB investors and entrepreneurs at the moment have to go get this information themselves.  Don’t make the mistake of considering an investment without perusing comparative investment opportunities.  You wouldn’t purchase a house without considering the value of other homes in the neighborhood, would you?

I have taken the July 31, 2010 trading day information and conducted some further research in order to present an even clearer picture of the differences between the way the over-the-counter market really works and how you otherwise might have expected it to work.  When I say “I” conducted some further research, I really mean “we.”  The numbers I am about to share with you here are not readily available on any website and are not easy to collect.  It took some time and effort.  What we researched was the most recently reported shareholder equity for each of  the top 100 most actively traded OTC and OTCBB companies so we could compare that figure to the market capitalization value of the company.  We researched the number of issued and outstanding shares one year ago so we could contrast those figures to the current number of issued and outstanding shares.

Shareholder equity is reported on a company’s balance sheet as a measure of the difference between a company’s assets and liabilities.  A positive shareholder equity indicates the company has more assets than liabilities, and a negative shareholder equity indicates the company has more liabilities than assets.  A negative shareholder equity is also an indication that a company has issued or is likely to issue common or preferred stock to finance operations or materials necessary for operations.  Market capitalization is the value of the company determined by the current price per share multiplied by the total number of shares issued and outstanding.  We found that the average shareholder equity for the top 100 most actively traded OTCBB securities on July 31 was approximately negative $5 million.  The approximate average market capitalization value of the top 100 was positive $10 million.

The shareholder equity and market capitalization ranges of the top 100 most actively traded OTC securities that day were much more dramatic though the ‘averages’ do not demonstrate the dramatic ranges.  The top 100 most actively traded OTC securities that day had an average shareholder equity of negative $1 million and a positive average market capitalization of $1.6 million.  However, approximately 25% of the OTC top 100 most actively traded securities we researched are non-reporting and not included in the shareholder equity and market capitalization figures.  Of note, we also took Fannie Mae’s negative $8 billion in shareholder equity and $2 billion in market capitalization out of the average, even though Fannie Mae appears on the top 100 most actively traded OTC securities on July 31 with a closing price per share of $0.38 and over 13 million shares traded. Even though Fannie Mae was removed, the OTC list included another company with a positive shareholder equity of $56 million and yet another with a negative shareholder equity of $65 million.  Not including Fannie Mae, the market capitalization values ranged from $8,000 to $25 million.

The conclusion I suggest to be drawn from the comparison of shareholder equity and market capitalization is that there is a lack of correlation between price per share performance and fundamental financial performance for over-the-counter quoted companies.  Keeping in mind that I am discussing here  over-the-counter quoted companies that are start-up and early stage, the lack of correlation is a good thing in regard to an over-the-counter quoted company’s potential to raise investment capital.  The price per share of all publicly traded companies primarily reflects speculation as to the company’s future potential value.  Since the historical financial performance of the early stage OTC and OTCBB companies is sometimes not even reported and often less than stellar, their trading and price per share performance  is  weighted even more so on speculation as to a company’s future potential.  If the OTC and OTCBB price per share were more closely correlated to the quoted companies’ shareholder equity, than these start-up and early stage companies would likely have little access to investment financing.

From an investor's perspective, I would suggest carefully considering this lack of correlation between shareholder equity and market capitalization in conjunction with the overall market average share prices when making an investment decision.  Alternatively, I would suggest evaluating the authenticity of management’s intent, credibility of management’s plan and the potential of a genuine and credible plan to meet forecasted milestone objectives and correspondingly produce milestone share price increases within the ‘actual’ $0.04 average price per share framework of the over-the-counter market.  I am discussing statistics from the top 100 most actively traded because as the most actively traded, odds are someone reading my letter might have purchased stock from one or two of the companies on that list, and perhaps the subject matter here might touch you more poignantly.  However, most actively traded or not, the fundamental financial performance and price performance trends discussed here are prevalent within the entire early stage OTC and OTCBB market, not just the top 100 most actively traded.

In addition to carefully considering the lack of correlation between shareholder equity and market capitalization, investors should also include in their consideration of the ‘actual’ framework of the over-the-counter market the tendency of OTC and OTCBB quoted companies to issue treasury stock.  The average increase in issued and outstanding of the top 100 most actively traded OTCBB quoted companies over the course of the last year was in excess of 5,600%.  Keeping in mind that we pulled Fannie Mae out of the calculations and that about another 25% of OTC companies are non-reporting, the average increase in issued and outstanding for top 100 OTC quoted companies over the course of the last year was over 15,000%.   

The top 100 most actively traded companies presented here on both the OTC and OTCBB have average share prices under $0.01.  The average shareholder equity of these companies is substantially negative indicating a high likelihood that the companies will be issuing stock to raise funds.  The combination of low share prices and negative shareholder equity also means the companies will probably be issuing a lot of stock.  If a company raises $100,000 at $0.01 per share, that will result in a 10,000,000 share increase to the issued and outstanding.  Most of these companies are likely attempting to raise more than $100,000 and with average share prices under $0.01, few are likely to raise money at $0.01 per share.

Let The Conversation Begin

I know the share price averages, average increase in issued and outstanding statistics and the average shareholder equity figures may be shocking and even off-putting.  I maintain that the over-the-counter market can provide the world’s best opportunity for consistent small business finance and small investor returns.  To realize the full potential of the over-the-counter market, investors and the entrepreneurial managers of over-the-counter quoted companies will have to better communicate with each other and together, substantially reset their expectations of how the over-the-counter market really works.

As I said at the onset of this letter, I think an unfortunate and unnecessary conflict exists between managers and shareholders of over-the-counter quoted companies resulting from a mutual misunderstanding of what to expect from share price performance.  It is my sincere hope that my letter today and recently can serve as a first step in opening up a dialogue between shareholders and managers that ultimately improves the over-the-counter market as a venue for individual investor returns and early stage investment.  Please write in response to my letters.  Forward the letter to the management of a company you have invested in and begin a dialogue. 
The OTCBB was launched as a pilot in 1990 as part of the Penny Stock Reform Act.  It was only approved by the SEC for permanent operation in 1997.  The OTCBB has changed and evolved substantially within its 20 year history.  In 1995, the average OTCBB price per share was $3.11 and in 2009 the average price per share was $0.04.  Dramatic changes to the OTC and OTCBB are under debate as I write this letter.  As best I can determine, none of the changes under consideration are the result of management and shareholders communicating their respective experiences let alone comparing notes with each other on their respective experiences.

The next over-the-counter market evolutionary changes are critical because the small business sector as the leading contributor to GDP and employment the world over is more important than ever.  The state of the world’s developed economies is still precarious in the aftermath of the recent global financial crisis and I contend the rate of new business starts versus business failures is being neglected when it comes to encouraging start-up and early stage investment.  A robust over-the-counter market can contribute to an improved recovery within the world's developed economic regions.  Within the world's developing economic regions, the over-the-counter market can provide a bridge between the investment capacity of the world's developed economies and the needs of the world's developing economies.  The best next steps in the ongoing evolution of the over-the-counter markets need to come from a dialogue between the managers and shareholders of today’s over-the-counter quoted companies.

Talk to each other, will you?

Philip Verges
Founder and Chairman
NewMarket Technology, Inc.

"SAFE HARBOR STATEMENT" UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This letter to shareholders contains forward-looking statements that involve risks and uncertainties. The statements in this release are forward-looking statements that are made pursuant to safe harbor provision of the Private Securities Litigation Reform Act of 1995. Actual results, events and performance could vary materially from those contemplated by these forward-looking statements. These statements involve known and unknown risks and uncertainties, which may cause NewMarket's actual results in future periods to differ materially from results expressed or implied by forward-looking statements. These risks and uncertainties include, among other things, product demand and market competition. You should independently investigate and fully understand all risks before making investment decisions.