ShiftPixy – A Reg. A+ Question Mark?

 I frequently get into discussions with proponents of Regulation A+ who believe small investors should be encouraged to invest in start-ups.  The proponents argue that small investors are being deprived of the opportunity to invest in new companies that may turn into the next Facebook.  Why, these proponents ask, should these “opportunities” only be available to Wall Street fat cats and the wealthiest 1% of the population?

The proponents of Reg. A+ shine the spotlight on those companies that have made successful offerings. That is a function of the sales and marketing effort. They fail to discuss the fact that just because an offering is successful does not mean that the company itself is a good investment.

Proponents of Reg. A+ and especially those who suggest that start-ups are suitable investments for small investors have convinced themselves that these small investors have the skills necessary to evaluate investments.  They constantly tell me that small investors can judge a company and separate the good investments from the not-so-good ones.

In the mainstream markets the task of judging the potential for success of a private company that is about to go public is left to very highly paid investment bankers and research analysts.  It takes a great many hours of hard work and in the end these highly paid professionals do not always get it right.

Simply put, evaluating a new company as an investment is a lot like sizing up a doughnut.  You are attracted to the sweet frosting which is the reward, but you really need to focus on the hole. The hole is what is left out. No company can succeed if key components are absent.

Whenever you evaluate a start-up as an investment the essential question is always the same; given the information presented, can the management make it happen?  Can they execute their business plan with the talent on their team and the money that they are going to raise?

This brings us to a company called ShiftPixy, Inc. which is currently making a Reg. A+ offering of 2 million shares that will be priced at between $6 and $8 per share.  Although the company is only 2 years old, it shows sales of $65 million in the last six months and may have gross sales of $125 million in 2017. There is even a research report from Zacks which suggests that the shares could be worth $12.60 in 2018. Not bad for a start-up. There is a lot of tasty frosting on this doughnut.

According to the registration statement the company is “a leading provider of employment law compliance solutions for businesses and workers in an environment in which shift or other part-time/temporary positions, commonly called ‘gigs’ are performed.”

Essentially, the company provides shift workers, currently in the restaurant and hospitality industries.  Customers move their workers over to be employed by ShiftPixy which then acts as a staffing agency for the customer. By pooling the employees of many smaller companies, ShiftPixy can administrate the human resource management function with economies of scale.

“In return for providing insurance, payroll processing, benefits, and compliance services these enterprises pay ShiftPixy a fee based on their payroll that is much less than the cost of doing these functions in house.”

The registration statement says: “A significant problem for employers in the Gig Economy involves compliance with regulations imposed by federal, state and local governments, including requirements associated with worker’s compensation insurance, and other traditional employment compliance issues, including the employer mandate provisions of the Affordable Care Act.”

I agree that this is a significant problem and any company that can solve a significant problem is worthy of attention.  Government regulations and the attendant paperwork can be expensive and strict compliance is a requirement at every level. A company that can provide employees to other companies while retaining the burden of benefits and paperwork would seem to have a good chance of success.

But can they?  The move to the “gig” economy is being fueled by the employer’s desire to reduce the cost of employees.  According the financial reports in the registration statement, ShiftPixy had deployed fewer than 1800 employees to other companies through the end of February 2017.  How much of an extra fee per employee do they charge?  How much of an extra fee will employers be willing to pay?

The financial reports in the registration statement are not audited. This is not a requirement for a Tier 1 Reg. A+ offering and it is one of my pet peeves.  I have seen too many questionable financial statements over the years.  Proponents of selling Reg. A+ shares to smaller investors necessarily assume that those investors are adept at reading and analyzing a financial statement even as accounting and MBA students struggle to learn how to do it properly.

How does ShiftPixy’s gross margin of compare with competing firms?  Do the smaller investors in this offering know enough to ask that question? Do they know how to find the answer?

For this offering, let’s stick with the more simplistic: can the management make it happen?

In this case the company has two founders; Scott Absher and J. Stephen Holmes. Mr. Absher is the current CEO. The only other executive officer is a newly appointed CFO.  There is a single outside director from another industry.  Since February 2010 Mr. Absher has also been President of Struxurety, a business insurance advisory company.  Neither Mr. Absher, the CFO, outside director or anyone else at the company seems to have any connection to the staffing industry.

There are several well known staffing companies from whom an executive or two might have been acquired. That does not seem to be a priority and it is the primary reason why I have trouble answering the question “can management make it happen?” in the affirmative.

The other founder, Mr. Holmes is not an officer or employee of the company. He is an independent contractor focusing upon building a sales network and providing consulting in relation to worker’s compensation programs as well as Affordable Care Act health insurance programs that the company will offer.  The registration statement notes that he is not involved in any part of the accounting or taxpaying and IRS return filing areas of ShiftPixy’s operations.

I suspect the reason for that disclosure is Mr. Holmes was convicted “for acts related to making false statements in relation to two quarterly IRS Form 941 Employer Federal Quarterly tax returns, one in 1996 and the second 1997, for a company for which he was an officer at the time.” That disclosure is in the registration statement. It does not disclose that Mr. Holmes was sentenced to 15 months of incarceration and apparently served at least part of it.

In order to find out the actual disposition of the case, I had to do some additional research. If you are evaluating any investment, you always need to look at facts outside of the offering paperwork in order to give what you are reading proper context.  That is what is meant by looking at the hole in the doughnut.

I am not here to sling mud. I, for one, think everyone who serves their time is entitled to a second chance. Mr. Holmes, because he owns over 12 million shares of the company will remain a “control person” of the company. He is going to be building up the sales force, not dealing with the paperwork involving taxes or employees. Being able to do that paperwork is this company’s critical task.

That brings us back to Mr. Absher, the CEO, who apparently has also had some issues with government required paperwork.  The registration statement discloses that: “On June 25, 2013, the Alabama Securities Commission issued a Cease and Desist Order (the “Order”) against Scott W. Absher and other named persons and entities, requiring that they cease and desist from further offers or sales of any security in the State of Alabama. The Order asserts, regarding Mr. Absher, that he was the president of a Company that issued unregistered securities to certain Alabama residents, that he was the owner of a company that was seeking investments, and that in March 2011 he spoke to an Alabama resident who was an investor in one of the named entities. The Order concludes that Mr. Absher and others caused the offer or sale of unregistered securities through unregistered agents.

Per the registration statement: “While Mr. Absher disputes many of the factual statements and specifically that he was an owner or officer of any of the entities involved in the sale of the unregistered securities to Alabama residents or that he authorized any person to solicit investments for his company, in the interest of allowing the matter to become resolved, he did not provide a response.”

If Mr. Absher was not an owner or officer of the company in question, he likely could have contested it by filing an affidavit with the State of Alabama.  In my experience, intentionally taking a default, usually indicates that the allegations are true and not worth the effort of fighting. By allowing this order to be entered these facts are deemed to be true.  Saying that he disputes them now has no legal effect and, to me, raises a “red flag”.

There is no prohibition against selling unregistered securities in Alabama (or anywhere else) as long as you file a form with the state, pay the filing fee and make the proper disclosures.  Given that the state of Alabama says that some of that did not happen, it seems difficult for me to imagine that Mr. Absher is well suited for the difficult world of employment law compliance.

I claim no expertise in employment law. I do know that it can be complex and that some aspects of it vary location to location. San Francisco, for example, prohibits employment discrimination and harassment based on the employee’s height and weight. That cannot be the law everywhere.

I would have expected to find an experienced employment lawyer, or more than one on the payroll of this company.  They do not disclose that they have one, nor do they seem intent on hiring one after the offering although “employment law compliance solutions” is what they sell.

Much of the current focus of ShiftPixy is in the restaurant and hospitality industry. Reporting and collecting taxes on tips paid to employees in those industries is another burden.  The IRS requires that an employer must ensure that the total tip income reported by employees during any pay period is, at a minimum, equal to 8% of the total receipts for that period.

ShiftPixy has responsibility to file the paperwork because they are the employer but they have no access to the cash register to see if the information they are reporting is correct or in line with that requirement.  The financial reports also note that there has already been a $280,000 reversal of a charge for workman’s compensation expenses that were “misclassified”. So to me this company has not demonstrated that it can solve the problem that it claims to solve.

ShiftPixy is a staffing/HR company that seems to lack any employees with significant expertise in this often complex field. I would have expected to have seen several people with this expertise in senior management and there is no mention of the need or intent to hire any at the culmination of the offering.

The company sells employment law compliance without employment lawyers and accounting services where everyone important to the company has prior problems with government paperwork.  There are other staffing companies and there is nothing here that screams “we are better.”

Any start-up that is going to compete in an established industry needs to distinguish itself.  To me, this company distinguishes itself by the size of the hole in the doughnut. I think that it specifically lacks the people who can get the job done.

It would seem to have been in Mr. Asher and Mr. Holmes’ best interest to fill this company with knowledgeable employees.  Each of the two founders owns in excess of 12 million shares. If the offering is completed at $7 per share it will increase their net worth by $90 million each. If the share price goes to over $12 in a year as Zacks suggests, by over $150 million each.  With that much on the table I find it surprising that the company seems to be so careless about hiring people with appropriate skills.

Finally, I noted that the attorney who prepared the registration statement was given rights to buy 200,000 founder’s shares at par value $.0001. No other legal fees were charged.

There is nothing illegal about this. Some securities lawyers accept stock in lieu of cash; personally I do not.  I think that it creates the appearance of a conflict of interest.

In a money center like New York or San Francisco, a lawyer preparing a Reg. A+ offering might charge $150,000.  If this lawyer’s gamble pays off and the share value does top $12 per share, he might walk off with more than $2.5 million.  He will be on his yacht while I am still writing blog articles.

Of course if the disclosures later prove to be somehow deficient and a regulator comes in and investigates, an allegation that the lawyer cut corners to get the offering sold may be hard to avoid.

In my opinion what this company lacks is the internal talent to perform the complex tasks that it is selling. It is talent that its more established competitors certainly have and without which I do not think this company can succeed.

The talent at this company is so thin and the payday so concentrated, there is certainly enough here for me to have considered that this offering may be nothing more or less than two people with checkered pasts trying to put one over on unsuspecting investors.  I am more skeptical than most people, but skepticism is what people who evaluate start-ups are supposed to have.



The Bitcoin Bubble

In the normal course, I do not do requests for this blog.

I have a job writing articles for a reputable publication. I write the articles that my editor assigns to me.  For the blog, I generally write about something that interests me. Usually, it is based on something that I have read or a conversation that I have had.

In the last few weeks, several people have asked me for my opinion regarding Bitcoins. The truth is I really do not have one. I think that they are a fad. They may be around for a while but ultimately I do not see that they will become a legitimate part of mainstream finance.

More and more people are investing in Bitcoins and more and more businesses are accepting them for payment. The recent run-up in their price has generated a lot of interest. Note that I said price, not value. Bitcoins have no inherent value.

A lot of people seem to confuse Bitcoins with blockchain. Blockchain or distributive ledger technology is just that ledgers; bookkeeping records of transactions that are created by parties to the transactions. Blockchain ledgers are public and every transaction is broadcast to everyone to reduce cheating.  Both FINRA and the US Federal Reserve have looked at blockchain and essentially yawned.

There is nothing inherently wrong with keeping various parts of transactional ledgers disbursed but I fail to see the benefit. The idea is to replace the institutional intermediaries like banks with digital ledgers where a lot of people enter their own transactions. This assumes that everybody in the system is honest.

Using blockchain, it is possible to effect transactions instantaneously everywhere in the world.  If I make an on-line purchase from a merchant they may not get my payment for a day or more.  The transaction is in fact, instantaneous, but the bank or banks in between slow it down so that they can have use of that money overnight.  With a large bank that can result in an enormous profit.

It would seem logical that a blockchain is only as secure as its weakest link and more susceptible to hacking and data breaches than any of the large banks or the US Federal Reserve.  And no matter where and how the ledgers are kept, every bank and public company that uses the blockchain system will still have to be audited once a year.

This brings us to Bitcoins which is essentially a string of computer code and which touts itself as a cryptocurrency. Bitcoins are not the only cryptocurrency. There appear to be more than 100 but Bitcoins seem to have the lion’s share of the market and are subject to the most hype.

I have some experience trading currencies in the foreign exchange market and teaching about them. When I was very much younger, I bought and sold currencies on the black market in Mexico and Italy.  So I think that I am qualified to peel back the curtain and take a reasonable look at Bitcoins and to size them up against other currencies.

When I did, what I found was essentially nothing.

Perhaps a unique aspect of Bitcoins is where they come from.  Bitcoins exist only on a distributed ledger and are the brainchild of an unknown computer programmer who first published the idea in 2008 and then the software to create the system in 2009.

The number of Bitcoins in the world increases every time someone, usually a cryptographer I suspect, solves a complicated mathematical puzzle. If you perform any task and receive a reward for doing it, I suspect that the IRS will consider that to be a taxable event.  I have yet to see IRS guidance on the subject, but I have no doubt that the IRS will catch up to this.

If you looked at this from the outside and said that a group of sophisticated cryptographers was going to create a code and that code would be accepted as money, you would be right to be skeptical.  Who, besides another cryptographer would want it?

Records of Bitcoin transactions are kept on blockchain ledgers and a lot of the trading is anonymous. A lot of people seem to think that most Bitcoin transactions are being made by criminals seeking anonymity. That may or may not be true, but the anonymity that comes with Bitcoin transactions would certainly attract a criminal element.

People who swear that Bitcoins will soon become the currency of choice usually make several arguments. When you examine them, it is obvious that none hold any water.

Bitcoin advocates argue that Bitcoins are no worse than any fiat currency. If the government can just keep printing money without anything behind it, why should not the marketplace be able to do the same?  As a member of the generation that first coined the phrase “question authority,” I think I am qualified to respond.

There was a lot of debate when President Richard Nixon took the US off of the gold standard in 1971.  Most of the people who favor Bitcoins today were not yet born and know nothing of the debate that took place then.  While it is true that the US no longer exchanges currency for gold at a fixed rate of $35 per ounce there is still a lot of gold stored at Fort Knox and elsewhere.  Most of it was purchased at $30 an ounce or less and at current prices would still back some portion of outstanding US currency.

Gold itself is a monetary fiction.  People have sought it and accepted it as an exchange for other items of value going back into antiquity. In reality, it is a rock. Once or twice every year someone walks along the bank of California’s Sacramento River and picks up a sizeable nugget. Any monetary system needs a hitching post and for centuries gold has been it.

Gold and all currencies are based on our willingness to accept them for things we consider to be valuable.  All currency is about perception.

In addition to gold, and perhaps more importantly, the largest asset held by the US government is land. Land has had value going back to feudal estates because they were places where you could grow crops and later build factories. Land adjacent to a river or shoreline has always had extra value.

The US government owns millions of acres of valuable land.  You might speculate about how much it would get if it sold the 98% of Alaska that it still owns but it is easier to add up the value of the someplace like Camp Pendleton, California with its miles of Pacific shoreline just waiting to be turned into high-rise condos, theme parks, and golf courses.

What is behind Bitcoins? Nothing. All fiat currencies are not created equal.

Currencies must be accepted in exchange for other goods and services. While more and more merchants are accepting Bitcoins, in most cases average wage earners in the US are required to pay their rent or mortgage in dollars and also their health and car insurance, groceries, cable, and phone bills.  There is not a lot left over for Bitcoin transactions.

I can get a meal from most street vendors in almost every country in the world with a US $20 bill.  In the aggregate street vendors sell a lot more meals every day than does McDonalds and McDonalds does not accept Bitcoins either.

Currencies function as a place to store value.  The recent run-up in the price of Bitcoins is an example of how poorly they perform that function.  There has been no countervailing deflation of the dollar to justify the increase in Bitcoin prices nor underlying economic events to explain it. The price of Bitcoins has run up based purely on speculation. The hype has created demand and the run-up has fed off of itself.

If the price of Bitcoins can increase that quickly, certainly the price can decrease that quickly. Would you want to contract to perform a service for one Bitcoin, perform that service today, send an invoice at the end of the month and be paid 30 days later?  The purchasing power of that one Bitcoin 30 or 60 days from today could be substantially less. Without stability Bitcoins are essentially useless as currency.

That is why many articles about Bitcoins refer to the tulip bubble in the 1600s. In both cases, prices were based upon what economists call the greater fool theory.  Everyone believed that the price would increase and bid the price up until there were no more buyers.  The bubble burst and the last fool got left holding the bag. I do not care if Bitcoins continue to go up until they reach $10,000 each or higher.  At the end of the day, someone will get left holding the bag.

A more recent twist on Bitcoins is their use in venture capital. Several companies have claimed to have raised millions of dollars by selling stock for Bitcoins or other cryptocurrencies.  They call them initial coin offerings (ICOs). Several companies profess that they have raised millions in a matter of hours. That may be because holders of Bitcoins cannot spend their coins in very many other places.

I could not locate a prospectus for one of these offerings. I do not believe that any were registered with the SEC. I would particularly like to see how the attorneys who wrote the disclosures handle the “risk factors” relating to the Bitcoins that the company received for its shares. Call it professional curiosity.

If I took anything away from my look at Bitcoins it is that there is a lot more hype than substance.  A lot of people seem to think that it is possible to create wealth by solving a mathematical puzzle. But Money for Nothing is a song by Dire Straits, not an economic reality.