Want to be a millionaire? That’s easy. All you need to do is find a failing company whose shares trade with some semblance of liquidity, offer to loan said company money, then make sure the fine print on the deal allows you to convert the note into equity at a guaranteed discount to where the stock trades.
You literally can’t lose unless of course you can’t find any buyers, but if the five or so people you hired to scout prospects did their job and chose companies whose shares actually trade, that shouldn’t be a problem.
That, apparently, is how one Joshua Sason has managed to make a fortune in penny stocks and while it’s not technically illegal, it most assuredly raises eyebrows. Here’s more, via Bloomberg:
What Sason discovered is a way to get shares in desperate and broke companies at big discounts by lending them money. Magna has done deals with at least 80 companies. Of those, the stocks of 71 have gone down since the investment. He can still turn a profit, because the terms of the deals allow him to turn debt into equity at a fixed discount. No matter where the stock is trading, he gets it for less.
Magna functions as a pawnshop for penny stocks—shares of obscure ventures that change hands far from the rules of the New York Stock Exchange. His customers have included a would-be Chilean copper miner, an inventor of thought-controlled phones, and at least two executives later busted for fraud. They come to Sason to trade a lot of their stock for a little bit of money. Often they’re aware the deal is likely to be bad for their shareholders.
If the share price goes lower before Magna can unload its investment, the companies have to give up even more stock, all but eliminating the risk for Sason. Critics call it “death-spiral financing” because it drives stocks into the ground. Others in the field say they sometimes make double, triple, or even 10 times their investment in just a few months.
The business is legal, but the loopholes in securities law it exploits are too sketchy for most of the Ivy League types at banks and hedge funds.
Too sketchy for Ivy League types at banks? That’s when you know something is wrong.
Here are the gruesome details of what happened to the next Skype when, down to his last $100,000 and burning through at least that much every 45 days, the company's owner turned to Sason and Magna:
Paul Riss’s deal with Magna in July 2011 was typical. The New York entrepreneur’s company, Pervasip, was developing a communications app to compete with Skype, but it was down to its last $100,000, barely enough to last a month at the rate the company was losing money. When Magna’s “Michael Goldberg” called offering cash, he didn’t even ask to look at the app, Riss says. “All they care about is the liquidity of the stock,” he says. “They want to see how many dollars are trading a month.”
On the surface, the $75,000 loan Magna offered seemed all right. It was in the form of an “8 percent convertible promissory note,” meaning it asked for an 8 percent return and gave Sason the right to convert it into stock. The fine print explained that if Pervasip didn’t pay back the money within six months, the lender could convert at a 45 percent discount to the market price. So, no matter where Pervasip’s stock was trading, the company had to give Magna shares that were worth more than $136,000—an 82 percent return in just six months. Essentially, Magna locked in a fixed return.
It would appear then, that all of those yield chasers who, in a desperate attempt to lock in anything that even approximates a respectable return, have piled into subprime ABS, consumer loan securitizations, and shale-related HY, are simply looking in all the wrong places. There are riskless triple-digit returns out there just waiting for someone to come along and collect them. Here is a blueprint to follow courtesy of Bloomberg’s art department...
Sason’s biggest win ever came when he agreed to pay for the right to collect the outstanding debts of a sinking company called Newlead. After paying some $45 million to the company’s creditors, Sason agreed to call it even if Newlead would grant Magna immediately-exercisable stock worth $62 million. Not a bad deal.
The punchline: Newlead is a Greek shipping company.