To pull off this trick, the company must have both ordinary and preferred stock. From this page from the Journal of Accountancy:
To value a business having both common and preferred shares, CPAs should value the preferred shares first and deduct that value from the entire equity of the entity.
The trick? Ignore the difference between preferred stock and ordinary stock, and then use the price paid for preferred stock and multiply it by the total number of shares. Presto! Massive overvaluation, it can be!
This is what happened. IH Holdings International bought IH through a stock swap. Original penny stock in IH became penny stock in IHHI. Then preferred stock was issued to two Woodford funds for a total of $50 million U.S. The cost of each share was $45.05 (minus a tiny fraction of a cent). (IHHI financial reports are available at Companies House.
See the Annual Return of 24 May, 2016, pdf page 13.
By assuming that this established a value for “shares” in IHHI, and neglecting the preferred status, the company was then drastically overvalued. Who did this?
Well, Sifferkoll and others, the idea being that Darden and other investors had magically multiplied their penny stock value by a factor of 4500. This became part of the Rossi story of “unjust enrichment.” I was reminded of this by a chart published by Sifferkoll July 18, probably a republication of an earlier chart, giving the ownership of IH as “95% Darden, Cherokee, and ~20 investors … & 5% Woodford Capital Funds @ $1 billion valuation.”
First of all, Cherokee does not own and has never owned stock in IH, nor in IHHI. This is all very inaccurate, replicating what Rossi claimed in his lawsuit.
The $1 billion valuation is obtained by multiplying the Woodford Investment in preferred shares, for which they paid $50 million, or $45.03 per share, by the total number of outstanding shares of all classes, or (as of that statement mentioned above), 25,913,614. That would be a bit under $1.2 billion.
What if they had only sold one share of preferred stock for $45.03? The same logic would establish the same conclusion, a billion dollar valuation!
Preferred stock is more like a loan than like common shares. It is first in line for any distribution of profits, or for payments on liquidation, standing behind only regular liabilities. Valuing a company based on a huge loan they obtained would be similar. Dumb. The loan does not increase the value of the company, because it increases assets (cash or property) but increases liabilities, the same. If this had been a sale of common stock, and especially a market sale by existing shareholders, that would be quite different. It was not.
This same misrepresentation was in the Chaiken opening statement in the trial.
May 2015, payday. Defendants successfully sell
4 percent of their company in exchange for 50 million dollars.
That’s a 1 billion dollar valuation. They kept 96 percent,
they gave out 4 percent of their shares for 50 million dollars.
“Their shares” were ordinary stock. So they did not sell “their shares” for $50 million. Had they done so, this would have established a valuation as claimed and they would have made a large profit, it would have been “payday.” Surely Chaiken would understand this.
So he was telling a story, it was a bit of theater, designed to create an impression of fabulous profit in the mind of the jury. Woodford invested in a new company, that became the full owner of IH. The business of this company was developing business relationships with other inventors (not Rossi) and with scientists (making substantial investments in research, some of it with no short-term possibility of commercial devices).
“Their shares,” all of them, were sold to IHHI, penny for penny.
Rossi hated this development, obviously, and it was the investments in “competitors” that he gives as his reason in his recent interview for wanting to get out of the relationship. It is entirely possible that he decided to exclude the IH engineer from visiting the Plant in July, two months later, because he would know that this would torpedo all possibilities of relationship, and he’d done that kind of thing before.