Stephen Watkins, a serial entrepreneur, builds upon his key ideas from that brief segment in this episode of the show. He explores the following:

1. How private companies can increase the valuation of their business by adhering to accounting and reporting standards.
2. How the Securities Act of 1933 and subsequent Acts of Congress have had the effect of limiting the entrepreneurial world of capital in an effort to protect shareholders of public companies.
3. How a new marketplace has been formed for private companies which works together with the investment community… making a capiltal market for entrepreneurs... "The Fourth Market".
4. How to leverage the use of financial reporting standards and governance to help achieve goals.

In this session, Stephen Watkins will explore how private companies can:

• Raise capital in the global market.
• Create wealth through transactions and equity.
• Attain exposure and credibility through accounting and reporting standards and increased transparency.
• Gain attention through a "fourth market" - a central global market for financial monitoring and reporting.

Biographical Summary:
Stephen Watkins, the Chairman and Chief Executive Officer of Entrex, is a serial entrepreneur who has founded six ventures from founding through exit.

Watkins started his first business while still in high school and is typically active in managing the numerous financial transactions of the companies. It is through these efforts that he has gained an understanding of the challenges of private companies and the associated private financial transactions which, in part, led to the founding and creation of Entrex. His effort creating Entrex as a capital market for private businesses led him to author a white paper; "The Fourth Market… the Private Capital Market" which is anticipated form fourth quarter 2004.

Watkins focuses on the need for both a global private equity market… but further on how entrepreneurs and small businesses can access the capital markets "creating wealth thru transactions and equity."

It is through these efforts that he has gained an understanding of the challenges of private companies and the associated private financial transactions which, in part, led to the founding and creation of Entrex. His effort creating Entrex as a capital market for private businesses led him to author a white paper; "The Fourth Market… the Private Capital Market" which is anticipated .

Watkins was awarded the prestigious U.S. Small Business Administration's 2004 "SBA's Financial Services Advocate of the Year" award for his focus on economic development through the creation of a private capital market: Entrex. This, along with the American Business Awards "Most Innovative Company" Award finalist, recognizes Watkins's effort in creating a capital and financial marketplace to entrepreneurs and the small business community. Watkins has received awards from Harvard Business School's "Entrepreneur of the Year" program and was a nominee for Ernst and Young's "Entrepreneur of the Year" award.

Boston CEO Club

On September 23, 2004, Watkins made the following presentation to the Boston CEO Club. The meeting took place at the Harvard Club on Commonwealth Avenue in Boston.

Steve Watkins: I'm going to first talk about some of my transactional experiences.

I'm going to give you a 50,000 foot overview of the capital markets. Then I'll take you into a discussion about the differences between the public and private evaluation arbitrage. We'll take about the multiples, the earnings multiples, the sales multiples and how that is so different between a private market and a public market.

I'm going to introduce to you a term, GASBORP, Generally Accepted Small Business Offering and Reporting Practices. Then I'll introduce the 4th market. It is a public market for private company shareholders.

My mantra is: wealth is made through transactions and equity.

And let me explain quickly what I mean by that. Everybody's got their house and everybody changes the evaluation on that when they're bored to say that now they are worth more. But the wealth only comes to fruition when you sell your house.

When you have a transaction that physically moves wealth around. And that's what I mean when I say wealth is made from transactions and equity. My passion from all of my transactions and businesses I've been involved with is to create a public market for private businesses. What I call the 4th marketplace.

I started out in Chicagoland in a cabling business back in the early 80s. This was when nobody understood what computer cabling meant. We took it from zero to about 5 million in a little over a 2 year period. And what I realized was I was making a lot of money. Others realized that I was making a lot of money and this is the time that they should copy us. And it's best to be in an industry that has no competition is what I learned.

As people started copying us in Chicago, we said, "Lets go out and build regionally." So we started building companies across the Midwest region.

And the mantra of the company was, "Let's have 200 offices by 2000." During that process we were even nominated for entrepreneur of the year from Ernst and Young. Yet, we quickly discovered a few weakness. The biggest was the Milwaukee office; we were spending $50,000 a month to keep it alive so I just decided to close it down.

On the drive up to Milwaukee, I called the manager and said, "We have to have a meeting. I'm on my way." But we started talking. My focus was on terminating employees. It was an ugly discussion. So, he said to me, "Well, why don't I buy it from you?"

I had to pull over. "I'm going up to close you down, I've lost probably a half million dollars on this one branch and you now want to buy it from me? What am I missing?"

In the end, we had a transaction. We took it from a $50,000 loss to a six figure gain. "Now that was interesting," we said, "why not just go and sell all of the branches." So we started slowly selling off the branches. We found employees to buy them out, outside sources to buy them. And my net worth was increasing exponentially with these transactions. We sold the house versus seeing that gain on my balance sheet.

So in the end we had nothing left which was kind of a good experience. We ended up with a company that had about $400,000 worth of sales left. It was done outside those branch offices, we subcontracted it out. We ended up taking that company from $400,000 to $10 million in a couple of years and then my job was to sell that.

The message here is that wealth is made through transactions and equity.

Each sale occurred without a marketplace for me. I had to go and find somebody. I had to use all of my contacts. Ultimately the transaction was done between me the seller and them the buyer at private company valuations. Which means a multiple of earnings...three to five times earnings. Typical numbers. There was no way I could get it up to the 18 times earnings of the public market.

What's interesting is the new owners ended up having limited liquidity for buying that company which is one of the reasons for the lower valuations. If you just look at the multiple values -- the differentiator was the thing that really frustrated me. I was getting compensated at a multiple of 3 to 5 times earnings where the public market is 18-20 times earnings.

We moved on knowing that was happening. Then the dot com era happened which was probably interesting for all of us and I don't really want to get in to the fundamentals of this but one of the things I did was take that 3,500 city distribution model, subcontractor model and we made a dot com out of it and in the end we had a transaction for 7% of and that was worth 93 million dollars. I had approximately 82% which was a good day for me.

At that point, as much as we can complain about the dot com era, investors believed that a good idea could get public. They believed there was liquidity options out there. They anticipated that it was going to be so easy to take this company -- a good idea, execute on it and flip it into the public market. So, obviously demand started exceeding supply which is beautiful as a buyer not necessarily as a seller.

Most interesting to me after doing those transactions, was that the valuation model started to converge. The 3x multiple in the private company started to move upward toward the public marketplace. It will never get to the public marketplace, but it can narrow the gap.

Steve Watkins: Company value is a function of exposure.

It's a function of credibility.

And in the end, it's a function of the liquidity options that the buyers have for your company.

So let's talk about those liquidity options. You've obviously have the public market, you've have the New York Stock Exchange, the NASDAQ, you've have the American Stock Exchange. In the private market place -- what we're trying to create here -- is a fourth market. A market for the public trading of private shareholder interests.

Being in Boston I think I should mention Charles K. Ponzi, just down on Charles Street. It was 1919 when he launched his first pyramid scheme that would forever carry his name. Though it collapsed within a year, Ponzi schemes and many other forms of corruption and dishonesty, culminated in the 1929 crash. The government responded by creating the Securities Act of 1933, then the 1934 Act, and they created a public marketplace.

By creating the public marketplace they created an inefficient private marketplace and that is fundamentally what I am trying to resolve here.

Let's take a look at the public marketplace and see how it works.

There's really two sides to the game. There is an informational structure supported by the SEC -- a group they call EDGAR, the Electronic Data Gathering Analysis and Retrieval system. Then you have what is called the SROs the Self-Regulating Organizations -- that essentially the three major exchanges. Then there are a number of regional and local exchanges that typically going transaction oriented businesses versus trading.

What this infrastructure allows people to do is ... With EDGAR up there, the public companies now report to EDGAR. As EDGAR feeds data down into the broker dealer community and down into the investor community people can make investment decisions. There's a single place to find, track manage and research public companies. Makes it very easy. By the time you have the local investor on the IPO side of the game the company gives stock to the investment banker so he can go out and raise money.

The investment banker and the broker/dealer community does a road show and they end up talking to the investor, the investors then send cash, the IB sends the stock certificate then in the end the public company ends up with money.

What happens next is really the secondary market of this stock. There is common information available. The investor can now make an intelligent decision, talk to his broker, wire his money, trade and the public company is not even involved. With the exclusion of constantly updating the EDGAR data structure. So we all have a place to look and learn about that public company.

You've got offering market and the secondary market. I need you to understand those two so we can discuss what happens in the private space in a little while. What's interesting is, as the government did this, and I don't think it intended to do, was limit it to 17,000 public companies. By the way, there are about 6,000 on the three top exchanges. There's another 6,000 on what they call over the counter bulletin board which is run by NASDAQ and then you've got the pink sheets probably 4,500 odd companies. The companies on the major exchanges meet the criteria for those markets -- when you fall off those criteria -- trading volume, stock price, market cap issues, you fall down into the over the counter bulletin board. You're still reporting to the SEC, you don't necessarily meet the market standards. When you fall off that you go to the pink sheets that's when you stop reporting and you're publicly trading.

There's about 500 million dollars a day traded in these penny stocks and pink sheets and investors are making decisions without any information. Fascinating market space. After working with pink sheets we thought, this is really quite interesting. That means the public is interested in buying companies they don't really know anything about, they're really private companies. How can we take that and move that into the private market place to create a benefit for the broker community and the investment community.

Out of the 17,000 public companies there's only about 3,500 that are actively traded everyday. Only 500 of those companies are actually bought. You call up your broker to ask for IBM or NCR or Dell or Microsoft. The other 16,500 companies are actually sold by their CEOs, investment bankers and broker dealers that are supporting them. So when you start tying to put all that together, it becomes a great vehicle to look at how can we structure this around creating a private market space.

The essence of the private market place are the offerings and the reporting structures that we all do privately today. Our lawyers and our accountants all do this pursuant to GASBORP-- Generally Accepted Small Business Operating and Reporting Practices. This is the stuff, if you go out on a private placement you might shop a private placement around the table today I have to do it pursuant to the 500 series offerings this is called. In the end this is called a private placement memorandum.

At some level, after you give me money, I have to report back to you. There are various standards, you decide. Obviously you've go the audit. It's not rocket science. It's a very standard industry practice. But, everyone of those deals is sold just like the 16,500 public companies. So when yo look at the size of the private marketplace 28 million private companies, there's 1.1 million greater than 1 million dollars in sales. Then there are 112, 000 that are greater than 10 million dollars in revenue. These are private companies.

And you know that every one of those deals is sold -- nobody's trying to buy those. What's interesting is when you start looking at those companies, private companies, they typically use their rolodex and the rolodex's rolodex that's how private deals happen.

If you consolidate all of the financial information it turns out that about 80% of the transactions are done within a 50 mile radius of the venue. So as much as I fly over to Europe to raise money in the end the deals are done locally. You can understand the logic. You want to be able to drive buy and see if the lights are on and the CEO is working.

Fundamentally deals don't happen if you can't be found. Capital is not going to fund what it can't find.

It's all about exposure, credibility and liquidity.

Let's just talk about the valuation issue for a second. If you look at the public market valuations and this is a great reason to figure out how to get more exposure for your company. The public market is really focused on 18 times earnings. Or about 3 times sales on average.

Which means if you are a $10 million dollar company with $1 million dollars of EBIT. At this point I'd like to talk about EBOT before I talk about EBIT. EBOT is Earnings Before Owner Theft. (laughter) That's not part of GASBORP. So $10 million in sales and $1 in profit. In a public market that puts a $30 million dollar valuation. Or $18 million on earnings.

In a private, I know you can all beat me up because someone sold at a better multiple, but the industry standards show it's 3 times earnings. So that means that the private company doing exactly the same earnings and sales is 3 million. That's a 27 million dollar arbitrage. Why is that? My argument is a function of exposure, credibility and liquidity that the shareholders have.

What's most interesting is what happens in the acquisition paradox as a public company. So here you are a $1M earnings company. You sell out for $3 million to the public company and you're very happy. They pick up your million dollars in profit, they also pick up that 27 million dollars of value. So they are 27 million dollars happier than you are.

All that happened was a quick transaction. Nothing else changed. Why does this arbitrage exist? I think it's because there is no centralized data structure for investors to find you and there is no brokerage market to help find liquidity for these private companies. So we have gone out and worked with an SEC-sanctioned exchange to create a reporting infrastructure like GASBORP as an informational infrastructure and then a trading infrastructure that supports the shareholder's interest in these companies.

We call that the 4th market. Its the public market for private company shareholders.

We've been acclaimed by the SBA; we're now sanctioned by the SEC and ultimately it's this GASBORP and the acknowledgment of the public trading marketplace and the brokers dealers marketplace that allows us to create a market space. So with this informational marketplace from a capital raise, you've got an offering infrastructure just through GASBORP, just as we do it today because we've got this offering side where the investors can learn about your company, they can send you the capital the you send the stock certificate. But by creating this mechanism that allows private companies to report through this informational platform and by working together with the SEC exchange that can now get your company symbol and knowledge out across the investment marketplace it allows the investment community to work through their broker dealers to learn about these private companies that have publicly traded shareholder interests.

You compare the two market spaces, the public and this Fourth Market. they become very similar with the exclusion of the original issuing market that is done in the public market space.

So what can this marketplace do? So what can it do for you?

We've created this thing -- it is making standards public. And, we've created a trading vehicle that can actually allow you to publicly trade your stock.

Compare the two market spaces. They become very similar with the exclusion of the original issuing market that is done in the public market space.

We can create a public valuation for your private company.

We can allow your shareholders, whether it's yourself your prior investors the other founders of the company to take some chips off the table. Now that there is a public audience looking at your private company stock and learning about you can now take some of the money you have earned and finally do that house sale I talked about earlier. You can now give new investors a known exit strategy.

The big thing I always hear in the VC discussion is what is your exit strategy? How am I going to get the money out? In today's economy it's difficult to say with a straight face that I'm going to go do a NASDAQ IPO. And probably realistically if you look at the 3,500 companies that are actively trading the likelihood of you being a successful IPO is very small. So if you can show how you have this known exit strategy through this 4th market place that's going to give you a path for your exit it provides this liquidity route.

Further it provides an external evaluation of your company. I'm sure you've all been in discussions with VC s and they love to discount you down to whatever they feel your company's worth. But if you can show there is actually some public trading of your stock you're now able to talk to that VC intelligently about the quantifiable evaluation of your company.

Further, if you have employee options or you would like to incentivize employees through stock ownership . This allows the potential shareholders that are employees to have an option marketplace and they can go see the value of their shares. And further it creates a currency for acquisitions. I don't know about you but when I was doing my acquisition strategies as a private company it was always a dance when they said well what is your private stock worth? I had to hem and haw around it and say well our future earnings are going to be this and you make a story. But what this does is it allows you to actually say well the last sale was $10 a share. I'm going to give you, out of the $6 million I owe you, I'll do it at the discount of $5 a share. So now you have discussions in the acquisitions market space as a private company because you've got this currency value out in this 4th market space.

And because you have information out there you have exposure out there and you're getting credibility it lowers the arbitrage between being a public company and being a private company. So you're half way in the middle.

If you look at this as the original founder -- how do you get out? --- well this is a great vehicle that allows you to use the broker dealer community to introduce your company to other investors and ultimately have one of them buy.

It can take the other investors, friends and family, sometimes known as fools as well, it can let them take some of their chips off the table. It gives new investors a known route to an exit strategy. It doesn't have to be that hopeful idea that home run that everybody wants. This could be a single or a double just so they know there is a path to liquidity.

Again, talking about the option of employees, they now have a place where they can go see the value of their stock. Rather than you telling them that it is worth $10 they can see it. For new acquisitions, you've got people giving you their company for stock and cash now your company grows a little bit and now you know that they as an acquired individual shareholder have a marketplace that they can go to.

So how is this done? There are about 27 steps. This is not about being a private company this is not about EBOT. But it is also not about being a public company. It doesn't have the Sarbanes-Oxley issues associated with it, it does have governance issues associated with it. In the end we need a GAPP* audit. You don't need a FASBE* audit. We need a legal opinion that your shares are free trading. All of this is managed by the DTC*. It's managed the same way IBM's shares are. Your shares have to be outside for a transfer agent to be able to manage that transaction. It legitimizes what's happening here.

You have to get a CUSIP* number from Standard and Poors, it's like getting an EIN number. The NASD can give you the symbol. There's about 27 steps. It's not easy but is also changes the evaluation. My job is to try to bridge that arbitrage gap between the multiples of private companies and the multiples of public companies. The fundamentals have to be the same. It's not a miracle. But it's by putting the effort behind that we can end up providing some exposure, creditability and liquidity for your company. Our intent is to do that through this 4th marketplace.

The cost of joining the 4th market: $15,000- $25,000 in fees to do the offering then $1,500 a month to stay listed.

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