| NEWTEK BUSINESS SERVICES INC Item 1A Risk Factors If any of the following risks occur, our business, financial condition and results of operations could be materially and adversely affected |
| In that case, the value of our common shares could decline and you may lose all or part of your investment |
| The risks set out below are not the only risks we face |
| RISKS RELATING TO OUR BUSINESS GENERALLY Our business focuses on the investment in and acquisition of small businesses, which typically have a high rate of failure, may take some time to become profitable and may never become profitable |
| We place primary emphasis on the investment in and acquisition of small businesses with the objective of developing a network of profitable businesses, most of which will principally serve the small and medium-sized business market |
| Early stage businesses historically have a higher rate of failure than larger businesses, and many that do not fail will have only limited profitability |
| Moreover, profit generated by any of our majority-owned companies or other investments could be offset by losses generated by others |
| Our profitability resulting from the operations of our businesses may be delayed for the foreseeable future |
| We have generated and carry goodwill as an asset resulting from some of our acquisition transactions |
| We can make no assurance that our current or future additional goodwill will not be written down pursuant to applicable accounting standards |
| A significant write down of a major asset, such as goodwill, could have a material adverse effect on our business, a negative impact on earnings and the value of our common shares |
| Each of our major investments and affiliated companies may be impacted by a variety of adverse economic, governmental, industrial and internal company factors unique to that business and outside our control |
| If our investments and affiliated companies do not succeed in overcoming these adverse factors, the value of our assets and the price of our shares would fall |
| 21 ______________________________________________________________________ [41]Table of Contents In the past few years we have increasingly concentrated our investments in companies participating in small business lending, electronic payment processing, the Newtek Insurance Agency and CrystalTech |
| Each of these businesses has numerous risks associated with them and you should read the specific risk factors set forth below with respect to each of these businesses |
| As we have concentrated our investments, typically made through the capco programs, in companies which are part of our nationwide marketing strategy of providing a variety of services to small and medium-sized businesses, our exposure and that of our affiliated companies to risks specific to these business lines has increased |
| We discuss below some of the risks of our significant operations in government-guaranteed small business lending, acting as an independent sales organization in the electronic card processing business, web hosting business and operating as an insurance agency |
| If we are not successful in implementing this business strategy and developing and marketing our new products and services, our results of operations will be negatively impacted |
| If we do not manage our growth effectively, our financial performance could be harmed |
| Our rapid revenue growth has placed, and will continue to place, certain pressures on our management, administrative, operational and financial infrastructure |
| As we continue to grow our business, such growth could require capital, systems development and human resources beyond current capacities |
| As evidence of our internal growth, on December 31, 2001, we and all of our consolidated and majority-owned affiliates had approximately 20 employees, and on December 31, 2005 we had approximately 360 employees and independent contractors |
| The increase in the size of our operations may make it more difficult for us to ensure that we execute our present businesses and future strategies |
| The failure to manage our growth effectively could have a material adverse effect on our financial condition, results of operations and cash flows |
| If we are unable to obtain the resources required for the growth and development of our affiliated companies, they will be highly susceptible to failure, which would directly affect our profitability and value |
| Early-stage businesses often fail due to their limited capital and human resources |
| The effective implementation of our business model is dependent upon the ability of the affiliated companies, with assistance from us, to arrange for the managerial, capital and other resources which they usually require in order to become and remain profitable |
| We may not be able to integrate acquired companies into our company and, as we acquire more and larger interests in affiliated companies, our resources available to assist our affiliated companies may be insufficient |
| We have made strategic acquisitions and we intend to continue to make acquisitions in accordance with our business plan |
| Each acquisition involves a number of risks, including: • the diversion of our management’s attention to the assimilation and ongoing assistance with the operations and personnel of the acquired business, which could strain the management resources we have available; • the potential for our affiliated companies to grow rapidly and adversely affect our ability to assist our affiliated companies as intended; • possible adverse effects on our results of operations and cash flows; and • possible inability by us to achieve the intended objective of the acquisition |
| Any strain on our ability to assist our affiliated companies as intended or to acquire and integrate businesses under our business plan could have a negative impact on our operations, financial results and cash flows |
| 22 ______________________________________________________________________ [42]Table of Contents Our business may be adversely affected by the highly regulated industries in which we operate |
| Many of the industries in which we operate are highly regulated and we cannot assure you that we or our affiliated companies are, or that we will continue to be, in full compliance with current laws, rules and regulations |
| If we or our affiliated companies are unable to comply with applicable laws or regulations or if new laws limit or eliminate some of the benefits of our business lines, our financial condition, results of operations and our cash flows could be materially adversely affected |
| If we lose our key personnel, we may not be able to find and hire experienced replacements |
| Our business relies heavily on the expertise of our senior management, particularly Messrs |
| Barry Sloane, Michael J Holden and Jeffrey G Rubin, our CEO, CFO and President, respectively |
| Sloane and Rubin currently serve pursuant to employment agreements which expire on June 30, 2006 |
| The loss of the services of these individuals could have a material adverse effect on our financial condition, results of operations and cash flows and it is likely that it will be difficult to find adequate replacements |
| Our method of income recognition derived from the capco tax credits causes most of such income to be received in the first five years of the programs |
| In the absence of income from our investments or other sources, we would sustain material losses in later years |
| In our capco programs we recognize the majority of our income from the tax credits in the early years of the programs because income recognition is tied to the schedule by which the tax credits become irrevocable and beyond recapture (approximately five years) |
| We recognize the majority of our income from an average ten year capco programs in the first five years and will not be recognizing significant tax credit income in the latter part of the program |
| However, we will continue to incur costs for the administration of the capcos and (non-cash) interest expenses on the capco notes |
| In the absence of income from other sources, such as our investments in small businesses and affiliated companies, our income would decrease materially and we would likely sustain material losses in the later years of the programs and in particular in 2006 and 2007 |
| We currently rely solely on common law to protect certain but not all of our intellectual property; should we seek additional protection in the future, we may be unable to register successfully certain trademarks, possibly causing us to lose our rights to such trademarks |
| While certain of our intellectual property and trademarks are registered all are not |
| We do not rely on these marks at present in our marketing efforts but if we should in the future and if we should attempt to register them we may be unable to protect the rights and potentially lose the rights to the marks |
| Our affiliated companies depend upon the ability to utilize the Internet for the conduct of a significant portion of their business; disruption to that system could make it impossible for them to continue to conduct their current businesses |
| Possible disruption to the normal functioning of the Internet through, for example, power failure or terrorist sabotage, could make it impossible for aspects of the lending, electronic payment processing, web hosting and in fact our referral system to function |
| Each of our businesses have addressed the possibilities of short term disruptions and planned accordingly |
| However, in the event of a major disruption, and assuming that the disruptions would be long lived, we would be required to make extensive changes in the way these companies do business |
| We and our affiliated companies depend on our ability to attract and retain key personnel and any loss of ability to attract these personnel could adversely affect us |
| Our success depends upon the ability of our affiliated companies and other investments to attract and retain qualified personnel and our ability to supplement those capabilities with our senior management personnel |
| Competition for qualified employees is intense |
| If our affiliated companies lose 23 ______________________________________________________________________ [43]Table of Contents the services of key personnel, or are unable to attract additional qualified personnel, the business, financial condition, results of operations and cash flows of us or one or more of our affiliated companies could be materially adversely affected |
| It can take a significant period of time to identify and hire personnel with the combination of skills and attributes required in carrying out our strategy |
| Our success depends on our ability to compete effectively in the highly competitive industries in which we operate |
| We face intense competition in organizing capcos, originating SBA loans, processing electronic payments and offering insurance, as well as in the other industries in which we or our affiliated companies operate |
| Low barriers to entry often result in a steady stream of new competitors entering certain of these businesses |
| Current and potential competitors are or may be better established, substantially larger and have more capital and other resources than we do |
| If we expand into additional geographical markets, we will face competition from others in those markets as well |
| Our success also depends on our ability to use effectively our electronic referral and processing system |
| We have developed and are placing in operation an electronic referral and processing system for the applications necessary for the sales of each of our business lines other than web site hosting |
| This system is critical to our ability to process such business with a low cost advantage and to obtain referrals from our alliance partners |
| In particular, their ability to access the referral system and to track the progress of a referred customer is a major feature of the perceived attractiveness of our system |
| If this referral system should develop problems which we cannot address, it would have a material negative impact on our business strategy |
| A major feature of our business strategy is the development of opportunities for our service and product provider businesses to market to the customers of our other business lines and to the customer bases of our alliance partners |
| Although our business strategy contemplates the referral of prospects between wholly-owned and partially owned companies in our network, there is no history of such cross-selling and there can be no assurances that any effort to make referrals across our network of affiliated companies will result in additional revenue opportunities |
| In order for our referral network to achieve the desired result, each of the constituent companies must have proper incentives and feel comfortable making such introduction, and furthermore, the service provider receiving such referral must properly service such referred client |
| Instituting a corporate culture conducive to sending and receiving referrals is difficult and may not yield the results anticipated by us |
| In addition, our marketing alliances are terminable and, if we make serious errors or fail to produce sufficient revenues for our alliance partners, we are at risk of losing these relationships |
| The inability of any one of our business segments to service customers adequately referred to it from within our other companies could impair our overall relationship with such customers |
| A significant benefit of our structure and strategy is the ability to cross market between our SBA, electronic payment processing and other business customers, including potentially those of CrystalTech |
| However, should the business relationship between one of our business segments and customers deteriorate for any reason, such customers may opt to withdraw their business from our other businesses |
| Such a loss of business could negatively impact our results of operations and cash flows |
| We rely on information processing systems, and our strategy of cross marketing to customers among our majority-owned subsidiaries will increase this reliance; the interruption, loss or failure of which would materially and adversely affect our business |
| Our ability to provide business services depends, and will increasingly depend, on our capacity to store, retrieve, process and manage significant amounts of data and expand and upgrade our 24 ______________________________________________________________________ [44]Table of Contents information processing capabilities |
| Interruption or loss of our information processing capabilities through loss of stored data, breakdown or malfunctioning of computer equipment and software systems, telecommunications failure or damage caused by acts of god or other disruption, could have a material adverse effect on our business, financial condition, results of operations and cash flows |
| Although we have disaster recovery procedures in place and insurance to protect against such contingencies, we cannot be certain that our disaster recovery systems or insurance will continue to be available at reasonable prices, cover all our losses or compensate us for the possible loss of clients occurring during any period that we are unable to provide outsourced business services |
| We are attempting to build a national “Newtek” brand for services and products marketed to small and medium-sized businesses, but we are unable to obtain a significantly high level of protection for the brand name due to its previous usage in other contexts |
| The current and past usage by others of names similar to “Newtek” may make obtaining a significant level of protection for the use of such name very costly |
| We cannot assure you that we will be able to prevent competitors from using the name “Newtek” in other contexts or even in competition with us |
| In the event of such an infringement, we would attempt to vigorously defend our rights to the name, but we can give no assurance that we will be successful in doing so |
| We have not registered the mark “Newtek” with the United States Patent and Trademark Office |
| RISKS RELATING TO OUR SBA LENDING BUSINESS We may be adversely affected by the regulated environment in which we operate |
| The activities of our SBA lending business are subject to the supervision and regulation by the federal government and to a lesser degree the state governments, as well as various laws and judicial and administrative decisions |
| Our possible inability to remain in compliance with these multiple requirements could result in the revocation or suspension of our license or the imposition of fines and penalties |
| We have specific risks associated with small business administration loans |
| We have generally sold the guaranteed portion of SBA loans in the secondary market |
| There can be no assurance that we will be able to continue originating these loans, or that a secondary market will exist for, or that we will continue to realize premiums upon the sale of, the guaranteed portions of the SBA loans |
| We believe that our SBA loan portfolio does not involve more than a normal risk of collection |
| However, since we sell the guaranteed portion of substantially all of our SBA loan portfolio, we incur credit risk on the non-guaranteed portion of the SBA loans |
| We share pro rata with the SBA in any recoveries |
| In the event of default on an SBA loan, our pursuit of remedies against a borrower is subject to SBA approval, and where the SBA establishes that its loss is attributable to deficiencies in the manner in which the loan application has been prepared and submitted, the SBA may decline to honor its guarantee with respect to our SBA loans or it may seek the recovery of damages from us |
| If we should experience significant problems with our underwriting of SBA loans, such failure to honor a guarantee or the cost to correct the problems could have a material adverse effect on us |
| Although the SBA has never declined to honor its guarantees with respect to SBA loans made by us since our acquisition of the lender, no assurance can be given that the SBA would not attempt to do so in the future |
| Curtailment of the government guaranteed loan programs could cut off an important segment of our business |
| There can be no assurance that the federal government will maintain the SBA program, or that it will continue to guarantee loans at current levels |
| If we cannot continue making and selling government guaranteed loans, we will generate fewer origination fees and our ability to generate gains on sale of 25 ______________________________________________________________________ [45]Table of Contents loans will decrease |
| From time to time, the government agencies that guarantee these loans reach their internal budgeted limits and cease to guarantee loans for a stated time period |
| In addition, these agencies may change their rules for loans |
| Also, Congress may adopt legislation that would have the effect of discontinuing or changing the programs |
| Non-governmental programs could replace government programs for some borrowers, but the terms might not be equally acceptable |
| If these changes occur, the volume of loans to small business and industrial borrowers of the types that now qualify for government guaranteed loans could decline, as could the profitability of these loans |
| Changing interest rates may reduce our income from lending |
| Fluctuations in general economic conditions and in interest rates may affect customer demand for our loans and other products and services as well as the performance of our existing portfolio |
| Our lending business may increase during times of falling interest rates and, conversely, decrease during times of significantly higher interest rates |
| Significant fluctuations in interest rates and loan demand could have a potentially adverse effect on our results of operations and cash flows |
| An increase in non-performing assets would reduce our income and increase our expenses |
| If our level of non-performing assets in our SBA lending business rises in the future, it could adversely affect our revenue and earnings |
| Non-performing assets are primarily loans on which borrowers are not making their required payments |
| Non-performing assets also include loans that have been restructured to permit the borrower to have smaller payments and real estate that has been acquired through foreclosure of unpaid loans |
| To the extent that our loan assets are non-performing, we will have less cash available for lending and other activities |
| Our reserve for credit losses may not be sufficient to cover unexpected losses |
| Our business depends on the behavior of our customers |
| We believe that our credit underwriting procedures are sufficient to protect us against all but the most unexpected events |
| In addition to our credit practices and procedures we maintain a reserve for credit losses on our SBA loans which management has judged to be adequate given the loans we make |
| We periodically review our reserve for adequacy considering current economic conditions and trends, collateral values, charge-off experience, levels of past due loans and non-performing assets and adjust our reserve accordingly |
| However, based on the increased volume in recent originated loans, along with changes in the credit quality of our customers, our reserves could materially be impacted thus affecting our financial condition and results of operations |
| We compete with numerous financing sources |
| We compete for our customers primarily on the basis of pricing, terms and service |
| Competition from both traditional lenders and new entrants is intense due to the recent strong economy and the ease with which the securitization process has increased the access to capital |
| While we have attempted to utilize our referral system as a means of obtaining customers at a low cost and processing the applications efficiently, there can be no assurance that we will be able to match the terms of our competitors without incurring losses |
| In addition, due to our relatively small size and capitalization, our larger competitors may be able to make loans when we are not due to our dependence on external warehouse financing |
| 26 ______________________________________________________________________ [46]Table of Contents RISKS RELATING TO OUR ELECTRONIC PAYMENT PROCESSING BUSINESS We rely currently on a single bank sponsor, which has substantial discretion with respect to certain elements of our business practices, in order to process bankcard transactions |
| If this sponsorship is terminated and we are not able to secure or migrate merchant portfolios to new bank sponsors, we will not be able to conduct our electronic payment processing business |
| Because we are not a bank, we are unable to belong to and directly access the Visa and MasterCard bankcard associations |
| The Visa and MasterCard operating regulations require us to be sponsored by a bank in order to process bankcard transactions |
| We are currently registered with Visa and MasterCard through the sponsorship of one bank that is a member of the card associations |
| If this sponsorship is terminated and we are unable to secure a bank sponsor, we will not be able to process bankcard transactions |
| Furthermore, our agreement with our sponsoring bank gives the sponsoring bank substantial discretion in approving certain elements of our business practices, including our solicitation, application and qualification procedures for merchants, the terms of our agreements with merchants, the processing fees that we charge, our customer service levels and our use of independent sales organizations |
| We cannot guarantee that our sponsoring bank’s actions under these agreements will not be detrimental to us |
| If we or our processors or bank sponsor fail to adhere to the standards of the Visa and MasterCard bankcard associations, our registrations with these associations could be terminated and we could be required to stop providing payment processing services for Visa and MasterCard |
| Substantially all of the transactions we process involve Visa or MasterCard |
| If we, our bank sponsor or our processors fail to comply with the applicable requirements of the Visa and MasterCard bankcard associations, Visa or MasterCard could suspend or terminate our registration |
| The termination of our registration or any changes in the Visa or MasterCard rules that would impair our registration could require us to stop providing payment processing services, which would have a material adverse effect on our business |
| We and our electronic payment processing subsidiaries rely on other card payment processors and service providers |
| If they no longer agree, or are unable, to provide their services, our merchant relationships could be adversely affected and we could lose business |
| Our electronic payment processing business relies on agreements with several other large payment processing organizations to enable us to provide card authorization, data capture, settlement and merchant accounting services and access to various reporting tools for the merchants we serve |
| We also rely on third parties to whom we outsource specific services, such as reorganizing and accumulating daily transaction data on a merchant-by-merchant and card issuer-by-card issuer basis and forwarding the accumulated data to the relevant bankcard associations |
| Many of these organizations and service providers are our competitors |
| The termination by our service providers of these arrangements with us or their failure to perform these services efficiently and effectively may adversely affect our relationships with the merchants whose accounts we serve and may cause those merchants to terminate their processing agreements with us |
| On occasion, we experience increases in interchange and sponsorship fees |
| If we cannot pass these increases along to our merchants, our profit margins will be reduced |
| Our electronic payment processing subsidiaries pay interchange fees or assessments to bankcard associations for each transaction we process using their credit, debit and gift cards |
| From time to time, the bankcard associations increase the interchange fees that they charge processors and the sponsoring banks |
| At their sole discretion, our sponsoring banks have the right to pass any increases in interchange fees on to us |
| In addition, our sponsoring banks may increase their Visa and MasterCard sponsorship fees, all of which are based upon the dollar amount of the payment transactions we process |
| If we are not able to pass these fee increases along to merchants through corresponding increases in our processing fees, our profit margins in this line of business will be reduced |
| Unauthorized disclosure of merchant or cardholder data, whether through breach of our computer systems or otherwise, could expose us to liability and business losses |
| Through our electronic payment processing subsidiaries, we collect and store sensitive data about merchants and cardholders and we maintain a database of cardholder data relating to specific 27 ______________________________________________________________________ [47]Table of Contents transactions, including payment, card numbers and cardholder addresses, in order to process the transactions and for fraud prevention and other internal processes |
| If anyone penetrates our network security or otherwise misappropriates sensitive merchant or cardholder data, we could be subject to liability or business interruption |
| We cannot guarantee that our systems will not be penetrated in the future |
| If a breach of our system occurs, we may be subject to liability, including claims for unauthorized purchases with misappropriated card information, impersonation or other similar fraud claims |
| Similar risks exist with regard to the storage and transmission of such data by our processors |
| We have potential liability if our merchants refuse or cannot reimburse charge-backs resolved in favor of their customers |
| If a billing dispute between a merchant and a cardholder is not ultimately resolved in favor of the merchant, the disputed transaction is “charged back” to the merchant’s bank and credited to the account of the cardholder |
| If we or our processing banks are unable to collect the charge-back from the merchant’s account, or if the merchant refuses or is financially unable due to bankruptcy or other reasons to reimburse the merchant’s bank for the charge-back, we bear the loss for the amount of the refund paid to the cardholder’s bank |
| We face potential liability for customer or merchant fraud |
| Credit card fraud occurs when a merchant’s customer uses a stolen card (or a stolen card number in a card-not-present transaction) to purchase merchandise or services |
| In a traditional card-present transaction, if the merchant swipes the card, receives authorization for the transaction from the card issuing bank and verifies the signature on the back of the card against the paper receipt signed by the customer, the card issuing bank remains liable for any loss |
| In a fraudulent card-not-present transaction, even if the merchant receives authorization for the transaction, the merchant is liable for any loss arising from the transaction |
| Many of our business customers are small and transact a substantial percentage of their sales over the Internet or by telephone or mail orders |
| Because their sales are card-not-present transactions, these merchants are more vulnerable to customer fraud than larger merchants and we could experience charge-backs arising from cardholder fraud more frequently with these merchants |
| Merchant fraud occurs when a merchant, rather than a customer, knowingly uses a stolen or counterfeit card or card number to record a false sales transaction or intentionally fails to deliver the merchandise or services sold in an otherwise valid transaction |
| We have established systems and procedures to detect and reduce the impact of merchant fraud, but we cannot assure you that these measures are or will be effective |
| Failure to manage effectively risk and prevent fraud could increase our charge-back liability |
| Our payment processing systems may fail due to factors beyond our control, which could interrupt our business or cause us to lose business and likely increase our costs |
| We depend on the uninterrupted operations of our computer network systems, software and our processors’ data centers |
| Defects in these systems or damage to them due to factors beyond our control, and notwithstanding any redundant systems we develop and implement, could cause severe disruption to our business and other material adverse effects on our payment processing businesses |
| RISKS RELATING TO OUR OPERATION OF A WEBSITE HOSTING BUSINESS CrystalTech operates in a competitive industry where technological change can be rapid |
| The website hosting business and its related technology involve a broad range of rapidly changing technologies |
| CrystalTech’s equipment and the technologies on which it is based may not remain competitive over time, and others may develop superior technologies that render CrystalTech’s products non-competitive without significant additional capital expenditures |
| 28 ______________________________________________________________________ [48]Table of Contents CrystalTech’s website hosting business depends on the efficient and uninterrupted operation of its computer and communications hardware systems and infrastructure |
| Despite precautions taken by CrystalTech against possible failure of its systems, interruptions could result from natural disasters, power loss, the inability to acquire fuel for our backup generators, telecommunications failure, terrorist attacks and similar events |
| CrystalTech also leases telecommunications lines from local, regional and national carriers whose service may be interrupted |
| CrystalTech’s business, financial condition and results of operations could be harmed by any damage or failure that interrupts or delays our operations and cash flows |
| Of primary importance to CrystalTech’s website hosting customers is the integrity of its infrastructure and the privacy of confidential information |
| CrystalTech’s infrastructure is potentially vulnerable to physical or electronic break-ins, viruses or similar problems |
| If a person circumvents CrystalTech’s security measures, he or she could jeopardize the security of confidential information stored on CrystalTech’s systems, misappropriate proprietary information or cause interruptions in CrystalTech’s operations |
| We may be required to make significant additional investments and efforts to protect against or remedy security breaches |
| Security breaches that result in access to confidential information could damage our reputation and expose us to a risk of loss or liability |
| The security services that CrystalTech offers in connection with customers’ networks cannot assure complete protection from computer viruses, break-ins and other disruptive problems |
| Although CrystalTech attempts to limit contractually its liability in such instances, the occurrence of these problems may result in claims against CrystalTech or us or liability on our part |
| These claims, regardless of their ultimate outcome, could result in costly litigation and could harm our business and reputation and impair CrystalTech’s ability to attract and retain customers |
| CrystalTech’s business depends on Microsoft Corporation and others for the licenses to use software as well as other intellectual property in the website hosting business |
| CrystalTech’s website hosting business is built on a technological platform relying on the Microsoft Windows^® products and other intellectual property that CrystalTech currently licenses |
| As a result, if we are unable to continue to have the benefit of those licensing arrangements or if the products upon which CrystalTech’s platform is built become obsolete, our business could be materially and adversely affected |
| CrystalTech depends on the services of a few key personnel in managing its website hosting business, and the loss of one or more of them could materially impair its ability to maintain current levels of customer service and the proper technical operations of its business |
| We depend upon the continued management by Tim Uzzanti of the operations of CrystalTech’s website hosting business, along with three or four other individuals to supervise CrystalTech’s technical operations and the customer technical service response |
| If we were to lose the services of one or more of these persons and were unable to replace them expeditiously, our website hosting business could be significantly diminished |
| RISKS RELATING TO OUR INSURANCE AGENCY BUSINESS We cannot assure that the insurance services we plan to offer will be price competitive or accepted by our customers |
| Despite our efforts to design, market and deliver integrated services to our customers, our proposed new services may not be widely accepted and we may not be able to compete with other larger and better capitalized providers of such services |
| 29 ______________________________________________________________________ [49]Table of Contents We depend on third parties, particularly property and casualty insurance companies, to supply the products marketed by our agents |
| Our contracts with property and casualty insurance companies typically provide that the contracts can be terminated by the supplier without cause |
| Our inability to enter into satisfactory arrangements with these suppliers or the loss of these relationships for any reason would adversely affect the results of our new insurance business |
| Termination of our professional liability insurance policy may adversely impact our financial prospects and our ability to continue our relationships with insurance companies |
| We must maintain professional liability insurance in connection with the operation of this business |
| If we lose this insurance, it is unlikely that our relationships with insurance companies would continue |
| If we fail to comply with government regulations, our insurance agency business could be adversely affected |
| Our insurance agency business is subject to comprehensive regulation in the various states in which we plan to conduct business |
| Our success will depend in part upon our ability to satisfy these regulations and to obtain and maintain all required licenses and permits |
| Our failure to comply with any statutes and regulations could have a material adverse effect on us |
| Furthermore, the adoption of additional statutes and regulations, changes in the interpretation and enforcement of current statutes and regulations or the expansion of our business into jurisdictions that have adopted more stringent regulatory requirements than those in which we currently conduct business could have a material adverse effect on us |
| We do not have any control over the commissions our insurance agency expects to earn on the sale of insurance products which are based on premiums and commission rates set by insurers and the conditions prevalent in the insurance market |
| Our insurance agency earns commissions on the sale of insurance products |
| Commission rates and premiums can change based on the prevailing economic and competitive factors that affect insurance underwriters |
| In addition, the insurance industry has been characterized by periods of intense price competition due to excessive underwriting capacity and periods of favorable premium levels due to shortages of capacity |
| We cannot predict the timing or extent of future changes in commission rates or premiums or the effect any of these changes will have on the operations of our insurance agency |
| RISKS RELATED TO OUR CAPCO BUSINESS Because our capcos are subject to minimum investment and other requirements under state law, a failure of any of them to meet these requirements could subject the capco and our shareholders to the loss of one or more capcos and would preclude participation in future capco programs |
| Involuntary decertification of all or substantially all of our capcos would result in material loss to us and our shareholders |
| In general, capcos issue debt and equity instruments, such as warrants, to insurance company investors and the capcos then acquire interests in companies in accordance with applicable state statutes |
| In return, the states issue tax credits to the capcos, which are available to and used by the insurance company investors to reduce their state tax liabilities |
| In order to maintain its status as a capco and to avoid the recapture of the tax credits granted, each capco must meet a number of state requirements |
| A key requirement in order to maintain capco certification is that a capco must comply with minimum investment schedules that benchmark both the timing and type of required investments |
| Although to date we have met all applicable benchmarks, we may not do so in the future |
| A final involuntary loss of capco status, referred to as a decertification as a capco, will result in a loss of the tax credits for us and our insurance company investors; it would also enable the capco insurer, which 30 ______________________________________________________________________ [50]Table of Contents has the obligation to make compensatory payments to offset the lost tax credits, to take control of one or more capcos and manage or liquidate the capco investments to offset its losses |
| This would deprive us of the value of the investments and make participation in future capco programs highly unlikely |
| The capco programs and the tax credits they provide are created by state legislation, and such laws are subject to possible action to repeal or retroactively revise the programs for political, economic or other reasons |
| Such an attempted repeal or revision would create substantial difficulty for the capco programs and could, if ultimately successful, cause us material financial harm |
| The tax credits associated with the capco programs and provided to our capcos’ investors are to be utilized by the investors over a period of time, typically ten years |
| Much can change during such a period and it is possible that one or more states may revise or eliminate the tax credits |
| Any such revision or repeal could have a material adverse economic impact on our capco, either directly or as a result of the capco’s insurer’s actions |
| During 2002 a single legislator in Louisiana did introduce such a proposed bill, on which no action was taken, and in Colorado in 2003 and 2004 bills to modify (not repeal) its capco program were introduced; the 2003 Colorado legislation was defeated in a legislative committee |
| The 2004 Colorado legislation was adopted and we have filed suit to challenge some of the provisions which increase the cost of doing business by the capco but would have no further material effects |
| In the event of a threat of decertification by a state, the capco insurer is authorized to assume partial or complete control of a capco which would likely result in financial loss to the capco and possibly us and our shareholders |
| Under the terms of insurance policies purchased by all but one of our capcos for the benefit of the investors, the capco insurer is authorized, in the event of a formal written threat of decertification by a state and absent appropriate corrective action by the capco, to assume partial or complete control of a capco in order to avoid final decertification and the requirement to pay compensatory interest to the certified investors under the policies |
| While avoiding final decertification, control by the insurer would result in significant disruption of the capco’s business and likely result in financial loss to the capco and our business |
| RISKS RELATING TO OUR COMMON SHARES Two of our shareholders, both of whom are executive officers, beneficially own approximately 30prca of our common shares, and are able to exercise significant influence over the outcome of most shareholder actions |
| Sloane and Rubin will be able to have significant influence over actions requiring shareholder approval, including the election of directors, the adoption of amendments to the certificate of incorporation, approval of stock incentive plans and approval of major transactions such as a merger or sale of assets |
| This could delay or prevent a change in control of our company, deprive our shareholders of an opportunity to receive a premium for their shares of common shares as part of a change in control and have a negative effect on the market price of our common shares |
| Future issuances of our common shares or other securities, including preferred shares, may dilute the per share book value of our common shares or have other adverse consequences to our common shareholders |
| Our board of directors has the authority, without the action or vote of our shareholders, to issue all or part of the approximately 19cmam000cmam000 authorized but unissued shares of our common shares |
| Our business strategy relies upon investment in and acquisition of businesses using the resources available to 31 ______________________________________________________________________ [51]Table of Contents us, including our common shares |
| We have made acquisitions during each of the years from 2002 to 2005 involving the issuance of our common shares, and we expect to make additional acquisitions in the future using our common shares |
| Additionally, we anticipate granting additional options or restricted stock awards to our employees and directors in the future |
| We may also issue additional securities, through public or private offerings, in order to raise capital to support our growth, including in connection with possible acquisitions or in connection with purchases of minority interests in affiliated companies or capcos |
| Future issuances of our common shares will dilute the percentage of ownership interest of current shareholders and could decrease the per share book value of our common shares |
| In addition, option holders may exercise their options at a time when we would otherwise be able to obtain additional equity capital on more favorable terms |
| Pursuant to our certificate of incorporation, our board of directors is authorized to issue, without action or vote of our shareholders, up to 1cmam000cmam000 shares of “blank check” preferred shares, meaning that our board of directors may, in its discretion, cause the issuance of one or more series of preferred shares and fix the designations, preferences, powers and relative participating, optional and other rights, qualifications, limitations and restrictions thereof, including the dividend rate, conversion rights, voting rights, redemption rights and liquidation preference, and to fix the number of shares to be included in any such series |
| The preferred shares so issued may rank superior to the common shares with respect to the payment of dividends or amounts upon liquidation, dissolution or winding-up, or both |
| In addition, the shares of preferred shares may have class or series voting rights |
| The authorization and issuance of “blank check” preferred shares could have an anti-takeover effect detrimental to the interests of our shareholders |
| Our certificate of incorporation allows our board of directors to issue preferred shares with rights and preferences set by the board without further shareholder approval |
| The issuance of shares of this “blank check” preferred shares could have an anti-takeover effect detrimental to the interests of our shareholders |
| For example, in the event of a hostile takeover attempt, it may be possible for management and the board to impede the attempt by issuing the preferred shares, thereby diluting or impairing the voting power of the other outstanding common shares and increasing the potential costs to acquire control of us |
| Our board has the right to issue any new shares, including preferred shares, without first offering them to the holders of common shares as they have no preemptive rights |
| As such, there are, to our knowledge, no other companies against which investors may compare our capco business, operations, results of operations and financial and accounting structures |
| In the absence of any meaningful peer group comparisons for our capco business, investors may have a difficult time understanding and judging the strength of our business |
| This, in turn, may have a depressing effect on the value of our shares |
| Provisions of our certificate of incorporation and New York law place restrictions on our shareholders’ ability to recover from our directors |
| As permitted by New York law, our amended and restated certificate of incorporation limits the liability of our directors for monetary damages for breach of a director’s fiduciary duty except for liability in certain instances |
| As a result of these provisions and New York law, shareholders have restrictions and limitations upon their rights to recover from directors for breaches of their duties |
| In addition, our certificate of incorporation provides that we must indemnify our directors and officers to the fullest extent permitted by law |
| 32 ______________________________________________________________________ [52]Table of Contents We may not be able to comply in a timely manner with all of the recently enacted or proposed corporate governance requirements |
| Beginning with the enactment of the Sarbanes-Oxley Act of 2002, in July 2002, a significant number of new corporate governance requirements have been adopted or proposed by the SEC and the Nasdaq Stock Market |
| Although we currently expect to comply with all current and future requirements, we may not be successful in complying with these requirements in the future |
| In addition, certain of these requirements may require us to make changes to our corporate governance |