Gypsy Swap

A gypsy swap is a method in which a company may raise capital without issuing additional debt or holding a secondary public offering. In some ways, a gypsy swap is quite similar to a rights offering, but with a gypsy swap the restricted party's equity claim doesn't lapse and so the swap is instantly dilutive.

Gypsy swaps consist of multiple transactions, with the ultimate result being an increase in capital for the business. By convincing existing shareholders to trade in common shares for restricted shares, the business can then sell the common shares to new investors, thus increasing capital. In many cases, gypsy swaps are seen as last-ditch efforts to avoid cash constraints or bank covenants by engaging in some "creative" capital raising.

While gypsy swaps appear to be a roundabout way of creating capital, the act typically results in the company having to sweeten the pot for both new and existing shareholders in order to accept the terms of the deal. This means that the company would probably be better off raising capital through traditional channels if possible since it would be cheaper and cleaner.

The SEC will sometimes consider a gypsy swap as a way circumventing regulations. For instance, Sections 5(a) and 5(c) of the Securities Act spell out that you can make no sale or offer to sell any security without registering the security in advance or receiving a waiver. The SEC has taken a fairly firm stance with regard to Section 5 violations and gypsy swaps. In the legal case of Zacharias v. SEC, the Court agreed with the SEC's position that both the original shareholder and the purchaser were participants in the transaction and upheld a disgorgement penalty of 100% of the proceeds of the sale.

The gypsy swap consists of two main transactions. First, a group of existing shareholders is convinced to exchange common stock for restricted shares from the issuing company so that the company receives the common shares to their treasury. In monetary terms, these shareholders break even - they do not gain or lose from the transaction itself, although there may be some tax consequences depending on the situation. Second, the company sells the common stock that they've received to new investors at a price that may be higher or lower than the current market price, receiving cash in return. The company successfully raised additional capital and the new investors become equity holders in the issuing company, while the first set of investors maintains a position in the restricted stock.

A gypsy swap is seen as a last-ditch financing option because the new investor(s) almost always demands some combination of below-market value price or special consideration from the deal. In fact, if the issuing company could raise funding conventionally—internally from the equity markets or from the debt markets—it certainly would choose to do so.