In 1993, William Rowe, president of Wichita-based Willie C’s Cafe and Bar, left the day-to-day operations of his two-restaurant concern and raised $950,000 for his business in 20 weeks. Rowe had sold the stock in his company directly to the people who came to his restaurants. There are now four Willie C’s in Kansas.
Not all company executives have to work so long and hard to raise money. Jim Berneau raised about $1.5 million in 21 days for his Willamette Valley Brewing Co. in Portland, Oregon, which is now called Nor’Wester and listed on the Nasdaq exchange. Rowe and Berneau are not alone. Since 1989, more than 800 small companies have sought to raise a total of close to $1 billion in equity capital by selling registered stock themselves rather than through an underwriter. About 30 percent of the companies have succeeded in finding investors. That is about the success rate produced by all companies with $2.5 million a year or less in revenues in raising money from all sources, according to a recent study by the Federal Reserve Bank of Dallas.
The 800 that have filed so far know one of the best kept secrets in corporate America: There is now a way to sell securities directly to the public without having to register them in Washington, without having to find a stock broker willing to handle small offerings, and without having to spend a fortune. Several of these pioneering firms have even graduated to public markets. Four are sold on the NASDAQ, one on the Pacific Coast Exchange, and 20 on the OTC market.
Since 1982, small corporations have been able to sell securities to the general public without going through the expense of a full Securities and Exchange Commission registration. However, it was not until 1989 that the process became truly practical, when the North American Securities Administrators Association (NASAA), the state securities regulators’ organization, adopted the Small Corporate Offering Registration (SCOR) form, also called Form U-7.
The SCOR form is a do-much-of-it-yourself offering document, or prospectus. It consists of 50 questions and almost 200 sub-questions designed so that a reasonably savvy businessman, his accountant, and his regular attorney can produce a securities sales document acceptable to regulators in 45 states. (The form is not accepted in Alabama, Delaware, Florida, Hawaii, or Nebraska.) While nothing says that a company has to use the form instead of the traditional narrative prospectus, this standard SCOR form ensures that the issuer has at least considered all the points regulators think are important.
Using the U-7 form and doing much of the work themselves, most companies have been able to register and sell their offerings for between $10,000 and $40,000. In contrast, hiring a securities lawyer to create a standard prospectus can cost into the hundreds of thousands of dollars.
Small offerings are exempt from filing with the SEC under the same regulation that covers private placements, leading some to regard them as a private placement that can be advertised. Company officers, directors, or agents of the issuing company may sell the offering themselves, provided they meet state requirements. A few have already had some success selling shares via the Internet.
How to file
The first step is to become an entity which can issue stock. That used to mean the issuing company had to be a corporation. In the past two years, however, a number of states have expanded the definition to include limited liability companies as well. The next step is to complete the U-7 form. The offering document is a contract between the corporation and the investor which describes the corporation, the key decision-makers and their backgrounds, and how they plan to use the proceeds of the stock sale. The offering document is designed to give the potential investor enough information to form a decision about the probability of the project’s success.
There are four basic small corporate offerings: the SCOR offering; the Intrastate offering; the Regulation A offering; and the SB-1 offering. SCOR and Intrastate offerings are not registered with the SEC, though the commission does require notification that the exemption is being claimed.
A SCOR offering limits the company to raising up to $1 million in a 12-month period. The company can register the offering in any state that recognizes the U-7 form and in as many states as it wishes.
While a company is not limited in the amount it can raise through an Intrastate offering, there are strict limits on where the offering can be registered and sold, and where the proceeds can be spent. The company can register only in the state where it has 80 percent of its assets, and it must spend at least 80 percent of what it raises in that state. In addition, it can sell securities only to residents of the state. If the company’s assets are not concentrated in any one state, it can register only in the state where it is incorporated.
Under a Regulation A offering, a company can raise up to $5 million in a 12-month period. This type of offering is also exempt from SEC registration, but it is reviewed by the SEC as well as the states. Just because an offering passes muster with the SEC, however, does not mean that the states must accept it.
As in the case of smaller offerings, companies issuing stock under Regulation A can register in as many states as they like. And there are no limits on the type or number of investors.
With an SB-1 offering, a company can raise up to $10 million. Unlike the other filings, an SB-1 can be used only once. The least used of the four types of filing, it was originally designed as a transitional filing, created to move a company from non-reporting to reporting status, possibly to a listing on a regional stock exchange.
Because all four types of offerings are state-registered, there is no limit to how many investors a company can have and, in most states, investors need not meet a minimum net worth standard. In other words, anybody can invest. In addition, the company may register its securities in as many states as it likes, although experience has shown that 90 percent of the investors come from within 50 miles of the company.
High failure rate
Whether they raise the money they need or not, most company executives who undertake a direct public offering (DPO) find that the process takes more time than they thought it would. Success in selling shares in a business without an underwriter depends on dogged marketing efforts. It has been pointed out that the issuers who are most successful sell to “affinity groups”—people who know and believe in the company, its products, or its management. These are people who tend to buy the stock because they like the product and/or the management.
Some critics of SCOR argue that while many business owners know how to sell their own products, they have little experience in marketing stock to a diverse public and are not very good at it. In my view, the business owner’s enthusiasm for his or her own company may, in fact, be an advantage in selling shares to others.
Bill Beatty of the Washington State Securities Division offers another explanation for the high failure rate. His state was the first in the nation to approve the SCOR form, but only 27 percent of DPOs undertaken in Washington have thus far succeeded, according to Beatty. “A SCOR is typically the last resort for a lot of people,” he says. “It’s a good tool, but it doesn’t turn a company that wouldn’t be a good candidate for the public markets into one.”
It is too early to tell whether this SEC experiment with do-it-yourself stock offerings will be successful—whether SCOR will score with small and mid-sized businesses. For family businesses that have been considering eventually going to the public markets for capital, however, DPOs can be a relatively inexpensive first step—free of SEC aggravation—that will force them to start thinking about what they will have to do to get their companies in shape to sell shares to the public.
Tom Stewart-Gordon is the founder and editor of SCOR Report, a newsletter of capital formation alternatives for small business.
Guidance on DPOs
The “SCOR Report,” published by Tom Stewart-Gordon, provides regular coverage of DPO requirements and other alternatives for raising capital. Cost: $280 for 14 issues a year. Contact: SCOR Report, PO Box 781992, Dallas, TX 75378. Phone: 972-620-2489. E-mail: tsg@scor-report.com
To request a U-7 form and instructions on how to fill it out, contact your state securities board. If you want a computer disk with a U-7 form on it, send a cashier’s check for $10 payable to the North American Securities Administrator’s Association Inc. (NASAA), One Massachusetts Ave. NW, Suite 310, Washington, D.C. 10001. Phone: 202-737-0900.
A firm in Denver, DataMerge Inc., sells a manual and software program that walk owners through the filing process for DPOs. The kit supplies sample documents, tips on sales/marketing techniques, and sources of information on state requirements. Cost: $388. Data Merge Inc., 1720 S. Bellaire St., Suite 310, Denver, CO 80222. Phone: 303-757-6298.
— T.S-G.