Blue Whale Movers, an Austin, Texas moving company founded in 1988, has earned bragging rights for moving everything from former Texas governor Ann Richard’s marble desk to the University of Texas’ electron microscope. Early on, the company, founded by Texan Brad Armstrong, began to win awards and recognition for its fast-paced growth and entrepreneurial leadership. In 2008, after 20 years of successful operations—and with 80 percent of sales coming from referrals—the company decided to fund its growth. They way it did it, though, may be one of the best-kept secrets among entrepreneurs for raising capital—a direct public offering.
Small businesses need new capital for many reasons: growth and expansion of an already profitable business, research and development, purchase of equipment, or to hire additional talent. Getting a bank loan or tapping into an already existing line of credit are some of the ways to finance growth, but what if an entrepreneur wants to raise money by selling shares of the company to the public? An initial public offering (IPO) is often too expensive and time-consuming for a small business. However, a direct public offering (DPO) could be the answer.
What goes into the costs of a DPO and how long does it take?
A DPO allows a small business to sell shares of the company on its own, directly to customers, employees, family, friends, suppliers, distributors, and other people in the community. This form of funding is typically less expensive and time-consuming than an IPO, with costs ranging between $50,000 and $125,000. Some of the expenses associated with a DPO, such as marketing, can be offset somewhat by performing them in-house, but others can’t be avoided, such as attorney and accountant fees.
Prior to the establishment of DPOs in 1976, small businesses needing the capital that an IPO could provide had little chance of navigating the complex, years-long Securities and Exchange Commission (SEC) registration process and expensive underwriting fees. In the early 1990s, the SEC’s Small Business Initiative programs, lifted many barriers to the DPO process. The advent of the Internet changed the game even more, primarily by making advertising and marketing much more accessible to small businesses.
Choosing the right type of DPO
Companies interested in raising capital through a DPO have multiple options, but by far the most common type of DPO is the Small Corporate Offering Registration, or SCOR (Regulation D, Rule 504), for private businesses that raise no more than $1 million through the sale of stock in any 12-month period. According to the U.S. Securities and Exchange Commission your company qualifies as a small business issuer, if it can file its registration statement using one of the simplified small business forms (SCOR Regulation D—$1 Million; Regulation A— $5 Million; SB1— $10 Million; SB2—$25 Million. The monetary values listed indicate the maximum amount that can be raised in a 12-month period under each regulation.) A small business issuer is a United States or Canadian company that:
- had less than $25 million in revenues in its last fiscal year, and
- whose outstanding publicly-held stock is worth no more than $25 million.
Although DPOs have no minimum requirements for sales, profits, or tenure in the industry, established firms use them more often than start-ups because of the expenses involved.
“A typical DPO will cost approximately $100,000 when you factor in all the various fees involved,” says Andrew Schrage, former hedge fund analyst and founder of Money Crashers, a financial advice website.
The lion’s share of the cost goes to accounting fees, professional advisor fees, and legal fees. Due to federal and state laws regulating securities and the sale of stock, a corporate/securities lawyer must be hired, since unlawful sales of securities (stocks and bonds) expose a business to criminal and civil liability and can include both penalties and jail time.
“A corporate/securities lawyer will guide you through the stock financing steps, prepare the appropriate documents and make the necessary state and federal securities filings,” explains Trenton C. Dykes In a 2011 TechFlash.com article. Dykes, who is the chair of the Northwest Emerging Growth and Venture Capital practice of DLA Piper in Seattle, Wash. also writes that “it will be helpful for you to have some understanding of how it is done so the process makes more sense as you go through it, and so you understand the reasoning behind some of the restrictions you’ll hear about from your lawyer.”
What’s involved in the DPO process?
Much like other avenues for obtaining financing, the DPO process requires audited and projected financial statements. This is the point where a certified public accountant (CPA) will be able to help with determining the fair market value of the company by reviewing the company’s recent financial statements together with the financial projections to determine the volume and price of shares. To be considered an audited financial statement, the documents need to be prepared and certified by a CPA. Be sure to get legal and financial advisers who have previous DPO experience.
“Lastly, although a DPO has fewer SEC requirements to meet, that’s not to say that they’re exempt from U.S. securities laws,” says Schrage. One step a small business owner can take on their own early in the process is to research the specific regulations governing DPOs in the state where they operate.
Who are the investors in a DPO?
A wise strategy is to recruit investors with a personal interest in your business, such as customers, employees, friends, family, other businesses in the supply chain, or industry. For a DPO to be successful, you must be in constant contact with those people in the affinity group in order to market the shares to them, by mail, newsletter, email or by social media such as Facebook, Twitter and LinkedIn.
Finally, realize that there is a lot of due diligence involved with a DPO. “The small business owner will most likely be solely responsible for promoting the offering,” says Schrage. “However, if you have a strong customer base, the job becomes easier, as you can market the offering to these customers.”
Quick Review: Steps in the DPO process
- Make a business plan, including projected financial statements
- Determine the market value of the company to decide on volume and price of shares
- Research the specific regulations governing DPOs in your state
- Get legal and financial advisers who have previous DPO experience
- Choose investors carefully, such as people with a personal interest in your business
- After a DPO, be prepared for an audit by a state or federal agency at any time.
Disclaimer: Please note that this post was not drafted as a complete analysis of all of the laws that your business may face when selling securities or as a guide to securities law compliance. Please contact an attorney before attempting to offer or sell any securities.
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