SMALL, CASH-HUNGRY FIRMS TURNING TO PUBLIC OFFERINGS

By Elizabeth Brandon-Brown

More and more small businesses, frustrated with trying to attract investment capital from traditional sources such as investment bankers, venture capitalists and wealthy individuals, are deciding to do it themselves through a Direct Public Offerings (“DPO”).

Last year a total of 185 companies filed 358 direct public offerings, an increase of almost 40% over 1995, according to the SCOR Report, a Dallas-based newsletter specializing in SCOR information. California companies ranked in fourth place in the nation for SCOR offerings, with 19 filings. This year California companies have already filed eight registration statements, although only two have become effective.

Most DPO offerings utilize the Small Corporate Offering Registration (“SCOR”) form, a standardized question and answer disclosure document accepted in 45 states. Under a Rule 504 SCOR offering companies may raise up to $1,000,000 in any 12-month period.

Companies willing to file certain disclosure information with the Securities and Exchange Commission (“SEC”) may raise up to $5,000,000 in any 12-month period under a Regulation A SCOR offering. Under Regulation A, a company may “test” the waters or solicit indications of interest in nine states in order to determine potential investor interest prior to incurring the cost of drafting a SCOR offering circular.

SCOR offerings must “Blue Sky” (file an application) in states where the company intends to sell its securities. The Blue Sky laws are designed to protect investors and ensure complete disclosure of material information on the company. Companies need to be aware that there are a great deal of differences among the states’ Blue Sky laws, with some states imposing much greater conditions than others. For example, the California Commissioner of Corporations imposes burdensome qualifications procedures. Under the present process, commonly referred to as “merit review,” the California Commissioner’s staff determines whether each SCOR offering is “fair, just, and equitable” to investors. A pending bill sponsored by the Department of Corporations, Senate Bill 1205, would change the current merit review to one based on disclosure — the standard in most states. Currently the Bill is still in committee and is not expected to be voted on until this summer, according to Blake Campbell of the Department of Corporations. Even if a California company opts not to Blue Sky in California, it is not precluded from Blue Skying its registration statement in other states. However, since the Blue Sky process can be lengthy and costly, it is important for a company to target the states where it has strong investor
interest.

One of the major benefits of a SCOR offering is the securities are freely-tradable stock. Even though such SCOR stock is freely-tradable, much of it remains illiquid for lack of a secondary marketplace. Although there are few organized marketplaces, the Pacific Stock Exchange has a PSE SCOR Marketplace that list SCOR offering, provided the issuer is able to meet certain listing criteria. Upon approval by NASDAQ, the Electronic Bulletin Board will list SCOR offerings if a market-maker agrees to file on behalf of a company certain disclosure information on a Form 211 with NASDAQ.

Cost savings is another major benefit. Generally, DPO offerings are less costly then registered security offerings. Companies that decide to sell their offering without the benefit of brokers will also save on commission fees.

As attractive as DPOs may appear, not all companies are suitable candidates. In fact, only 30% of the DPOs were successful last year, which is up from a success rate of only 20% three years ago. In comparison the major stock exchanges and NASDAQ had a total of 755 initial public offerings last year with only 38 of such offerings withdrawn or postponed, according to Securities Data Company, a New York company that complies securities data.

The best candidates for a DPO are companies seeking expansion capital. Start-up companies and those seeking capital for initial research and development will have a much harder time enticing investors.

Before jumping into the DPO marketplace, a company should ask itself the following questions:

Is management ready to take the time and effort required to prepare a SCOR offering?

Does your company have an affinity group which can be targeted for sales of your securities?

Who will conduct research to determine this affinity group and in which states most of these potential investors are located?

Who will conduct follow-up to initial leads and close?

Does your company have name recognition or sizzle that will help sell the offering?

Is your company willing to develop and pay for a marketing program to sell the offering?

These are only a few issues that management must address before devoting time and money to a DPO offering. For many small businesses a DPO is a cost-effective method for raising equity capital; provided the company is a suitable candidate and is willing to commit the resources required to make the offering a success.

PART II of this 2-part series will discuss successful factors and common mistakes of DPO offerings, including war stories from companies that have been there.

Elizabeth Brandon-Brown is a securities and corporate attorney and can be contacted at (561) 289-3815 or by e-mail at elizabeth@brandonbrownlaw.com.

<< Back

More Information