Danger zone: scam artists are targeting capital-hungry entrepreneurs - includes related tips to prevent being a victim

Entrepreneur, August, 1996 by Brian Steinberg

To hear Don Spencer tell the story, he and his business "got screwed."

Spencer is no stranger to starting and running businesses. Between 1987 and 1993, the nationally certified training coach ran a gymnastics complex in Canon City, Colorado, which cleared approximately $200,000 a year. The business eventually expanded to a satellite operation in Pueblo.

Colorado proved too small for Spencer's ambitions, however, and, after doing a great deal of study, he left in January 1994, determined to build a bigger and better operation in Las Vegas. "I researched the entire United States," he recalls, and every time I looked at Las Vegas, I was just amazed."

The bright lights of that city's gargantuan casinos may have blinded Spencer temporarily. How else to explain why he put up a $10,000 retainer, plus several thousand dollars in upfront fees, for a Nevada broker-dealer to raise money on a "best efforts" basis?

What Spencer was trying to do was raise capital for his company, Go for It Inc., through a Small Corporate Offering Registration (SCOR), a 50-question form used to register public offerings in 43 states without going through the time and expense of filing a registration with the Securities and Exchange Commission (SEC). Trouble is, SCOR laws vary among states, and in Nevada, brokers are not allowed to solicit indications of interest from potential investors until after the SCOR offering is approved by the state securities commission.

Bob Tretiak, president of Retirement Financial Centers of America Inc., which tried to raise money for Spencer, says lawmakers and brokers alike are working to overturn that law. "We busted our hump on it," Tretiak says of his company's efforts to raise money for Go for It. Sadly, he adds, few of Spencer's vendors or clients seemed inclined to invest.

All Don Spencer knows is that "[Tretiak] said in front of many witnesses that he could raise $500,000 In 60 days and $1 million in 100 days. One year later, he had raised $4,000."

Spencer might have been more careful, knowing after all that Retirement Financial was only working on a best-efforts basis and had no obligation to deliver on what it had proposed.

"We believe an issuer, like Mr. Spencer, when he says people are coming out of the woodwork wanting to buy his stock," Tretiak says. Enthusiasm, however, is no substitute for a realistic view of the possible financial pitfalls involved in raising capital. "I would caution every small company [that] desires to go public to realize that there are unreimbursable risks and costs attendant to such an effort," Tretiak adds.

That advice means little to Spencer, who came out of the deal a little wiser and a lot more bitter. All he knows about the transaction is this: He lost his cash. And now he has turned to another investor to do a private placement for the firm. Could he be tempting fate once again?

* RED FLAGS

For entrepreneurs seeking expansion capital, danger lurks at every turn. With any viable method of acquiring additional funds comes a warning, a caution, a potential scam. Because small business is on the rise nationwide, more would-be plunderers are picking inexperienced business owners as possible target.

Securities enforcement officials across the country report a variety of tricks, from dishonest brokers taking a wide array of unreturnable upfront fees to market manipulators who merge a relatively small but expanding firm with a dormant "shell" company. With the Internet taking on Increased importance, the possibility for electronic chicanery is on the rise as well.

What makes matters worse in some cases Is that most of the losses could have been avoided with a little common sense and greater attention to sound business practices. Risk-taking comes naturally to many entrepreneurs, some of whom readily fall victim to a combination of their own greed and foolishness. Getting money isn't easy, but in the quest for expansion capital, overeager entrepreneurs often miss some obvious, telltale warning signs. In the process, they can lose their companies, most of their money or both.

"As a result of our activities with capital-raising individuals, we have an Iron-clad rule in the company that we simply don't pay upfront fees," says Joseph Meshi, a principal with Genovation Inc., an electronics product development company in Irvine, California. "Hundreds of people come here [offering to raise money for us]. As soon as we say `No. Go ahead and perform, and we'll really fatten your wallet in the tail end,' they disappear, in which case we know [they were unscrupulous]." Other small-business owners report a similar plague of dubious brokers descending upon them. Placing an ad in a newspaper seeking capital can be tantamount to putting out money for a swarm of flies.

Perhaps that's because small businesses represent a sector of the nation's economy that is doing so well. The number of new small businesses opening in the United States has Increased steadily since 1991, according to the U.S. Small Business Administration (SBA). That number reached approximately 810,000 in 1995. Corporate downsizing, the declining price of office technology, and a new emphasis by banks on lending to small businesses are all contributing factors to the phenomenon, says Bruce D. Phillips, a director of economic research for the SBA.