Low-Profile Money Sources

Nation's Business, Oct, 1998 by Roberta Reynes

Roberta Reynes is a business and financial writer in Spencertown, N.Y.

While "hands-off" privateplacement investors don't require control for their stake, they may expect rapid growth of stock value.

This story is part of a continuing series on ways far small companies to locate the financing they need to run their businesses.

Three times in the past six years, Stan Cipkowski needed money for his fast-growing company, but he wasn't willing to give up control of the firm to gel the funds. So he stayed away from venture-capital and buyout groups, which take some control in exchange for investing in a business. He opted instead for private placements to "hands-off' investors.

Cipkowski's firm, American Bio Medica Corp. (ABM) of Hudson, N.Y, has raised $6 million from the deals, no two of which were alike. What's more, key managers still own more than half the company, which has developed a kit for screening employees for drugs.

In a private placement, investors buy stock or lend money, using a variety of financing instruments. (See "Capital Terms," on Page 33.) Those with a handsoff approach don't ask for board seats, and they are content to "fund the business plan that already exists," explains Jim Tilton, vice president of Shoreline Pacific Institutional Finance, an investmentbanking firm in Sausalito, Calif. The firm specializes in financing for small and medium-sized businesses.

Hands-off investors typically look for a 25 percent return per year; Tilton says, and they expect to get it primarily through appreciation of the firm's stock value. Most frequently, he adds, the buyer is "a sophisticated, higher-risk-oriented mutual fund" that accepts few investors. Individuals with high net worth and institutions such as pension funds may also take a hands-off approach to private placements.

It's difficult to determine how much money flows to small businesses through these financing arrangements. Part of the reason is that "hands off" is defined by 'the management philosophy of the investor" rather than by the structure of the investing entity, says Robert L. Paglia, partner in charge of the Financial Advisory Services Group of PricewaterhouseCoopers in Boston.

Nevertheless, private placements are more open to small businesses than they were a few years ago, says Tilton. Because of the bull market of recent years, he adds, "there is a lot of money out there looking for investments."

The Hunt Fur Development Funds

For ABM, private-placement investing has helped stimulate growth. The firm's drugscreening kit, says Cipkowski, president and CEO, is quicker and simpler to use than competitors' kits, and business is expanding fast as production gears up. From March through June, the number of employees jumped to 48 from 25.

Development of the kit began in 1992. The company had already gone public and was listed on the OTC Bulletin Board, an information service for investors. The company had been in some unrelated businesses, but they weren't making money. Cipkowski closed them, paid the bills, and was left with "a clean, publicly traded shell," as he puts it. He renamed this shell and began the hunt to fund product development.

Some options fizzled fast. "We talked to venture-capital people," he says. "They simply wanted too much." Wall Street wasn't interested. A public offering was out because "we didn't really have revenues, we were tiny, and had very little trading activity"

A regional broker who had read about Cipkowski introduced him to a New York City-based attorney Joel Pensley. Working with Pensley, Cipkowski raised more than $2 million from 1992 through 1995 with private placements of convertible debentures. ABM paid 12 percent on the loans, sometimes in cash and sometimes in stock.

The offering was sold to the company's 350 existing shareholders--high-networth individuals, investment clubs, and even a monastery in the region. ABM also gained shareholders by putting ads in newspapers in nearby cities.

ABM stock soared from 38 cents a share in 1992 to $6 a share four years later. By 1996, Cipkowski was getting calls from brokers at regional investment-banking firms offering to help with financing. These agents identify companies that need money, find investors, and receive commissions. ABM had become attractive to them because its stock was being traded regularly This meant that prospective investors would foresee a market for the shares they would get in private-placement deals.

At the time, ABM's revenues were still negligible, so the financing alternatives were limited. Cipkowski opted to do a convertible preferred stock offering in September 1996 for $1.5 million. The transaction was done through representatives such as the buyer's lawyer and a broker who had called Cipkowski to ask if he needed money. The entrepreneur never met the investor.

Blocks Of Loans

To make private-placement-financing arrangements attractive to investors, entrepreneurs must part with some stock cheaply When the first deal began in 1992, ABM stock was at 38 cents a share. Investors lent money, typically in blocks of $5,000. After three years, these lenders could choose to get their money back or to convert their debentures to shares of stock at 75 cents a share. By then, the stock was trading at $3 to $4. Similarly, the 1996 convertible-preferred-stock offering allowed investors to convert their shares to common stock in just six months and at 25 percent below its market price.