Easier avenues to equity capital

Nation's Business, Jan, 1998 by David R. Evanson

Tapping the stock market for equity capital can be a daunting prospect for a small business. Although each year about a half-million firms incorporate, there are relatively few initial public offerings -- just 432 IPOs in the first three quarters of 1997, according to Securities Data Co., a financial publisher in Newark, N.J.

A major reason that not many emerging -- let alone established -- businesses go public to finance their growth, experts say, is that securities laws make the process complex, time-consuming, and expensive. In fact, an IPO is one of the most difficult transactions that a business can undertake.

Moreover, says financier Art Beroff, the problem with high-profile IPOs is, in fact, their high profile: "They leave most entrepreneurs with the mistaken impression that there is just one way to tap the U.S. public equity markets."

That's simply not true, notes Beroff, principal of New York City-based Beroff Associates. He maintains that far more companies could raise funds with public offerings if they took advantage of federal and state securities laws' exemptions for firms seeking relatively small amounts of money.

Under federal securities law, companies that seek to raise less than $1 million in 12 months are excused from registration requirements. The exemption is granted by Rule 504 of Regulation D of the Securities and Exchange Act. Hence, the stock sales are often known as "504 offerings" or "Regulation D" offerings.

In addition, most states offer various exemptions for offerings of $1 million or less.

Even with exemptions for such offerings, however, some states' rules -- on the maximum number of stock purchasers, for example, or on purchasers' minimum net worth -- are stricter than the federal rules that apply to 504 offerings. Among the least-restrictive jurisdictions are Colorado, Florida, New York, and Washington, D.C.

Nonetheless, by taking advantage of exemptions at the state and federal levels, companies can conduct small public offerings that are relatively simple and inexpensive to execute.

The first step, Beroff says, is to contact the securities commission in your state or in the states where you want to sell your stock to find out what securities-law exemptions are available for small offerings.

Next, you must determine if you can structure the kind of deal you want within the confines of the state regulations.

Third, find or hire at least one skilled professional -- a financing consultant, an attorney, or an accountant -- to help you with the transaction. The key is to hire someone who has already worked with small public offerings.

Once the structure of the offering is established, file Form D with the Securities and Exchange Commission. This is a simple form that will ensure your stock sale enjoys the exemptions available to 504 offerings under federal securities laws.

A Place On The Board

Perhaps the most important benefit of a 504 offering, says Beroff, is that a company's shares can be traded after they are quoted on the Bulletin Board of the Nasdaq stock-listing network. The Bulletin Board is an electronic marketplace listing generally small, thinly traded public companies.

"The value of creating a public company, even if it's thinly traded, is almost incalculable," Beroff says. Once a stock is on Nasdaq's Bulletin Board, investors have a mechanism for selling shares and reaping the rewards of the company's success.

He adds: "If you ask someone to invest in your company and in the same breath tell them it's not only risky but there is absolutely no way they can sell their shares, that eliminates perhaps 90 percent of potential investors."

Another plus with 504 offerings is the exemption from the requirement to prepare an audited financial statement before going public, says Glen Bierman, a founder and chairman of Tycon Equity Partners in New York City. Tycon invests in and advises private companies on raising capital. The audit certifies that the company's financial records are accurate and truthful. An audited statement can cost more than $100,000.

Exemption from the requirement to produce an audited financial statement doesn't mean the financial data can be fudged, of course. Federal securities laws provide for substantial penalties for fraudulent representations of a company's financial status.

A Financial Recharge

A firm that used the 504 approach successfully is the Electric Car Battery Co. in Solana Beach, Calif. Electric Car had developed a new battery that inventor George Carlsen, senior vice president, believed gave the firm enormous potential for sales for electric vehicles used on golf courses and in retirement communities.

When the company looked for money to finish development and fund a commercial rollout of the product, a 504 offering "seemed to be the most straightforward path to the capital we needed," says Don Hutton, the firm's chief financial officer.

Initially, the company raised $200,000 by selling 100,000 units consisting of common stock and warrants. The warrants are options, which give the holders the right to purchase additional shares at set prices.