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College of Entrepreneurial Studies (CES)

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Lesson 24:
Private Stock Offerings

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The Basics of Private Stock Offerings

Most people are aware of public stocks traded openly on the New York Stock Exchange (NYSE), the Pacific Stock Exchange, NASDAQ, and over the counter (OTC). Few people, however, are aware of the power of private stock offerings in raising capital for business ventures. Contrary to popular belief, it has become relatively easy to produce these private offerings and raise the money needed.

A private placement is EXEMPT from federal registration, simplifying the process considerably. In 1982, the SEC adopted Regulation D, which set forth objectives and quantifiable rules for exemptions from federal registration. Offerings exempt under these rules 504, 505 and 506 have become the most common cost and time saving methods for small and growing businesses to raise capital from private investors.

How Private Stock Offerings Work

Through private offerings, entrepreneurs can often raise significant amounts of capital by selling only 10-35% of stock in their venture to wealthy private investors and institutions. They retain complete control of the company and control the use of the funds raised.

These investors understand the high-risk/high-reward nature of putting money into cutting-edge young companies. They look for promising opportunities where they can purchase stock for a low price now ($5-10 per share is considered optimal at opening) and sell for a high price (like $50, $75 or even $100 a share) in two or three years when the company goes public or is bought out.

The "sales brochure" for prospective entrepreneur clients would offer the following process:

  1. Business Plan. Every venture should have a business plan. Much of the information required in the private offering documents can be taken from the business plan.
  2. Business Incorporation. You will be raising money by selling stock in your company so you must be incorporated.

  3. Creating the Offering Documents. Most private offerings are done with a document called a Private Placement Memorandum (PPM). It contains specific legal language to satisfy all requirements of the SEC as well as state and federal laws. It also contains an overview of your business plan so that potential investors can understand what you do and why your business will be successful. The offering will also include an opening date and closing date for the offering and additional terms and conditions. The private placement memorandum document is usually about 30-40 pages in length and is bound in a specific way to be sent to investors.

  4. Investor Resources. When the offering document is complete, investors must be found for your venture. With luck, you may be able to skip this step and sell stock only to your friends, family and business associates. For most types of private stock offerings you are not allowed to solicit or advertise, so direct contact to interested investors is often the key to a successfully raising money.

  5. Contacting Investors. In a private offering, you will actually have the opportunity to deal directly with the people who will be putting money into your venture. This is accomplished by sending complete PPMs or summary letters to the list of investors you may have built up. If you send summary letters, interested investors will contact you requesting the complete offering. With each complete offering package you send out, you include investor qualification forms and a stock purchase agreement, called a Subscription Agreement.

  6. Getting The Money. Investors who need more information about your company or want to purchase stock will contact you directly. To purchase stock, investors will send you the completed qualification forms, the subscription agreement and a check. All checks will be deposited into an escrow account upon receipt. No money can be spent until the "minimum" amount stated in the offering has been reached. The minimum is usually from one third to one half of the total offering amount. Once the minimum is reached, that amount can be taken from the escrow account and the offering continues until either the full offering amount has been raised or the closing date is reached.

  7. Issuing Stock Certificates. Once the minimum amount has been raised, stock certificates are issued to the investors and recorded in the corporate records according to your corporate bylaws and the requirements of your state of incorporation.

  8. Additional Offerings. Need more money? The SEC allows you to do an offering every twelve months. There's no limit to the number of times this process can be repeated, so you could raise money through a private offering every year for as long as you need to. A completely updated PPM would be required for each new offering.

Private stock offerings can be completed quickly. If you have a current business plan and financial projections, the offering documents can be prepared in as little as 30 days. Once reviewed by your legal advisors, the offering can be delivered to potential investors and their response received quite quickly.

Types of Private Offerings

There are two popular and distinct types of private (nonpublic) stock offerings:

Each type of private offering has a different set of paperwork which must be prepared and unique forms which must be filed with the appropriate state and federal offices. Here is a quick overview of their features, advantages and disadvantages.

Regulation D Offerings

The requirements under each of the following rules include the amount of money that can be raised, total number of investors who may purchase stock, and the financial sophistication of the investors. Investors are said to be "sophisticated" (also called "accredited" or "qualified") if they have a certain net worth, income and/or experience in the purchase of stocks.)

Rule 504 - Raise up to $1 million in a 12 month period.
Rule 505 - Raise up to $5 million in a 12 month period.

This exemption limits the number of non-accredited investors to 35 but has no investor sophistication standards. Rule 505 requires disclosure similar to that required for Rule 506 offerings, under $7.5 million.

Rule 506 - No dollar limit.

This exemption does not limit the number of accredited investors, but the number of non-accredited investors may not exceed 35. All non-accredited purchasers, either alone or together with a designated representative, must be sophisticated enough (i.e., have the knowledge and experience necessary) to evaluate the merits and risks of the investment. (An offering company typically determines the sophistication of its investors with a questionnaire subscription agreement.) Rule 506 requires detailed disclosure of relevant information to potential investors; the extent of disclosure depends on the dollar size of the offering.

Reg. D Offering Advantages

  • Easy, fast and inexpensive to prepare.
  • No underwriting company, brokers or agents required.
  • Stocks may be sold by you and company employees.

Reg. D Disadvantages

  • Stock is non-liquid (not traded on secondary markets)
  • Soliciting and advertising for investors not allowed

Small Corporate Offering Registrations (SCOR)

SCOR offerings are registered on a state-by-state basis with each state reviewing your offering to make certain that it meets their specific requirements. These offerings are now legal and available in over 40 states, and the rest are likely to be on board soon. Offerings are limited to $1 Million in a 12 month period

SCOR permits the sale of securities to an unlimited number of investors, accredited or non-accredited. For this reason SCOR is known as a REGISTRATION BY EXEMPTION because it is basically a hybrid between a public offering and a private placement. This type of offering is often referred to as a DPO, or Direct Public Offering because the stock can be sold to the public without the use of an underwriter, agent or brokerage.

While companies filing a SCOR are subject to some requirements and an application process, SCOR securities can be resold into established secondary markets. The Pacific Stock Exchange has created special rules and a review process for SCOR securities that will hopefully improve the secondary market for these offerings. In addition, various bulletin boards have been established on the Internet for SCOR securities, adding to the potential liquidity of these investments. As the Internet grows, so should the secondary market for securities in smaller companies.

Under a SCOR offering, a company can advertise for investors, and sell securities to anybody who expresses an interest. Obviously, this gives businesses a much-needed tool for raising capital. Small companies have successfully used SCOR to sell stock without a securities underwriting firm. This works particularly well with an established customer base or other supportive source of investors including employees.

SCOR Advantages

  • May be done in selected states
  • Stocks may be traded in secondary markets
  • Advertising the offering and soliciting investors is OK

SCOR Disadvantages

  • Requires registration and review in each state
  • Slower, more complicated and expensive than Reg. D