Amy Cortese of The New York Times recently wrote about direct public offering, which is a way small business can raise money from the public without the expense or complicated process of using a stock exchange. She featured a small business owner named Brahm Ahmadi who is the founder of People’s Grocery, a nonprofit focused on food justice issues. He hoped to open a commercial grocery store that would offer fresh produce in West Oakland, Calif., to provide the 25,000 needy residents with healthy food options. A public-private loan fund, California FreshWorks Fund, intended to lend Mr. Ahmadi two-thirds of the $3.6 million he needed to open. There was one condition — he would first have to raise the remaining $1.2 million from investors. Mr. Ahmadi spent a year pitching to social investors and private equity firms, but despite a great track record, he had not been able to attract a single investor.
Mr. Ahmadi’s lawyer suggested a direct public offering (D.P.O.). The term is used to describe a public securities offering similar to an initial public offering (I.P.O.), but without the need to hire an investment bank. D.P.O.’s are often referred to as “do-it-yourself I.P.O.’s.”
Do-it-yourself I.P.O.’s have been around for decades. In 1984, two entrepreneurs raised a first round of capital for their struggling ice cream company in an intrastate offering. Ben & Jerry’s raised $750,000 from 1,800 Vermonters, allowing them to build a new plant and expand.
Traditional sources of capital remain out of reach for many small businesses, especially in this economy. Direct offerings can offer a compelling alternative.
Let’s look at the pros and cons of raising capital through direct offerings.
The pros of direct offerings
- A Wall Street underwriter is not required. In a direct offering, shares are marketed directly by the issuing company to customers, supporters and social media followers. Your company can advertise the offering freely and accept funds from an unlimited number of investors. Your company is not subject to the quarterly reporting requirements and comprehensive registration process that come with an initial offering.
- A direct offering might cost you around $25,000 in legal fees, while a formal initial public offering can cost $1 million or more. That makes direct offerings an attractive option for small businesses that need a substantial amount of capital between $500,000 and $5 million.
The cons of direct offerings
- Business owners must invest a substantial amount of time and effort in the process and deal with hundreds or even thousands of small investors.
- Most direct offerings require assistance from a knowledgeable lawyer.
Small businesses qualify for a direct offering under one of three federal securities exemptions: Regulation D Rule 504, for offerings up to $1 million; Regulation A, for offerings up to $5 million (scheduled to be raised to $50 million under the JOBS Act), and the intrastate exemption (…for companies that do business primarily in a single state). The offerings are filed with state securities regulators and are subject only to state regulations, which vary.
There are also exemptions for nonprofits and farmer cooperatives.
Finding capital can be as big a challenge as forming a company. Learn more about resources for incorporating small businesses on our blog and knowledge center today.