Some states are championing new, simplified public offerings tailored to small companies* * *
Let's face it: These are bleak times for financing growth companies. The banking industry is reeling from bad loans, and the venture capitalists are feeling anything but adventurous. Rich "angel" private investors are about all that's left -- and with the structure of current tax laws, even they don't have as much incentive to invest. All in all, it seems high time for somebody to come along with a new financing technique. The good news is that somebody has. The bad news is that the process has more than its share of bugs and is a very small-scale experiment. Still, if the snags can be worked out, we could eventually see a new capital market open up.
The new financing method is a way for small companies to sell stock to the general public without the costs of a Wall Street offering. Although it is roughly similar in cost to a small private placement, this method has fewer sales restrictions. Unlike private-placement stock, this stock may be advertised, freely traded, and sold to any type and number of buyers.
The process, sometimes called a "ULOR" or "SCOR" offering, stems from a part of the federal-securities law known as Rule 504 of Regulation D, adopted in the early 1980s. Among other things, Rule 504 exempts offerings of up to $1 million a year from federal registration, leaving their registration and regulation up to the state or states where they occur.
Rule 504 offerings received scant attention until, in 1985, a study group from the American Bar Association started to develop a special registration form. The lawyers had a radical idea. To protect investors yet keep costs affordable for small businesses, why not create a form that could be filled out by a competent CEO with a lawyer who is not a securities specialist -- a form that could be understood by an ordinary person? It would serve as a business plan, a state securities registration, and a prospectus to protect both the investor and the stock issuer.
The lawyers' brainchild is known as the U-7. After Washington State pioneered the form, the North American Securities Administrators Association endorsed it in 1989. Since then 18 states have formally adopted the form, 4 informally accept its use, and 6 others are giving it serious consideration.
Most states have had only a few companies try the U-7 so far. The main problem? Few businesspeople know about the changes. The states that have had the most interest, such as Washington and Arizona, have undertaken substantial publicity campaigns to promote the program. Without such championing, the U-7 form is likely to languish.
Lack of publicity isn't the only problem. Washington State, for example, has had a hard time finding securities dealers who think they can make money selling such small, risky offerings. (One key point: all SCOR/ ULOR offerings must be priced at $5 or more a share. That stipulation exempts them from the Securities and Exchange Commission's tough new penny-stock rules -- and makes it more difficult to manipulate the price.) Without brokers, CEOs often find it hard to sell their own stock. "I wouldn't sell it again. I would hire someone," says Gail Yarnall, chief operating officer of Dr. Cookie Inc., a $1.9-million Bothell, Wash., company that stopped its U-7 offering after selling 5% of the company for $175,000. "We did not have any time to sell."
With a broker/dealer, the process can be much smoother. Janelle Terry, president of CV Posi-Drive Corp., a Redmond, Wash., start-up that has developed a transmission for bicycles to ease gear shifting, was happy to pay a securities firm 13% of the offering to sell the stock. She says that by offering 27% of the company for $850,000, its owners are getting a better deal than they would get from venture capitalists or private investors.
Of course, many companies that file the U-7 form don't have the growth and profit possibilities to attract investors or brokers. Of the 39 companies that have filed with Washington State, 22 have been approved, but just 8 have reached their targets and have been allowed to use the money.
Still, some regulators believe that U-7 offerings will become much more common once they are better known among entrepreneurs, lawyers, and brokers. However, their usefulness will be somewhat limited by the relatively small size of the offerings and the subsequently small profit potential for advisers or brokers.
One bright spot is that the SEC has a task force working on revising a seldom-used form of public offering called Regulation A. Two proposals under consideration include raising the $1.5-million limit on Regulation A offerings to something between $3 million and $5 million, and allowing use of the U-7 form. With more money involved, there would be a greater incentive for securities firms and companies.
If that happens, there could be a whole new source of capital available to promising entrepreneurs. After all, at CV Posi-Drive, the average investment was only between $2,000 and $4,000; these aren't rich angels. At Dr. Cookie, also, Yarnall reports that the new shareholders are mostly local people who are comfortable, but by no means very rich. "They're really just a nice bunch of average people," she says.
Think about it: here we have ordinary people who know and investigate a company and want to invest a little, long-term, in its development and growth. Long ago -- before the days of pension funds and split-second Wall Street computer trading -- wasn't that what investing was all about?
* The following states accept the U-7 form for Rule 504 offerings: Alaska, Arizona, Colorado, Idaho, Indiana, Iowa, Kansas, Maine, Massachusetts, Mississippi, Missouri, Montana, Nevada, North Carolina, North Dakota, South Dakota, Tennessee, Texas, Washington, West Virginia, Wisconsin, and Wyoming.
* Some general restrictions apply to U-7 offerings -- for example, no limited partnerships or blind pools. For details, contact a participating state securities office or write to North American Securities Administrators Association, 555 New Jersey Ave. NW, Suite 750, Washington, DC 20001.
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