A company founder describes the process he went through to file a small-corporate-offering registration to raise money.
Pioneer direct marketer Real Goods Trading Corp. was growing nicely, and so was its need for capital. Founder John Schaeffer blazed a new trail to raise money from the public
Last August about 150 shareholders of the environmental-products catalog Real Goods Trading Corp. gathered for their first annual meeting in a field near the company's Ukiah, Calif., headquarters. CEO John Schaeffer stepped up to the pondside podium and nervously surveyed the bucolic scene and the people who had a few months earlier become co-owners of his company. "I'm a little embarrassed to say that not only have I never led a stockholders' meeting before -- I've never even attended one," he confessed. "Just out of curiosity, how many of you have never been to one before, either?" All but a few raised their hands.
Not so long ago owners of small, young companies like Real Goods would have given scant consideration to selling stock to the public. The time and expense of complying with Securities and Exchange Commission filing requirements and the continuing responsibility for disclosure were too daunting. Moreover, most companies going public do so with investment bankers, who prefer to underwrite offerings of $10 million or more.
But small companies can get around those impediments. The process for going public hasn't changed, but there are other, albeit smaller-scale ways to sell shares to the public. One approach, the small-corporate-offering registration (SCOR) has been around since 1989 -- and offers a simplified process to raise up to $1 million. It's designed for finance tyros, like John Schaeffer, who own demonstrably solid companies and who want to raise money from outside investors.
Back in the 1980s a federal securities regulation, Rule 504, exempted companies that wanted to raise modest amounts of capital from the exhaustive process of registering with the SEC and filing a conventional public offering, often referred to as a '33 Act registered offering. The exemption allowed for simplified registration requirements, filed on a state-by-state basis.
In 1985 a group of lawyers and securities administrators transcended routine regulatory obfuscation to devise the unimaginable: they crafted a universal form that not only could be used from state to state but also was easy enough for any competent businessperson to use. That formidable task took a good three years, and in 1989 Washington became the first state to process SCORs. Today 36 states endorse such offerings, variously known as SCORs, ULORs (for uniform limited offering registration), and U-7s (for the name of the form).
For Real Goods, stumbling on the SCOR vehicle was a piece of good fortune. Started in 1986 with just $3,000 to cover its first mailing, the company never was handsomely financed, growing by cash flow alone. Customers prepaid for the solar-power products and composting toilets Schaeffer sold by direct mail. That allowed him to drop ship orders directly from his distributor, slowly building inventory stock in his house.
But cash flow took the company only so far. By late 1988 Real Goods needed a computer, a new phone system, and a warehouse. Schaeffer managed to borrow $250,000 informally from customers who had responded to a blurb he'd published in the Real Goods catalog. He'd offered 10% interest.
The loans didn't go far, and the company soon needed more cash. "By 1991 we were doing about $5 million a year," Schaeffer says. The company was, he says, in the infamous black hole of mail order, "when you're between $3 million and $7 million in sales and your growth rate is far outstripping the available capital. The nature of that black hole is that your debt-to-equity ratio shows you way undercapitalized; we had probably a 10-to-1 or 15-to-1 ratio." A loan wouldn't be easy.
Raising money by taking the company public was one option that didn't cross his mind until 1991, when the Wall Street Journal's profile of Real Goods inspired readers to offer growth strategies. "I had gotten probably 200 phone calls from all kinds of wackos around the country," says Schaeffer, when securities lawyer Drew Field, who wrote Take Your Company Public! The Entrepreneur's Guide to Alternative Capital Sources (New York Institute for Finance/Simon & Schuster, 800-227-6943; from New York City, 212-344-2900; 1991, $29.95) rang up to tell him how he could easily sell shares to the general public. Smelling snake oil, Schaeffer's first reaction was to remember that "my mother taught me if it sounds too good to be true, it probably is." But he agreed to meet with Field over lunch.
Field described the advantages of filing a SCOR: Schaeffer could handle the paperwork himself. The offering costs -- legal, accounting, printing, and registration expenses -- would run a relatively modest $100,000. There would be no need for underwriters or a road show. There were no limits on the number of investors or on their wealth or sophistication. And once Real Goods had gone public, there would be no disclosure requirement to file financial reports. Moreover, because the company was a direct marketer with a large customer database, it had a ready pool of potential investors.
The simplicity of a SCOR parallels its limitations: The offering could raise no more than $1 million. There was the risk that Real Goods wouldn't be able to line up enough subscribers. Because each state required its own filing, there would be tiresome, although not complicated, paperwork. Some of Schaeffer's target states had never before processed a SCOR. Furthermore, since the company wouldn't be eligible to list its stock on any exchange, an order-matching service would handle all buy and sell transactions. That compounded the downside to the investors: they risked finding themselves unable to dump their stake when they wished.
Schaeffer did consider a standard offering but was dissuaded by the tremendous cost -- 20% to 25% of what he raised, he was told. For one thing, he worried about putting together the historical financial statements. "To get an accounting firm to go through shoe boxes in the garage with any authenticity seemed nearly impossible," he says.
