Ed Palmer might not think of himself as a pioneer. But he's among the first wave of company builders to look for investors on the Internet without a middleman

Ed Palmer is at his desk, bracketed by two Macs, poring over the number of hits received by the various components of his business's Web site. The company's only other full-time employee is a cubicle away, dashing off a string of E-mail notes from his computer. This could be almost any Web start-up, if it weren't for the company's only other room--a storage room across the hall--one that should be filled with humming servers and blinking modems. Instead, the room turns out to be littered with crates, pallets, and ungainly mechanical devices--an inventory of actual things.

Palmer's company, SolarAttic Inc., is not a flash-fire Silicon Valley Web start-up but a conventional small company in a Minneapolis suburb that has been engaged in a gritty, 13-year struggle to score with products that could at best be called medium-tech. What especially distinguishes SolarAttic from the typical Internet business is that despite the fact that sales have been taking off, venture capitalists, angels, and other investors have not been lining up to hurl money at the company to propel it into the next stage. As a result, Palmer has modified SolarAttic's growth strategy to include an on-line wrinkle so cutting edge that few Web businesses have dared to try it. Namely, the company is trying to go public by finding its own $1,000-here, $500-there investors over the Internet. No investment banks, no brokers.

The realization of ultra-low-cost, wide-open stock offerings--a pure, frictionless transfer of money from the public to a company--may ultimately become one of the most powerful applications of the Internet. It's turbocapitalism: for ordinary investors, a chance to get in on the ground floor of even tiny, distant, or obscure companies; for underfunded, non-Web start-ups, an opportunity to get their story out to people who might be willing to take a modest gamble.

Dozens of companies have already altered the conventional model of fund-raising to take advantage of the Internet's reach and efficiency. But surprisingly few companies have tried to go all the way and strip their efforts down to a simple on-line proposition: send me money and I'll give you a piece of my company. SolarAttic, as unlikely a high-tech pioneer as it may be, is one of them. The results have not been entirely pretty. Despite garnering a small sea of leads, the flow of actual on-line investment in the company has barely reached the level of a trickle. Among the challenges the company continues to face: getting the right people to its site, differentiating its offer from those of con artists, and slogging through a morass of state regulations.

But SolarAttic is forging ahead, learning what works and what doesn't as it goes along. As the company embarks on its third public offering--the second that is based on the Web--Palmer offers a simple explanation for why he keeps at it: he is convinced, as are many others, that this is just too good an idea to ultimately not work.

Anyone who has ever climbed into an attic on a sunny day can appreciate the basic idea behind SolarAttic. Heat gets trapped up there. Why not put it to work?

Palmer, for one, cannot abide the fact that energy is literally floating around the tops of homes while their owners pay good money for heat in other forms. Call it an engineer's disdain for the inefficient. Palmer worked on guided-missile-system computers for the navy and later on civilian computers, before a friend's offhand remark 16 years ago changed his life. The English, said the friend, often keep their water heaters in their attics not only for the pressure gain that gravity provides but also for the free temperature boost.

Never mind that the English also eat meat in pies and beat one another up at sports events. Free energy was a good thing, Palmer declared, and worth following up on. Two years later, with salaried life permanently behind him, Palmer began his attic-heat-tapping experiments--ultimately taking over nearly two-thirds of the floor space in his Elk River, Minn., home, including the entire basement and garage. The goal: to figure out a way to transfer the heat to piped-in water that could then be pushed into a swimming pool. Since he didn't own a pool, he set up a 125-gallon horse trough in the garage; to compensate for Minnesota's frequent dearth of sunlight, he set up electric heaters in the attic to provide heat that he could then get rid of. His efforts fell short until he hit on the missing ingredient: a fan to blow the hot attic air over his boxed-in network of thin piping.

Unfortunately, having a good product concept and moving a good product are two different things. At the rate Palmer was going, he had already run through his savings; he and his wife were living on $12,000 a year, mostly borrowed, and his wife was doing all their home maintenance and repair work. He went to a venture capitalist and was told to come back after he sold the first 100 systems. He went looking for angels but found himself in a geographical bind: investors based in mostly chilly Minnesota couldn't relate to the pool market in general and to a solar-dependent product in particular; investors in warmer climes were not interested in a company that was so far away. He kept plugging away. "If you lose faith, that's when things start to unfold on you," he says. Finally, in 1986, Palmer wrote up a list of just about everyone he had ever known and sent roughly 700 of them a letter asking them to invest, valuing the company at $1 million. He was even willing to trade away majority ownership of the company if he could raise that much, since he figured he could exercise effective control with a concentrated 20% of the stock. In any case he raised a nonthreatening but badly needed $50,000.

Palmer's first sale wouldn't come for three more years. In 1989 he finally sold a pool heater--to a reseller in Florida--for $1,600. And the feedback from that first sale was extremely promising. After performing a test, the customer reported that his pool's water temperature had risen by 20 degrees to 98 degrees Fahrenheit. Even better, as the temperature in the pool went up, the customer's energy costs to heat the pool went down. Typically, pool owners have reported costs as high as $300 per month to heat their swimming pools. By contrast, Palmer's heater costs about $11 a month to operate, treating pool owners to a "warm pool without hot bills," as Palmer puts it.

Heating pools is not a quirky endeavor. According to Palmer, it is a $200-million annual market, based on the number and retail cost of pool heaters being sold. By the early 1990s, Palmer started thinking seriously about going public. It wasn't grandiosity; he had simply recognized that the SEC had lowered the bar for small-company securities offerings a few years before by creating the small-corporate-offering registration, or SCOR, and so-called Regulation A offerings, both of which require no or minimal scrutiny from the SEC. Subject to state regulation, companies can raise up to $1 million in a 12-month period with a SCOR, or $5 million with a Regulation A offering. Palmer talked to brokers, but none were interested in taking part in offerings below $10 million (Palmer's was less than $5 million) and the correspondingly small fees that their 10% commission would generate. No problem, he thought. He'd do it the way he had done everything else: on his own. In 1994, Palmer filed for a $1.5-million-minimum and $3-million-maximum Regulation A offering in Minnesota, and was promptly blindsided by state regulators, who told him he had only 180 days to raise the money--even though there was no such rule on the Minnesota books. Palmer eventually resolved the matter with state regulators, but the fight had been so time-consuming that the offering languished and ultimately fell short, necessitating the return of the $250,000 he had raised and placed into escrow. But Palmer walked away with a list of 1,000 interested investors, and to a few of them he sent a letter offering a private placement at a 20% discount from the public offering price, which generated $125,000.

Two years later Palmer figured it couldn't hurt to put up a Web site that provided sales and technical information about his company. It wasn't long after the site's debut that he realized the Web could be a big selling tool for SolarAttic. "People used to call about a product and ask something like, 'What's the PCS1?" notes Jim Stanley, Palmer's half-brother and SolarAttic's vice-president of sales and marketing. "Now they download the technical manual first, and then call and say, 'Here's my credit-card number." By mid-1997, the site was pulling in as many as 40,000 hits a month (and it now pulls in roughly 100,000 a month).

That was the good news. The bad news was that the company was now generating far more leads and opportunities than Palmer and Stanley could handle. Ultimately, Palmer wanted to hire more people--and he figured that with an expanding array of products, the potential market he could tap into could be worth as much as $10 billion. The capital requirements of that vision, combined with the fact that he was still living on fumes himself, meant that he needed another round of financing. Drawing on a heady brew of desperation, optimism, and masochism, Palmer decided to go back to the public offering well in a big way.

While mulling over strategies for how to make things turn out better this time, Palmer stumbled across an article that told how Spring Street Brewing Co. had conducted a successful Regulation A initial public offering over the Internet. (See " The Real Legacy of Spring Street Brewing.") It all double-clicked for Palmer. To his engineer's eye, using the Web to facilitate the transfer of small plugs of money to the stock of a small company whose potentially fabulous growth was being stunted by a lack of capital was like, well, using the PCS1 to transfer heat from a stuffy attic to a chilly pool.

Three trends central to the recent evolution of our economy point to the likelihood that small investors will embrace Internet-based direct stock offerings from small companies:

  • The small investor has become more independent of brokers and mutual-fund managers, less risk averse, and more enamored of IPOs.
  • The Internet has gradually been greasing the gears of investment mechanisms, cutting commissions and making more investment instruments and professional-quality information about them directly available to anyone with a computer and modem.
  • The country's economic engine is increasingly fueled by small companies.

Direct public offerings will provide opportunities far more interesting than today's typical IPO. Currently, the vast majority of small investors are locked out of IPOs altogether, and anyone who does manage to buy in is paying not only for a piece of the company, but also for the underwriter's 7% commission and at least 3% or so in other fees related to the costs of going public. What's more, the companies represented by today's high-profile IPOs have had their growth and market potential thoroughly plumbed by venture-capital and investment-banking pros; the chances that you'll see something that everyone else has missed, and thus end up with a true bargain, are not good.

Buy directly into a tiny, unsung company's do-it-yourself Internet offering, on the other hand, and you've got a genuine, undiluted chance of surfing in front of a wave of growth that other investors--including the pros--haven't spotted. Needless to say, the risks would be correspondingly high. To pick the gems out of what will likely be a field made up predominantly of losers, small investors will have to do what angels do today: apply careful analysis and good instincts. Except you won't have to risk $50,000 or more, as you typically do today, to buy in at ground zero; $500 or so should do it. Welcome to the dawn of the micro-angel.

What can small companies hoping to raise money through an Internet DPO do to connect with potential micro-angels? Unfortunately, you probably won't learn much by examining the offerings out there today. I searched the Web using keywords and phrases like IPO, direct public offering, investors wanted, SCOR, and the like, and checked out dozens of small-business and capital-raising-related sites and bulletin boards. Of the 20 or so registered small-company stock offerings that I turned up, many appeared to be hybrids of one sort or another, depending at least as much on conventional techniques as on the Web to attract and convince investors.

The bottom line: the pure Internet DPO is largely unexplored territory. On the other hand, three years from now it will probably seem like old hat, with thousands of small companies competing for investors' attention. The ideal moment to strike will probably lie somewhere between now and then--and your guess is as good as anyone else's.

If there's a shadow hanging over the on-line DPO market, it's that being cast by securities fraud. Traditional stock offerings are heavily scrutinized by brokers and the SEC; typically, no one does due diligence on a DPO. DPOs that take place entirely on the Internet are ripe for con artists for the same reason that they are so appealing to legitimate companies: they are quick and cheap to set up. The SEC has charged 83 individuals and companies in the past year with Internet securities fraud, 26 of them for hawking entirely fictitious deals. Two years ago a company called Interactive Products and Services (IPS) Inc. rolled out a DPO to develop WebTV products; the offering was listed entirely on the Internet. IPS pulled in about $200,000 from small investors before California officials shut the operation down as a scam and sent its CEO to jail. Not surprisingly, con artists have figured out the kind of leverage they can achieve via the Net. In my search for offerings, I came across hundreds of bulletin-board investment solicitations in almost comically fishy-sounding ventures ranging from gold mines to magazines for "exotic models." But only the most naïve investors would be taken in by those sorts of come-ons. On the other hand, what to make of a company like Fonecash.com? Listed on Direct Stock Market (DSM), a Web site that specializes in listing DPOs and private placements, as a developer of a credit-card-transaction-processing device, Fonecash.com is floating a $990,000 DPO. The Fonecash.com Web site consists of an "under construction" notice, and the company had not returned phone calls by press time. Another DSM-listed company, Specialized Autocore Services Inc., also failed to respond to a request for information, and the phone number of a third company on the site, the Gourmet Source Inc., yielded a "no longer in service" message. Investors aren't likely to throw their money into an operation that doesn't even answer its phone.

In mid-1996, Ed Palmer decided to run a little test, putting up on the SolarAttic Web site the prospectus from his 1994 stock offering. Sure enough, he started getting E-mail requests for more information. By the end of 1997, his new offering was in place on the site.

SolarAttic now had a better picture to present to potential investors. The company's sales-growth rate was close to 80% and accelerating hard. A pool dealer in Arizona signed on as the first official SolarAttic regional dealer.

But once again Palmer found himself facing off against state regulators. The offering met with relatively little resistance in Connecticut, New Jersey, and Rhode Island. Palmer also painlessly tacked on Delaware, Arizona, and Colorado because those states require almost no paperwork, provided that a company is going after only a limited number of accredited investors. But Wisconsin, representing seven midwestern states that allowed pooled registration, dictated that a minimum amount of money be raised. The funds had to go into escrow until the minimum was met; if not, the money had to be returned to investors. California refused to accept the filing as a SCOR offering, instead requiring that Palmer fill out a long questionnaire that addressed the same information. The Nebraska Department of Banking and Finance sent Palmer a letter threatening criminal prosecution for violating a state law against unregistered solicitation of funds because of the Web site, even though the site clearly stated that Nebraska residents were not eligible. But it was Minnesota regulators who again seemed to set out to prove themselves the pit bulls of the DPO world, demanding that the company set up an "independent, disinterested" board of directors and even issuing a stop order against the offering.

Reflecting on those and other state regulatory hassles sends Palmer into a Lenny Bruce-like rant. "These regulators were engaging in illegal activities," he fumes. "They were breaking their own laws. How is a company supposed to put together a disinterested board? Is that an oxymoron, or what?" He churned out a press release accusing one Minnesota regulator of imposing several illegal requirements on SolarAttic. And he ended up dropping most of the rule-mongering states from his offering. Palmer claims the battles with Minnesota regulators cost him in excess of $90,000 in legal fees and his time, and set the company back years. "The SCOR rules were supposed to make it easy for small businesses to go public," he says. "It's supposed to be uniform, but each state lobs its own preposterous things at you. They say it's to protect the public from crooks, but crooks don't care about the rules. It may seem strange to hear this from a small-business owner, but I wish the federal government would take over the regulation of these things."

When the regulatory hassles were finally behind him, Palmer started to focus on driving potential investors to his Web site. He started by analyzing statistics that told him where visitors were coming from and what they were doing when they got to his site. For example, 9% of visitors came to the site from a Yahoo search, and of those, 38% had included the word solar in their search, versus only 3% who had used accredited. Only 2.5% of visitors were examining the offering "tombstone," and eight times as many visitors were downloading technical manuals as were downloading prospectuses. Conclusion: Yahoo searches were a great potential source of referrals, but they were sending over mostly potential customers, not investors.

In light of that information, Palmer decided to sign up for a $4,500 banner ad with Yahoo. The ad would be displayed at the top of the search-results page whenever someone asked for such investment keywords as IPO, DPO, SCOR, and so on. But after studying stats revealing that after 20,000 showings the banner had enticed only 200 people to click to the SolarAttic site, Palmer discontinued the ad. Next, he contracted for 50,000 page views of an ad for his offering with the Wall Street Journal Interactive Edition--ads that, he says, would be shown only to the site's 18,000 subscribers in New Jersey, Connecticut, and Rhode Island. But again, the results were disappointing: 200 hits, after subscribers had been exposed an average of three times each to the ad. "I realized that people don't want to be distracted by banner ads when they're on-line looking for information," says Palmer. "It doesn't make sense to pay thousands of dollars for 200 hits when I can generate 300 hits from a $90 Business Wire press release."

Palmer also tried talking up his offering in various newsgroups, on bulletin boards, and in chat rooms, posting nearly 7,000 messages. But most of the forums quickly erased his messages, presumably for the same reason cited by the Motley Fool when it erased the message Palmer had placed in the "Minnesota" section of that site: the site is for publicly traded companies only. The sites that didn't erase his message generated mostly "nastygrams," as Palmer puts it. By that point, he knew better than to try a mass E-mailing, a.k.a. spamming. "People don't want unsolicited E-mail, period," he says, noting that it's difficult to limit such mailings to particular states. Instead, Palmer limited his mailings to "opt-ins"--Web surfers who indicated their interest in receiving them.

Finally, Palmer says he spent $750 to place his offering on DSM. DSM has since turned over some 40 leads to him, but most turned out to be from states in which the offering wasn't registered. Palmer says DSM and other sites like it can be useful; for one thing, such sites often offer mechanisms for investors to trade stocks originally offered in a DPO, providing much-needed liquidity to the investment. Other lessons: few people are interested in downloading an 82-page prospectus (a process that takes about 10 minutes via a standard modem connection), judging by the fact that only a small number of people ever bothered to download his; no matter how interested investors become in the stock, they're more likely to call up to buy rather than plug in their credit-card number; and $500 is the largest acceptable minimum investment for most Web surfers, something Palmer figured out after starting off with a $3,000 minimum before dropping it to the lower figure.

Oh, and one more thing: pioneering is hard, be it for attic-heat-transfer systems or Internet fund-raising. Palmer ended up raising a mere $20,000 on this round. On the plus side, the company got to keep the money this time around because it had avoided states that required a minimum level of funding--proving, at least, that some sort of useful learning curve is in effect. Even better, the company's increasingly bright sales picture has helped Palmer bring the total amount of money he has privately raised to over $600,000. (He now owns no stock personally but through a family trust exercises control of 40% of the company.) The obvious conclusion: private fund-raising was the way to go for SolarAttic. But that wasn't the way Palmer saw it. "I know we're destined to be a public company," he says.

Ever the optimist, Palmer concludes, "We could grow to a hundred million a year, easy." That's a long way from the $118,000 the company brought in last year, but, on the other hand, revenues so far this year are up 250% over the same period last year. There are now more than 200 SolarAttic pool-heating units installed throughout 31 states.

Buoyed by that growth rate, at press time Palmer was registering a $4.8-million Regulation A DPO in New York and--combative fellow that he is--Minnesota. He ticks off the reasons that things will be different this time around: he's learned a lot of the ins and outs of marketing stock on the Internet; Internet DPOs are gaining credibility; and he knows how to keep the satanic state regulators at bay. He also says he's going to try to play the affinity card this time around, using the Internet to zoom in on the environmentally conscientious. He's also going for a reverse affinity play. "If you're a pool owner who learns about our technology as a potential investor, I might get you as a customer, too," he says.

And if this round fizzles like the others? Then he'll try again. "I go by the kick-the-can theory of money raising," he says. "I won't allow myself to think I have to have a certain amount or I can't make the business go. That's linear thinking. I'll spend the rest of my life making this work."

You can almost hear the Minnesota regulators gnashing their teeth.

David H. Freedman is a contributor to Inc.

Virtual road show

Clay Womack, CEO
Direct Stock Market
Launched: 1993

What Direct Stock Market is: A listing service for direct public offerings (DPOs) and private placements. Direct Stock Market provides an on-line community environment in which investors can discuss offerings, but they must do their own due diligence. Direct Stock Market also helps companies to put together Web-based "virtual road shows."

And isn't: An automated system for filing a Regulation A or Regulation D offering. You still have to do all the paperwork yourself--off-line.

The on-line advantage: Investors can scan the prospectuses of several dozen DPOs and private placements, and companies can get their offerings in front of thousands of small-business-friendly investors. "There are 80,000-plus businesses in the United States that are growing at a rate of at least 50% per annum, and the VCs are only doing 2,000 deals at any point in time," says Womack. "I want the other 78,000 businesses on our site."

Your odds of finding funding: Probably better than if you posted the offering only on your own Web site. Womack has done a good job of generating publicity for the site. But mismatches are common. Interested investors may respond on-line from states in which your DPO isn't registered. On the other hand, if Direct Stock Market becomes a broker-dealer as planned, your offering could find a much wider audience. (For a price.)

Fee: From $2,500 to $4,000, depending on the size of the offering, for a 90-day listing. --D.F.

We're from the government. We're here to help

Terry Bibbens, Entrepreneur in Residence
Launched: 1997

What ACE-Net is: A Small Business Administration-sponsored listing service for companies that have completed the paperwork for a streamlined direct public offering (DPO). The Angel Capital Electronic Network (ACE-Net) was designed to make small offerings (up to $5 million) cheaper and easier to pull off by eliminating the need for a broker-dealer and lowering the legal barriers; a listing on ACE-Net satisfies many states' securities regulations.

And isn't: A vehicle for launching a full-fledged DPO--you can't sell stock to just anyone, only to "accredited" investors.

The on-line advantage: "A single filing on ACE-Net suffices to exchange stock certificates and checks in multiple states. The offering document is created from a simple Q&A the entrepreneur fills out on-line. Your lawyer, accountant, and board can also log on and review the document and make changes in real time. And you can also quickly modify the offering depending on the marketplace. Rewriting the offer and refiling it is not hard to do on-line."

Your odds of finding funding: Until recently, dismal, if you hoped to do a national direct offering. Despite its government connections, ACE-Net has lacked crucial nationwide support and publicity. That's slowly changing, now that 37 states and 1,000 investors are on board. In one recent six-month period, 20% of the 140 companies listed in ACE-Net's national database had received financing. The DPO route hasn't exactly caught fire, perhaps because it's the wrong vehicle for appealing to angels. But you don't have to do a DPO to tap local ACE-Net resources--and connections to angel groups.

Fee: Up to $450 for an annual listing. --Susan Greco

The IPO classifieds

Stephen D. Pelletier, CEO
Offroad Capital Corp.
Launched: 1999

What OffRoad Capital is: A "placement agent" for established private companies seeking growth capital of $3 million to $15 million. Several thousand accredited investors--including angel groups and some VCs--are expected to kick in a minimum of $25,000 per investor per deal. Road shows will be real and virtual: CEOs make studio appearances and take questions from investors via E-mail or phone. "We're not just a listing service. We help these companies get financed."

And isn't: An underwriter of deals.

The on-line advantage: The ability to create a public "marketplace" for vetting and selling private placements. "Real companies with real revenues and profits should be able to tap equity, not just debt. Within three years, it will happen," says Pelletier. "We're using the Internet to create a marketplace for growing companies."

Your odds of finding funding: Slightly better than at Garage.com if your annual sales growth is at least 20% and your company's valuation is at least $20 million. You also need a clear exit strategy, such as a public offering, merger, or acquisition. Of 400 companies recently considered, 5 have received financing. All industries are welcome, but "don't be surprised" if the first deals are Internet plays, says Pelletier.

Fee: From 3% to 9% of any money raised. --S.G.

A match made in . . . cyberspace?

Guy Kowasaki, CEO
Launched: 1998

What Garage.com is: A matchmaker for company founders and sophisticated angel investors, select venture capitalists, and corporate venture-capital divisions. Entrepreneurs receive help with creating a management team or marketing strategy and with pitching their companies to the investors involved, who collectively have kicked in an average of $2.9 million per deal. "We're a broker-dealer, quasi investment banker, and what I call a venture 'gapitalist.' We fill that gap from $1 million to $4 million," says Kawasaki. "The bottom line is we're trying to help two guys or two gals in a garage get seed capital. We find 'em, fix 'em, and fund 'em."

And isn't: The final word. "Angels have to do their own due diligence. There's no on-line yenta yet."

The on-line advantage: "It's compressing time to 'high value' money and providing a greater breadth of exposure for the entrepreneur. It's all about opening up the channels. Taking information over the Internet is 100 times more efficient for us than taking a paper business plan. We determine the questions and how much space entrepreneurs have to answer each one--it's all standardized. And the plans are searchable forever. All plans are created equal through the Internet. And we read every one of them."

Your odds of finding funding: Nil, unless you're a hot start-up in high tech, biotech, or health sciences. Garage.com expects to close on 30 deals culled from a projected 10,000 business plans to be submitted by the end of the year.

Fee: Typically, 5% of money raised. Garage.com also buys a small stake in the company at the "pre-deal valuation" price. --S.G.

On the auction block

Ian Zwicker, President
WR Hambrecht & Co.
Launched: 1998

What OpenIPO is: A process by which WR Hambrecht & Co., an investment-banking firm, takes companies public by auctioning shares over the Inte