What if you could sell shares in your company and raise millions of dollars without having to surrender control, give up seats on your board, or comply with a slew of onerous Securities and Exchange Commission regulations? You can. In fact, such deals, known as private placements, are on the rise. With stock market returns mediocre at best, wealthy individual investors are increasingly eager to stake claims in well-run private companies with strong cash flow and solid revenue growth. "If you have that type of company and you're not exploring your options, you're crazy, says Brodie Cobb, CEO of Presidio Financial Partners, a San Francisco-based investment bank that handles private placements.
Private placements often involve dozens, if not hundreds, of investors—most of them high-net-worth individuals—and tend to offer business owners more control than deals with a single venture capital firm or angel group. What's more, many businesses are able to offer private placements on a take-it-or-leave-it basis, virtually eliminating the usual haggling over, say, preferred stock and board seats, notes Michael Membrado, a New York City-based securities attorney. Instead, investors are presented with a one-size-fits-all proposal, also known as a book deal, which they either accept or don't.
Because such deals are private, determining how many take place each year is tricky. A good indicator is the number of filings submitted by companies under Regulation D, an SEC rule governing the exemption of private stock offerings. Last year, Regulation D filings, which companies usually use when there are multiple investors involved rather than, say, a single venture capital firm or private equity group, jumped 14% to nearly 16,000.
The take-it-or-leave-it approach of private placements appealed to Mike Haider—president and CEO of BioE, a St. Paul-based biotechnology company—when he began drumming up a new round of financing in late 2003. Haider had already raised $14 million from 200 investors in several small private placements since 2002 and he thought he'd explore other options. But after meeting with several venture capitalists, all of whom low-balled BioE's valuation, he decided to give private placements another go. Much to his surprise, interest from new and existing investors was so high that he extended BioE's 120-day fundraising effort to a full year. Last February, he closed the round with $8.5 million from 240 investors, mostly bankers, doctors, and businesspeople from Minneapolis and St. Paul. "We built up a lot of momentum, Haider says. "It was a window of opportunity.
Wealthy investors taking part in private placements tend to have lower expectations than VCs, another perk for entrepreneurs. Many VCs, and even some angel groups, expect a return of 10 to 15 times their initial investment within about five years, usually through a sale or IPO. Individual investors, on the other hand, are apt to look for returns of about 20% over a longer time frame of about 10 years, Membrado says. Like venture capitalists, high-net-worth individuals are drawn to sexy industries such as biotechnology, wireless telecommunications, and security-related technology. Keep in mind, however, that individual investors tend to be silent partners, which could be good or bad, depending on your needs. If you're looking for hands-on investors willing to roll up their sleeves and help guide your company, a private placement probably isn't advisable.
Many of the meetings went on for hours as potential investors grilled Haider about BioE's sales prospects and medical technology, which may one day be used to treat diseases such as Parkinson's.
In some ways, private placements can be just as time-consuming as initial public offerings. Haider, for example, spent several weeks creating a memorandum detailing BioE's business plan, historical financials, revenue projections, and risk factors. During the next year, he made more than 100 presentations to potential investors, mostly at BioE's offices, where scientists have discovered how to harvest and clone adult stem cells from umbilical-cord blood. Many of the meetings went on for hours as investors grilled Haider about BioE's revenue prospects and medical technology, which may one day be used to aid in organ transplants and the treatment of diseases such as Parkinson's. To stay motivated during those long days, Haider recalls, he pretended his company didn't have a dime in the bank.
Companies must also follow SEC guidelines or risk losing exemption status, in which case investors would be able to demand an immediate refund. Rules governing private placements vary slightly according to factors such as deal size, but, in general, offerings can involve an unlimited number of accredited investors (individuals with at least $1 million to invest or $200,000 in annual income), but no more than 35 nonaccredited investors. Keep in mind that accredited investors are preferable, since they tend to be more savvy and financially stable, and less likely to panic if your company encounters problems down the road. Nonaccredited investors are often the first to sue if a company's performance weakens, according to Membrado.
Another drawback to private placements is that the SEC prohibits businesses from advertising the stock offerings, a potential roadblock for entrepreneurs without an established network of wealthy contacts. Haider, for his part, spent years cultivating ties with wealthy professionals in the Twin Cities by attending conferences and other networking events. Each time he meets a new contact, Haider adds the person to BioE's e-mail list and sends him or her regular press releases about the company's progress. Many investors turned Haider down during the first one or two private placements, only to invest later on. So stay in touch, he advises. Haider also enlisted several so-called finders, such as Maple Grove, Minn.-based MedVest Capital, to play matchmaker between BioE and potential investors. By the time Haider closed the yearlong private placement effort last February, BioE had racked up roughly $600,000 in legal and accounting costs and finders' fees.
As far as Haider is concerned, it was well worth the effort. Thanks in large part to BioE's latest private placement, he expects the company to generate revenue for the first time this summer by selling vials of cloned cells to medical researchers. He also expects the company to turn a profit by 2007. But Haider is not resting on his laurels. "My full-time job is to ensure capital for this company, he says. "Just when you've finished raising money, it's time to start another round.
Sidebar: Private Placement Pro
Raising money from hundreds of individuals isn't easy, but this CEO has mastered the process.
Mike Haider, CEO of BioE
Number of investors
Transaction of choice
The take-it-or-leave-it book deal
Never take no for an answer. Some investors turned Haider down, only to invest in later rounds.
For a complete rundown of the U.S. Securities and Exchange Commission's rules governing Regulation D filings, see sec.gov/answers/regd.htm.