Off-the-Grid IPOs

An underused SEC exemption that deserves another look.

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In some respects, it wasn't such a terrible problem for Martin Lightsey to have: The value of Specialty Blades had increased so much since he founded the medical and industrial blade manufacturer in 1985 that some of the company's 11 shareholders, including Lightsey's two daughters, wanted to cash in some of their earnings. In 12 years, the median $42,000 investment in the business, based in Staunton, Virginia, had soared to a value of more than $350,000. The problem was, Lightsey didn't have enough cash to fund the buyouts.

Lightsey briefly toyed with the idea of going public, which would allow his investors to buy and sell shares as they pleased. He called Gordon Smith, a securities lawyer at Richmond law firm McGuire Woods, who told him that the legal and accounting fees related to being a publicly held company would amount to roughly a half million dollars every year, overwhelming for a business booking $6 million in annual sales.

Lightsey asked Smith about a privately held community bank in Staunton that seemed to be trading its shares. Smith explained that the bank was taking advantage of a little-known Securities and Exchange Commission exemption called an intrastate offering, which allowed it to sell stock to Virginia residents without registering with the SEC. It seemed like a perfect solution for Specialty Blades: Lightsey could cash out the company's current investors by selling their stock to a new group of shareholders and avoid the hassle and expense of an IPO. At the same time, he could spread out ownership to a larger, more diverse pool of investors. "The public model is just more stable," Lightsey says.

Intrastate offerings allow privately held businesses to create small local stock exchanges by selling shares to residents of a single state. Companies issue shares to investors through investment banks or brokerage firms, which then handle ongoing trading between interested buyers and sellers. To qualify for the exemption, a business must be incorporated in the state where it is making the offering and carry out the bulk of its operations there. The offerings also must comply with state securities laws, also known as blue-sky laws, which vary by state and may limit the number of shares a company can issue. As long as the company has less than $10 million in assets and fewer than 500 security holders of record, it is exempt from filing reports to the SEC.

The intrastate offering exemption has been around for years. But few businesses are taking advantage of it. In Virginia, for example, only seven such offerings have been made since 2001, according to the Virginia Corporation Commission. One explanation may be the exemption's rigid residency requirements: If a single share of a business is sold to a nonresident, or traded within nine months of the offering to someone living in another state, the entire transaction could be voided and the issuer could be forced to buy back all of the shares sold in the offering.

After the conversation with his lawyer, Lightsey spent the next few months researching intrastate offerings before deciding to take the plunge. His first step was to convert Specialty Blades from an S corporation to a C corporation, which would permit the company to take on an unlimited number of shareholders. Next, Lightsey began working with Bruce Campbell, then executive vice president of Richmond brokerage firm Scott & Stringfellow and a Specialty Blades board member who owned several thousand shares of the company. Campbell and some fellow board members estimated a value for the company's stock, based on factors such as cash flow and earnings, and began contacting clients to gauge their interest. Many of them were Staunton residents who were familiar with Specialty Blades and seemed enthusiastic about the novelty offering.

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