LEGAL ISSUES

His Way

In which Chris Reed, the founder of a soda company, undertakes an initial public offering -- his way. What can go wrong does. What should go right doesn't. Five painful years pass. As the man himself says, "You have to work hard to create that much trouble."
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The Don't-Do-It-Yourself IPO

7/19/99 Dear Potential Investor: Thank you for your interest in our company. We are veryexcited about our potential investors and grateful the offering is having such a tremendous response! … We are investigating getting listed on the OTC Bulletin Board which is a pre NASDAQ stock exchange (see www.otcbb.com). This will probably not happen before the endof 1st quarter 2000.

Even before he wrote this letter, Chris Reed had never had much of a taste for authority or for other people's restrictions. Sure, it was aggressive to promise that he would be on the OTC board within nine months. But he was an iconoclast, an outlaw in this business world of rules and paperwork. He had been ever since he started his little natural-soda company, Reed's, from his kitchen, in Venice Beach, California, in 1987. Back then he was a burnt-out chemical engineer who had taken a sales job at 1-800-Dentist while trying to conjure up a company. He liked the taste of ginger, and while studying herbs, as one tends to do in Venice Beach, he learned that ginger soothed stomachaches and motion sickness. He began brewing a spicy ginger beer and tinkered with the concoction for a couple of years. Once the brew satisfied him, he bought 90 pounds of ginger, cut it up by hand, and threw it in the back seat of his Volkswagen Bug. He drove to a local brewery to borrow a vat and used a canoe paddle to mix the ginger with water, roots, and spices. He poured that into some bottles, slapped on some labels, and drove the Bug to health-food stores, delis, and a Philly cheesesteak joint to sell test batches. Then he stuffed some bottles into his backpack and wandered to the Natural Foods Expo West 1990, where a couple of big distributors liked his product and signed him up. He was in Whole Foods by the end of the year.

He had no idea that that 1999 letter would kick off an extended entanglement with the very people he was trying to avoid: the lawyers, the bankers, the regulators, the state officials, the people who believed in rule books and orderly procedures. By the time he wrote the letter, Reed's had revenue of $4.2 million, and Reed wanted to buy an L.A. warehouse and turn it into a brewery. He decided to raise the money through a special, non-IPO offering for small businesses called a Small Corporate Offering Registration, or SCOR, which lets companies sell up to $1 million worth of stock to the public without having to go through Securities and Exchange Commission reviews. As his hippie heroes at Ben & Jerry's had, Reed used his products to sell shares: He hung neck tags on his bottles and invited customers to become owners at $2 a share. "He's like, 'Aah, nobody's gonna have any faith in me, but I'll peddle it around and maybe make something of it,' " says Peter Sharma, who met Reed at a gathering for the Hindu guru Sri Sri Ravi Shankar around that time. The SCOR was a modest effort--after Reed brought in, then fired, a couple of penny-stock hawkers to manage the calls, he handed investor relations over to Kristie Hannum, his shipping and receiving clerk. Nine months into the 12-month offering, Reed had raised only $50,000 and was about to shut it down. Then Sharma, a onetime actor who had trained himself as a stockbroker, offered to help. "I said, you got 50 grand in from shysters and your shipping clerk," Sharma says. "It's working in spite of the fact of everything being wrong." Reed and Sharma printed thousands more neck tags and brought in $900,000 and 179 investors in those final three months. The whole thing cost Reed $20,000.

Reed ran through the SCOR money quickly and kept going. In 1999, with a $250,000 loan from his father, he bought a root-beer company called Virgil's for $371,000 down and $100,000 a year for five years. The next year he picked up a licensee called China Cola in exchange for 130,000 shares of stock plus 75 cents per case sold for two years. He added an ice cream, a cherry-flavored ginger drink, and ginger candy to his product line. And in December, he finalized the purchase of that 18,000-square-foot warehouse for $850,000 with a Small Business Administration loan. Searching for more cash but wary of big investors, hostile to the control that venture capitalists wanted, and too busy to put much time into researching other options, Reed decided to put together an initial public offering.

The thing about Reed is that although he's pure hippie on the outside, with his frizzy graying hair and psychedelic T-shirts with his little potbelly underneath, his belief in the properties of ginger, his refusal to kill the ants in his office (he had an infestation once; he drew a line with ginger root to ward them off), he's actually pretty rigid. His father was a U.S. Army colonel, if that has something to do with it, and Reed was going to attend West Point before a slight heart murmur sent him on a different path--to chemical engineering, then a world-music band, spirituality, and natural sodas. So when he decided to do the public offering, to go for the big time and raise $18 million, Reed wanted to do it his way. And his way of doing an IPO was to avoid the ridiculous fees and regulations of Wall Street and its associated lawyers and accountants and document processors, to deal cleanly and directly with the SEC, to do it all fast and cheaply. He was thinking $250,000, start to finish.

That frizzy hair is graying only now, it should be mentioned; when this process started, it was brown. Looking back onhis IPO debacle, Reed says, "You have to work hard to createthat much trouble."

PROSPECTUS (SUBJECT TO COMPLETION)
DATED OCTOBER 22, 2001
REED'S, INC.
Offering of 3,000,000 common shares of Reed's, Inc. at $6.00 per share.

This offering is being made directly by us through written announcement, under the direction of Christopher J. Reed, our President and CEO. We will publish announcementsof the offering on certain of our products and on ourInternet web site, and will mail and e-mail copies of theannouncement to our shareholders, customers and inquirers.

Reed filed his first attempt at a prospectus before he had even lined up an underwriter, because everyone he had looked at was charging a fortune. "The broker-dealers wanted $800,000 just to have their name on the cover, and we were like, 'To hell with that,' " he says. He decided he would save money by buying a broker-dealer--a function that is presumably noncore to a soda company--rather than paying one to sell his stock. "Is that nuts, or what?" he says. Sharma found a broker-dealer up in Washington State called Blue Bay. Blue Bay's owner, Dale Garnett, didn't want to sell his company to Reed, but he agreed to let Sharma sell under Blue Bay's auspices, and also to take a lower commission. "There's not many people who could claim this level of creative financing," Reed says.

The SEC, however, is not a big fan of creative financing, as became evident when Reed received its responses to his first-draft prospectus. "Oh, my God, it was hell," he says. "Because we were pushing all their buttons, and we didn't even know it." He wanted to market the stock over the Internet, and "there were so many questions as to the legality of it; it was a whole new thing for them. So the fact that we mentioned we were going to do most of our marketing, or even giving prospectuses and subscription documents, through the Internet, it was just ridiculously stupid." Reed clung to his approach, though, which meant it took more than a year and 13 amendments before he got the document approved, at the end of 2002. "I think it was the last five minutes of this guy's day," Reed says. "We finally get him on the phone. We did beg, and we were on our knees, and finally he did let it go forward. And it was hell."

Cleared on December 31, 2002, the $18 million offering valued Reed's at $46.3 million--a stretch, given that in the first three quarters of 2002, the company's sales were only $3.3 million, and it was losing money. Reed was expecting results like those he had had with the SCOR, but by the first quarter of 2003, he had sold no more than $10,000 worth of shares. Blue Bay's Garnett says, "Part of the arrangement was Peter was going to be in charge of all the selling, and he didn't sell any"; Sharma blames it on Reed's putting out very little promotional material; Reed thinks the IPO market was bad because of the looming invasion of Iraq.

The indifference of investors was bad, but what was even more aggravating for Reed was learning he would need to have his10-K--the company's annual financial statement--audited by the end of March, and that it would cost around $50,000. Says Sharma: "He doesn't want to pay another $50,000 to his accountants up there in Oxnard; by now he's spent half a million dollars on this offering [Reed says it was more like a third of a million, with the money going to audits and lawyers' fees], and he says, 'You know what? I'm going to pull the offering.' " Reed returned money to everyone who had bought shares and began the withdrawal process. He was tired. "Management was me," he says. "I was the CFO, CEO, COO. So management was pissed and upset and saddened and bent down and frustrated and everything else. It was not an easy decision."

March 26, 2003
Chris Reed to the United States Securities and Exchange Commission

…Reed's, Inc.(the "Company") hereby applies towithdraw the registration of shares of its common stock pursuant to the Registration Statement.

It wasn't such a mess, Reed figured. Ignoring what he had learned so far about the SEC's flexibility, he reasoned he could resume the IPO when the markets looked better and be quickly cleared by the SEC. A little over a year later, he decided it was time. By then, summer 2004, his numbers were good: Sales for the first half of the year were $4.5 million, on track to beat 2003's sales of $6.8 million. His loss for those six months was just $38,037, a fraction of the almost $500,000 he had racked upsix months into 2003. And the public markets seemed to be supporting natural-soda companies. Jones Soda was trading at$4.10 in July, up from around a dollar a year prior, and Hansen's, which had opened the year at $8.43, was up to $24. Plus, business was strong. He was still in Whole Foods (NASDAQ:WFMI), as well as Costco (NASDAQ:COST) and Trader Joe's, and he had started a direct distributor that got him into movie-studio commissaries, mom-and-pop groceries, and industrial food-service chains. Reed had just raised $334,400 ina private placement to cover offering fees, and he startedupdating his old prospectus. "We went through hell to clear the last one," he says. "You'd think it would be easy sailing only a year and a half later."

This time, Reed decided to line up a broker-dealer before he filed. He charged Sharma, who by now had a board position at Reed's, with finding one. Sharma chose Brookstreet, a firm with a mottled past and several National Association of Securities Dealers, or NASD, violations. Sharma liked Brookstreet's owner, Stan Brooks, and was comforted by the fact that he employed several family members. Sharma figured Brooks wouldn't staff up with his own family if he wasn't running a legitimate operation.

Reed, meanwhile, had forgotten another lesson, this one concerning his record as an independent researcher on stock offerings. He knew that unless a company is big enough to list on the major exchanges, it has to clear its offering with the SEC and with the regulators in each state in which it plans to sell. Reed could easily have chosen a few states to focus on. But an Internet investigation led him to what he thought was another money-saving shortcut, something called a coordinated review. With this, two states--in his case Pennsylvania and Delaware--would take the lead in amassing and coordinating comments from the 28 other states in which he wanted to sell. (He chose the 30 states by excluding those that were "obnoxious with their fees," meaning they required a $2,000 or $3,000 filing fee, and some, such as Arkansas and Wisconsin, he "just dissed.")

Reed was already getting worried about the cost by the time he submitted his first filing to the SEC, in November 2004, offering two million shares at $4 a pop and giving the company a putative value of $26.9 million. His worries spiked immediately. All documents submitted to the SEC need to be in a peculiar format customized for the SEC's Electronic Data Gathering, Analysis, and Retrieval database, or EDGAR. Financial-publishing firms "Edgarize" documents for a fee, and Reed's lawyer instructed Reed and Sharma to meet him at one of these firms, called Bowne, on the day of their first filing. "We go there, and there are billiard tables and swanky chairs and fully stocked bars and a butler and a runner who will run anywhere to get anything for you, and it's beautiful and sumptuous, and I'm like, 'How much does this have to cost?' " Sharma says. Reed was furious--especially after he was slapped with a $21,000 bill for his four-hour sojourn. He refused to pay Bowne, despite frequent collection calls. "We told them they were obnoxious; we said, 'You're not gonna get a cent,' " Reed says. (He eventually paid Bowne around $18,000.)

That one interaction with the establishment convinced Reed that his frugality was justified. From then on--"You don't even wanna know how sick we are," Reed says--he mandated that Sharma Edgarize the documents by hand. "If you ask anyone in the industry, they will say they have never heard of this in their whole life," Reed says. Sharma spent many a late night going through page after page. "Actually, I think I have a little bit of carpal tunnel from it," he says. A few months later, when Reed fired the lawyer who had taken him to Bowne and hired a lawyer named Larry Horwitz, Horwitz balked at the hand-Edgarizing and sent the documents to a publisher called Vintage Filings, which did the job for about $4,000. But properly formatted documents weren't enough to spare Reed the scrutiny of the SEC.

December 10, 2004
SEC to Christopher Reed

We have reviewed your filing and have the followingcomments….After reviewing this information, we may or may not raise additional comments….

We note that you have not filed a number of keyexhibits….

Your use of fully justified margins impedes readability. Please revise throughout to use only a left-justifiedmargin….

[P]lease add disclosure about the following in yourcore summary:

* disclose that you have significant net losses…

* explain that your shares are not traded on any market or exchange, and briefly explain how this impacts shareliquidity…

[Revise the] Founder's Statement:…

* Delete any unprovable statement such as manyconsumers of your products buy them "for their rangeof benefits" because ginger has "healing properties"

* Provide us third-party annotated documentaryevidence substantiating your claim that your ginger ale recipe is from the "log cabin days"

In all, the SEC had 69 comments on Reed's registration statement. Some were basic, which made the company look amateurish; the substantive ones, questioning his accounting practices and requesting disclosures, were even more troubling. Reed, of course, pushed back on almost every comment. The SEC responded with item after item stating, "We reissue our prior comment."

As Reed went back and forth with the SEC, he also started tussling with the states' responses. In choosing a coordinatedreview, he realized as he read their comments, he had chosena system in which each state fed off every other state's concerns. He thought he had discovered a shortcut, but once again, hisdo-it-yourself approach plopped him on a tortuous path. With the coordinated approach, he soon found, "youhave them all get together and have someone go, 'What about this,' and everyone else goes, 'Yeah, what about that?'…It was so bad."

Reed originally offered Horwitz $2,500 per response to the comments from the SEC and the states. When it became clear how many responses would be necessary, Reed attempted to do them on his own. Characteristically, he kept trying to explain why his way of doing things made perfect sense. That led to a lot of exchanges without many changes. "There were certain state comments that kept coming back the same way," Reed says. "Finally we had to call them up, and we had to say, 'What do you mean? Why is it we keep giving you the same answer, and you don't get it?' We'd try every permutation on the answer, and we just gave up."

And a problem with doing the states' coordinated review along with the SEC review soon became clear.In just one of several examples, the SEC asked Reed to edit his founder's statement to its specifications, which he did. The states then mandated that he remove it from the document altogether. With every response, Reed thought he was finished and could finally turn his attention to his business. "Then the states could say, 'I want all this crap,' then the SEC'd say, 'I gotta review all the crap that the states made you put in.' It's like they fester on each other. Then the SEC says, 'You gotta change that,' and the states say, 'I see you changed that'--it's like, OK, stopit! Stop it now!"

The state-federal conflict came to a head in the middle ofMay 2005, when Reed finally received clearance to sell fromthe SEC…

May 13, 2005
United States of America
Before the Securities and Exchange Commission
In the Matter of Issuer(s) Reed's Inc.
IT IS ORDERED that the said statement is hereby declared effective at 4:30 PM E.D.S.T. May 13, 2005

… only to be thwarted by the states:

May 16, 2005
Pennsylvania Securities Commission and Delaware Division of Securities to Larry Horwitz, Esq.

This morning we received an e-mail from Mr. Chris Reed advising us that "Reed's Inc. went effective with the SEC on Friday 13th at 4:30 PM." We responded by e-mail advising Issuer that the application was still pending…until such time as all comments are satisfied.

Pennsylvania wanted minutes from a recent board meeting; Arizona wouldn't allow Reed's to sell there until 800,000 shares had been sold elsewhere; all 30 states wanted a note that Reed's had withdrawn its previous IPO. Once the states were finally sated, the SEC had to review everything; by then, it had been so long that Reed's had to update its numbers and get those figures cleared with both the SEC and the states. "When you're sending it in, you're going, 'OK, now there isn't much left,' " Reed says. "Every day for six months we'd expect to be cleared. Every fricking day."

Finally, on August 13, 2005, three months after the initial clearance, Reed's was cleared to sell. Rather than feeling relief, though, Reed started worrying about the next stage, the hard work of selling. His concern was warranted. In the first two months of the $8 million offering, Reed's sold only about $90,000 in shares. "In 2002, our analysis was that the issue was wartime," Reed says. "So now, the stock market's doing well; Jones Soda is doing great; Hansen's is doing great. We're the next beverage company, and I just couldn't believe we weren't doing well." He harangued Brookstreet and Sharma, but nothing changed. "I got more and more desperate," Reed says. He had spent years doing everything he could to outwit Wall Street and avoid expensive lawyers, to prove that he could do this his way. Now, with a second public offering that was on the brink of collapsing, he considered that he might have been wrong all along.

He perked up, however, at a Halloween party, when he heard that someone at the party had been complimenting the Virgil's cream soda being served. He perked up further when he met the man, Jim West, who turned out to be a business development consultant. West started offering him IPO advice and later came by the office. He asked Reed to call 20 names from Sharma's database of people who had responded to the neck tags. Only one of the 20 had heard back on their inquiries. And all 20 people were still enthusiastic about buying stock. Reed decided he had screwed up the offering by leaving it to Sharma and Brookstreet but could still fix it.

Four weeks later, with West's urging, Reed traveled to Las Vegas to present at a conference of the National Investment Banking Association. He begged for an afternoon slot--he's not a morning person--but he was assigned the 9 a.m. opening presentation. "It was the first time I ever got up in front of a group of investment bankers," he says. Dressed up in a short-sleeve Tommy Bahama print shirt and battling nerves from public speaking and from a general fear of bankers, he rushed through his pitch, then retreated to his Reed's booth, where he poured Dixie cups of soda and waited. He walked out of the conference with three offersto underwrite the deal. Reed chose an outfit called U.S. Euro, which co-underwrote the deal with Brookstreet. Brookstreet, wanting to earn back its money, agreed to amp up its marketing of the IPO. Sharma, frustrated with what he considered West's takeover of his role, left the company.

This being Chris Reed, though, he wasn't quite out of the weeds. In February 2006, he was heading to India for a world-peace celebration when the SEC notified him he would need to update the financials in his offering document--it contained numbers from the third quarter of 2005, and it was by then 2006. Reed says he left this to his lawyer, Horwitz, then flew to India for a few weeks. (Horwitz says his recollection is different, but he declines to comment further.) When Reed returned, he called the SEC with a minor question. The SEC official he spoke with told him the SEC hadnot cleared the offering document with the updated financials, which meant that Reed's was now selling stock illegally.

Chastened at last, Reed, instead of trying to find some eccentric solution, adhered to the establishment's rules. First, he hired a new lawyer, from an expensive firm recommended by U.S. Euro. Then he told his new lawyer to respond in the most conservative way possible. That meanta rescission, whereby Reed would return the money to the investors, though not before clearing a new public offering document to solicit the buyers to rescind, then clearing another publicoffering document to start selling again. Reed was still confounded by the absurdity of it but was willing to pay an eventual $835,000 just to get this thing over with. He waited and meditated for several months as the SEC reviewed his submitted, pulled, resubmitted, cleared, updated, rescinded, resubmitted, reupdated offering document.

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Notice of Effectiveness
Effectiveness Date: October 11, 2006

Reed's went public on October 11. This time the offering was not only legal, it was successful: It sold out in two months, raising $8 million for the company and valuing it at $28 million. Reed started spending the cash right away. Besides finally paying that two-year-old Bowne bill, he began building out his sales force and making plans. He wants Reed's to be not just a natural brand but a mainstream brand, in grocery stores, delis, and restaurants across the country. The company has been growing fast. In the first nine months of 2007, the most recent figures available, sales hit $10.4 million, up 31 percent from sales in the same period a year earlier. Losses, however, were $2.6 million for that nine-month period. The stock has been trading at about $6, and it just got listed on the Nasdaq.

The cost of going public was extraordinarily high for the small company--$2.3 million, plus the $835,000 in rescission costs. That's money the company could use, because it has never stopped gulping cash. Just six months after the IPO closed, Reed's did a private placement for $9 million; at presstime the company was putting together another private placement, for $10 million. Reed's own stake is steadily decreasing: Before the IPO, he owned 68 percent of the company; after the $9 million round, he was down to 37 percent.

Reed is now 49, and he still likes wearing his tie-dye shirts, especially to his investor meetings. "I'm not really a suit-and-tie kind of guy, and I don't think my story is a suit-and-tie kind of story," he says. That's true, but he's coming around to some Wall Streetish ways of seeing things--he finally hired a CFO rather than doing the accounting himself, and he kept that expensive lawyer onboard because it looks suspicious when a public company switches lawyers every six months. ("He went beyond his estimate by three times," Reed grumbles. "But we try to educate him on the nature of our company and how we are not a $200 million company able to afford all of his excesses. He's getting better.") When he talks these days, he has a wry smile on his face and breaks into frequent guffaws, as if carried away by the improbability that he, Chris Reed, would be running a public company. You may have made me comply with your rules for the past five years, he seems to be saying. But look at what I got away with in the end.

Senior writer Stephanie Clifford wrote the October 2007 cover story about Pandora.

Last updated: Feb 1, 2008




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