Non-Public Sources
of Capital
The best way for you to raise significant capital is the easiest, quickest
and cheapest way that really works. The real challenge is to raise any
capital. There are many stories from corporate managers and owners where
they have given up after investment community promises to raise capital
were not fulfilled. And there are as many ways to raise money as there
are people that you personally know. But first we should look at the
main possibilities to raise money being offered today and then consider
the advantages and disadvantages of each.
Banks and other institutional lenders may assist you with debt capital to grow your business in the early stages. However, few of these lenders will make you a loan without collateral and personal guarantees that makes them seem more like personal loans. In addition to your house, other assets and first-born, they will look appropriately at the assets being funded. However, the cost, restrictions and personal commitment for such loans usually will only take the business far enough to get started. In addition, there are requirements for audited financials and strong collateral to increase the loan amounts to what you really need.
Most institutions like banks are not in the business of providing risk capital to anyone no matter how solid the business unless as the old saying goes that “you don’t need the money.” Small Business Investment Companies (“SBIC”) and other local and national government programs can assist you when they have money available but they also require special circumstance and compliance from the borrower that meet their rigorous standards.
Experienced entrepreneurs and company founders know that the time and effort it takes to raise money from private investors and deal with private investors many of which are friends and family is exhausting.
There is another level of
greater effort that may yield somewhat larger dollar amounts known as
a Private Placement. This approach to raising capital will require all
the proper legal document such as the Private Placement Memorandum "PPM"
created by an attorney. Further, any time an attempt is made to directly
raise capital from the public, you have entered an area of securities
law and regulation even if an offering appears exempt from SEC registration.
And entrepreneurs who have ventured down the path of securities law
to legally prepare a private offering themselves know that you can lose
sight of your business goals. The results may be a delay the business
launch by trying to do it all including the legal work. However you
can hire it done by a lawyer, but the cost of Private Placement Memorandum
legal work can approach the cost of legal work for a public stock offering
Prospectus.
Another possibility is the straight Private Placement of your stock
with an institution like a venture capitalist or private equity fund.
However, their requirements for a substantial ownership share of the
company and/or Board/management control usually leaves most entrepreneurs
with too little of their operating business to be interesting. Private
Placements of this type are usually better suited for the development
company in bio-technology and other high technology plays that involve
high risk of total loss offset by an occasional large win for the venture
capital types.
Another possibility is obtaining
capital as a “public stock” company. Although you are required
to do the legal preparation for such a company including the creation
of audited financials and SEC filings, the process for raising public
capital can open up many new doors to financing the current and future
growth of your company. There are several main strategies that have
worked over the past years with pros and cons associated each as follows
Reverse Merger is where your
private company is merged into a public shell (inactive public company)
to change the private company to a public company. Although the popularity
of reverse mergers has grown over the last few years, the problems associated
with them have also grown and the problems are reaching a point that
makes reverse mergers very difficult to impossible to do in any reasonable
time.
The Securities and Exchange Commission (“SEC”) has moved to control and restrict the use of reverse mergers as a way to “go public.” by creating new rules. The changes basically say that you will need audited financials and the equivalent of an SB-2 registration within four days of the merger to be in compliance with the law. The rules are intended to protect investors by deterring fraud and abuse in securities markets through the use of shell companies. The reverse merger also known as the “back door exchange act” can actually take longer to do than both an IPO registration with a clean start and a business development company spin-out or partnership.
Beyond the regulatory issues, a reverse merger has potential problems for the private company going public from the undiscovered and/or undisclosed history of the shell company. Old investors and/or old creditors of the shell company may come forward with financial claims when they see the new life and new resources of the merged companies. And litigation for the newly merged company can be devastating to the share price of the company. Therefore, the unknowns along with the other legal and compliance issues have limited the acceptability of reverse mergers with public shells.
Pros &
Cons of a Reverse Merger
See the exhibit at the end of this section:
“Is a Reverse Merger, IPO or Business Development Company Spin-Out
the best way for you to raise significant capital?”
Initial Public Offering (“IPO”)
is where an investment banker member of the FINRA arranges for a group
of in-house broker representatives or an independent group of FINRA
investment bankers to form a money raising syndicate (group) to sell
your shares to primarily individual investors.
The first and greatest challenge with the IPO is that the size of your deal may be too small to justify the amount of effort the investment bankers will need to make it worthwhile. Of course the catch-22 is that although you would probably take all the money you could get for your business, the larger amounts cannot be justified by your current size and business plans today, Also, if you receive too large an amount of money, you could lose control of the company.
As a practical matter, the
IPO simply is not viable for a company raising only a few million or
less due to minimum up front cost required and the lack of FINRA licensed
investment banker interest in doing small deals. An IPO deal has to
be sold to at least several hundred investors to get started with a
reasonable shareholder base to make a trading market. This simply requires
too much effort for the investment banking community relative to their
cost and the minimum compensation they need to get their sales system
started.
Even the currently promoted Mini-IPO’s require a commitment of
several $100,000 up-front from you and leave you with too few motivated
shareholders to make a difference in the value of your publicly traded
shares. Therefore, an IPO for an initial money raise less than several
to ten million dollars is not possible and/or generally not the best
solution for you.
Pros &
Cons of an Initial Public Offering (“IPO”)
See the exhibit at the end of this section:
“Is a Reverse Merger, IPO or Business Development Company Spin-Out
the best way for you to raise significant capital?”
Spin-Out is where a public Business Development
Company (“BDC”) takes a private portfolio company in which
the BDC has a mutual fund investment, to public status through a stock
dividend to the BDC shareholders.
The issuance of the private portfolio company shares to the BDC shareholder
as a stock dividend along with the filing of a Registration Statement
by the portfolio company will allow the portfolio company shares to
be traded. Essentially the Portfolio Company has acquired the same shareholders
as the BDC. In this way, the Portfolio Company has “gone public”
Under the current interpretation of the law by the SEC, using a method
of “spin-off” through a “Super Corp” or non-BDC
parent company is no longer acceptable as a means of avoiding the standard
registration process for the distribution of shares of a new public
company. However, there is a very particular exception for the use of
spin-out involving a strict procedure created by Congress in 1980 as
an improvement to the 1940 Investment Company Act designed to help American
businesses gain access to capital.
Pros & Cons of Spin-Out
See the exhibit at the end of this section:
“Is a Reverse Merger, IPO or Business Development Company Spin-Out
the best way for you to raise significant capital?”
| Pros & Cons of Reverse Merger |
| Pros | Cons |
| You get the Shareholder from the shell company. | You may pay a lot to acquire a trading bulletin board shell. The average cost ranges from $500,000-$900,000 cash. |
| You get the market makers for the shell company. | You may give up 5%-15% of equity of your company plus cash to the shell company owners for no services performed. |
| Market sets the price of your shares, not underwriter like an IPO. | Your initial trading volume and resulting liquidity in your company may be low. |
| Fast way for you to go public. Trading of your shares could begin in a matter of months if there are no problems with the SEC. | You may have unknown and/or undisclosed litigation or liabilities appear against your company. |
| You can start to raise money as soon as your are reporting and have a public market valuation for your stock. | You may have unknown or undisclosed shareholders appear with rights in your company. |
| New restriction on sale of 144 stock period starts at the time of merger for investors to help you keep orderly market with supply and demand. | Stock promoters that hold free trading shares in your company may “dump” shares and drive down the market price of your shares as you try to raise additional capital. Shareholder lockups to prevent sales do not usually work since these shareholders have their own agenda and will go around or not participate in the lockups. |
| You will need to hire investor relations consultants for your new company to support the price of your stock in the market. | |
| You will need to file a 15c211 form with the NASD to begin trading on the NASDAQ Bulletin Board. This process could take many months with challenges. | |
| You will have to comply with new SEC regulations on reverse mergers requiring the filing of information equivalent to an SB-2. And, the SEC is especially reviewing reverse merger transaction because of alleged abuses by shell promoters This could take up to a year. | |
| If your shell is determined to be a “Blank Check” company by the regulators, you may be restricted from trading in some states and you will have to perform a full registration for $50,000 or more. | |
| You may have to spend significant time dealing with expensive legal processes rather than running your business. |
| Pros & Cons of IPO |
| Pros | Cons |
| You get the Shareholders with the new investors | You may pay a lot to retain the services of a new security attorney and CPA to prepare the initial filing and responses to comments. The average cost ranges from $100,000-$500,000 cash |
| You get the services of an NASD licensed investment banker to sell your shares and raise your capital | You may give up 20%-25% of equity of your company to the new investors and underwriter through stock and warrants. |
| You get the services of an NASD licensed investment banker to help support the value of your shares for your company | Your initial trading volume and resulting liquidity in your company may be low |
| You get a clean history of shareholders and creditors | Underwriter sets the initial price of you shares not the market |
| Slow way for you to go public. Trading of your shares will not begin for many months to a year if there are no registration problems with the SEC. | |
| You will need to hire investor relations consultants for your new company to support the price of your stock in the market.. | |
| You must have help with Sarbanes Oxley compliance and the filing of quarterly and annual reports to SEC immediately with your new public CFO position. | |
| You will need to file a 15c211 form with the NASD to begin trading if your stock on the NASDAQ Bulletin Board. | |
| You may have to spend significant time dealing with expensive legal processes rather than running your business. |
|
Morris Business Development Company MBDC has been used as example for Exhibit. |
| Pros | Cons
|
| MBDC can provide a loan for your business development on a monthly basis from our Capital Fund and other private sources during your SEC registration | MBDC can not provide significant lump sum funding until after you are pubic. MBDC will only fund on a monthly basis until you are public. |
| MBDC Provides extensive mentoring to prepare your organization to be a public company and provides efficient Sarbanes Oxley advisors, SEC attorneys, CPAs and consulting on a “group” rate | 10%- 20% of your equity is retained by MBDC and other investors to create market liquidity and support |
| MBDC allows you to keep your management focused on your business rather than going and being public | MBDC does not accept a start-up company into its portfolio of companies |
| Your new shareholders are inherited from and are the same as MBDC shareholders. These shareholders already know about your company through prior company owner communications and filings of the MBDC | MBDC will not accept your negative cash flow company into its portfolio unless your company has funding in place to reach positive cash flow and can prove it through documentation. |
| Market sets price of your shares that are spun-out, not an underwriter. You inherit Market Makers of MBDC and MBDC handles your share float management | Your loans must be repaid upon spinout of your Company. Loans may be repaid within three months through the issuance of free trading shares in the new public company. |
| MBDC provides introductions to investment bankers, market makers, investor relations firms and other services at “group” rates after going public | |
| MBDC advise and arrange for substantial PIPE funding on best efforts basis after going public to provide capital amounts for growth through special events | |
| MBDC cost to a portfolio company for a Spinout is only $50,000 and paid on a time payment basis and efficient low cost guidance and consulting is available after going public |
| Is your public company share value depressed? |