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Why Small Businesses Should Consider a Direct Public Offering


October 17, 2016
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Should Your Business Consider a Direct Public Offering?

We’ve previously discussed on our Firm Insights what you should consider before going public via initial public offering (IPO), but what about a direct public offering (DPO)? For many small businesses, the idea of eventually taking a company public is a pipe dream. But this is a misconception because while initial public offerings are ideal for larger and mid-sized corporations to raise capital through investment, direct public offerings are more beneficial for smaller businesses.direct public offering

Not only do DPOs enable small-business owners to sell stock in the company to generate additional investment, DPOs also come without some of the strict securities regulations and high costs of IPOs.

The advantages of a Direct Public Offering for a small business

With a DPO, small businesses can file relatively uncomplicated papers with the SEC as compared to a registration statement for an IPO, but they can also issue securities and raise substantial funds without contracting to do so through brokerage firms acting as underwriters. This also allows a small business to register with the SEC to obtain crowdfunding from investors of all types. In essence, a small business can maximize investment capital by increasing spend on sales and marketing efforts, rather than pay underwriters and other costs totaling as much as 20 percent of the capital raised if an IPO was used. Small businesses only have their own direct costs in a DPO, and if done through crowdfunding, a small “commission” paid to the site operator of the crowdfunding site, which must be a FINRA/SEC registered approved website for crowdfunding.

Another key advantage of DPOs is that like IPOs, they can be structured in many different ways. This enables any size of business to provide many different types of securities, such as shares, units consisting of shares and warrants, debt offerings and rights offerings. Since the company raises its own capital, it has the opportunity to solicit investment at its own pace. 

A key benefit of DPOs is the low cost. Eliminating the underwriter cuts the underwriter’s compensation, which, pursuant to FINRA rules, can range as high as 18 percent or more. There is a difference allowed between “firm” underwritings, in which the underwriter actually purchases the securities from the issuing company and re-sells the securities creating the market for the issuer’s securities. A key difference between IPO’s and DPO’s is that after the funds are raised, in a DPO, the issuing company has to find market-makers, FINRA registered broker-dealers who quote prices for the company’s securities in the trading market, creating the “bid” and “asked” needed so that liquidity is provided for the company’s securities holders. That liquidity is one of the reasons for going public in the first place. It creates not only a way for the company’s shareholders who wish to do so to sell their shares, it also provides a currency in its shares that the company can use to reward employees with options on its shares, or that it can use to buy other companies. While substantially less expensive, DPOs do require the company to engage attorneys, accountants, auditors and transfer agents, and to make EDGAR, SEC and State Blue Sky filings. EDGAR is the SEC’s public offering submission system. For more information on EDGAR fees, small business owners should consult the SEC website.

Any business making a securities offering, whether public or private, IPO or DPO, will need an experienced securities lawyer. Even with the flexibility and reduced regulatory restrictions that DPOs provide, there are still federal and state rules applicable to these offerings. Securities attorneys’ expertise is particularly important because the issuing company and management could expose themselves to risks of lawsuits, substantial fines, civic penalties and investor rescission obligations if they are without proper legal guidance.

Bottom line

Before determining whether a DPO is right for your small business, it is important to make certain preparations. DPOs, like IPOs, require disclosures to investors and regulators of the material information concerning the company, its business and management, with heightened emphasis on financial statements and risk factors. A company considering a DPO should arrange to have its financial records reviewed early in the preparation process. While future projections are to be considered, particularly when valuing the company for pricing of the offering, past financial results must be reported, usually showing the financial results for at least the prior two fiscal years.

These are just some of the requirements and benefits of DPOs for small businesses that you should consider. Our team of attorneys can help. We can sit down with you on a one-to-one basis to go through all available options that address your specific financial needs and explain and guide you through this process, as we have done for numerous companies that have benefitted by getting funding through selling their securities and having their securities publicly traded. This process, and working in and writing about it and these trading markets, have been our practice and expertise for decades, particularly for dozens of start-ups, small and mid-sized corporations we have guided through to funding. The government is now seeking to further encourage capital formation for smaller businesses, and the DPO is just one example of the new opportunities available to raise capital as a result of recent technological advances and creative thinking by the regulators.

If you have any questions or would like to discuss the matter further, please contact me, Dan Brecher, at 201-806-3364.

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