August 5, 1997

DPOs: IPOs FOR THE LITTLE GUY

You've got a small, private business, so why in the world would you want to take it public? In this latest Enterprise Q&A, author Drew Field discusses the pros and cons of direct public offerings (DPOs) with BW Online's Dennis Berman.

Like any other stock or security, a DPO comes equipped with complicated nomenclature and operating rules, not all of which can be explained here. But generally, here's how DPOs work: Since 1989, Securities & Exchange Commission rules have allowed companies to sell up to $1 million in stock without an SEC filing. This is called a Small Corporate Offering Registration, or SCOR. Unlike the better-known initial public offerings (IPOs), SCOR shares are offered directly to the public -- not through the sales network of a brokerage house. With lower overhead and fewer regulatory requirements (there are, however, state filing guidelines), small companies are able to raise solid chunks of money at relatively low cost.

Another form of DPO is the so-called Regulation A offering, which allows a company to raise up to $5 million. Filing requirements are more stringent than with a SCOR. A registration statement must be filed with the regional SEC office, and some matters are referred directly to the SEC's Washington headquarters.

Since they lack a brokerage's sales force, DPO companies must make stock pitches on their own. An increasing number are using the Internet to inform potential investors, but others still rely on word-of-mouth, catchy product inserts, and Tupperware-esque home meetings. It's not easy work, but if done with the company's full commitment, it just may yield the capital needed to take a business to the next level. The most famous DPO example is Wit Brewery, which is now in the process of establishing an online stock exchange (see Enterprise, May 16, 1996: "A Stock Exchange in Cyberspace?").

Certified public accountant Drew Field, who wrote Direct Public Offerings: The New Method for Taking Your Company Public, (Sourcebooks, 1997) has advised 20 DPO companies since 1976. Here are excerpts from his talk with Berman:

Q: You've been in this field since the mid-1970s. Since then, what has changed about how small companies get financing?

A: The biggest changes have been the securities regulations for small business, which has helped. Secondly, electronic communications. And the third is that individuals are taking more responsibility for their own investments, instead of leaving it up to intermediaries.

Q: How should a company determine if it's ready to make a DPO?

A:The screen test gets down to two basic principles, which are related. One, is this company really a good prospect for public ownership -- is it something I would offer to people I cared about? Secondly, are there really enough people who are willing and able to buy shares who can make it successful?

The process with a DPO is usually that here is this large group of people who like a company, its products. Most of them are neighbors in the community. So the question is: Why not see if they'd like to own shares in the company, as well as provide us with some growth capital.

Q: Are high-visibility companies, say retail stores, more attractive to the general public than firms operating outside the public view?

A: A company whose purpose can't be quickly understood should probably go to venture capitalists or institutional financing, or someone who's going to spend the time to learn about the company. To properly launch a DPO, the company needs to be a business that can be grasped in seconds.

Q: How do prospective DPO companies perceive the Internet as a marketing tool?

A: We get a lot of people who think that the Internet can make up for their own lack of market for their shares and others who think that being on the Internet lends credibility, credence, or "coolness" to their offering, as if it's some sort of seal of approval.

Owners believe that this ease of communication somehow means that people will be attracted, and we have not seen that. The Internet has been a big help for DPOs in making communication faster and particularly, cheaper. But for it to work, the relationship between the investor and the company has to already exist, and then the Internet is just a fast and cheap way to communicate general information. A prospectus can be accessible online as well as the share purchase agreement -- which can be completed and transmitted online.

Q: In the future, how will DPOs fit into a typical investor's portfolio?

A: I think the whole asset allocation model will change. People will put so much in stocks and bonds, as well as 10% over here for playing venture capitalist. That concept will become much more widespread, and there will be a lot more services to meet that. Services meaning ways for people to access information and analyze it, and to get advice from other people, as well as exchange information with other people like them.

Some people are going to say, ''I'd like to invest $1,000 in a company that is in a certain kind of business and is at a certain stage of its development," and then they'll go searching for a company that meets their own specifications. The way of doing that is through the Internet. Five years from now, it may be that a company with no community will be able to put itself out there on the Internet and be found.

Q: That said, would you invest in a small company sight unseen? Would information from an Internet site be enough for you?

A: Yes, if I had other experiences, such as having been a customer.

Q: Do companies using a DPO lose sight of the fact that they're actually selling a piece of the firm, not just raking in fresh cash?

A: People who do this have to seriously believe in sharing ownership with the public, not just in finding a source of money. Otherwise, people are in for a surprise. If they think this continues to be only their company and they don't change their own thinking, they're going to have problems.

Q: What about stock fraud? It seems easier to perpetrate with tiny stock offerings.

A: The main source of fraud comes from communications on the telephone and in person that appeals to people's fear and greed. And the more that people have access to information, and become educated, and are able to make their own decisions, the less they're going to be subject to being talked out of their money.

Q: What's your advice for investors in DPOs?

A: People really need to read the prospectus before they make the decision, which is a big advantage of DPOs. Traditionally, you get a telephone call that introduces you to a company and closes the sale all at once -- you get the prospectus at the same time you get the bill for your purchase. In a direct public offering, you get the prospectus before you're asked to make the decision.

Q: What does the future hold for small companies's financing?

A: I think that there will continue to be more small businesses that don't become large businesses -- either by being acquired or acquiring others -- because they can accomplish their objectives without getting large. This will be a matter of choice. Also, there will be a trend for individuals to invest in direct-share ownership, instead of mutual funds, and that will really accelerate capital formation.