Mını I.P.O.s’ Expand
Mini I.P.O.s’ Expand Pool of New Investors
By STACY COWLEY JUNE 18, 2015, New York Times
Growing companies seeking to raise up to $50 million have a new financing option, starting Friday: a process that will open some private businesses to a wide pool of new investors.
More than three years in the making, the regulatory change, an expanded version of a rule known as Regulation A, is intended to let promising companies — the kinds typically backed by venture capitalists and wealthy angel investors — raise money by selling equity stakes to people of more modest means.
Businesses will be able to advertise their offerings — described as “mini I.P.O.s” by many in the industry — on websites and through social media, giving fans and customers an opportunity to buy shares in companies that are not yet, and may never be, publicly traded.
The new rules are complex and controversial. Advocates see the change as an egalitarian move that will let people invest in brands they love and take a shot at finding new companies like Facebook, whose earliest investors made far more than those who bought shares after it went public. Critics, however, say that complying with the rules of the new fund-raising process is so costly and complicated that few high-quality companies will bother to use it.
That has certainly been the case for the system the new rule is replacing.
Any company that wishes to sell securities to investors must either register with the Securities and Exchange Commission and file regular financial reports or find a legal exemption. The most commonly used one, called Regulation D, allows companies to sell shares mainly to accredited investors with an annual income of more than $200,000 or a net worth of at least $1 million.
The law assumes that accredited investors are wealthy enough to take significant investment risks. But when it comes to average investors, regulators want more safeguards in place. An earlier version of the Regulation A rule allowed companies to raise up to $5 million from nonaccredited investors — but it required those companies to first file an extensive, financially detailed offering document, subject to review by the S.E.C. and regulators in every state in which securities would be sold.
More than 22,000 companies used Regulation D last year to raise money from investors. Only seven jumped through all the hoops to use Regulation A.
“I’ve been practicing for 22 years, and I’ve never done a Regulation A deal because of all the cost, complexity and brain damage that goes along with it,” said Roger Hauptman, a Denver lawyer who specializes in corporate financing. “I think 99 percent of lawyers would say that you should avoid taking money from unaccredited investors at all costs, unless it’s absolutely necessary.”
But some entrepreneurs say they do consider it necessary, for either financial or philosophical reasons.
“We have companies that are eager to do this because they have passionate customers they want to invite in on the deal,” said Ryan Feit, the chief executive of SeedInvest, an investment platform that had previously been open to only accredited investors. Mr. Feit is working with several companies, including Virtuix, a virtual reality hardware maker, andDietBet, a weight-loss business, that are considering using the new rules to raise money.
The new Regulation A rule has a number of revisions intended to fix some of the earlier version’s drawbacks, but the most significant change lifts the cap on how much money companies can raise, to $50 million from $5 million. (Companies that raise more than $20 million face more stringent reporting requirements than those seeking smaller amounts.)
That higher cap is attracting entrepreneurs who say they are eager to test-drive the new rules. Kevin Harrington, the founder of a mobile-focused shopping site called StarShop, plans to file paperwork on Friday for an offering.
Mr. Harrington is a serial entrepreneur who made a fortune as an infomercial pioneer and gained fame by appearing as an investor in the first two seasons of “Shark Tank,” in which entrepreneurs compete for financial backing. StarShop, based in New York, opened for business just weeks ago, but he is already envisioning its long-term future: “This is a business that will require tens of millions of dollars in funding if we’re going to build a billion-dollar company,” he said.
He could try to raise that money the traditional way, from venture capitalists and large investors — Sprint already owns a minority stake in the business — but Mr. Harrington is a populist who likes the idea of having a broad network of investors.
“When I did segments on ‘Shark Tank,’ I would get texts from people saying, ‘Why didn’t you invest in that company!? You should have done that deal!’” he said. “Everybody wants to be a shark. If we have a huge base of small owners, they become very vocal about their involvement in StarShop, and they can spread the word.”
Regulation A deals will not be fast, or cheap. Kendall Almerico, the lawyer preparing StarShop’s paperwork, says a typical company will need to spend $50,000 to $100,000 on legal, accounting and filing fees. Every offering must be reviewed by and gain approval from the S.E.C., a process that takes more than 300 days, on average.
Those hurdles could discourage the most attractive investment candidates, the kinds of high-growth companies that rich individuals and venture capitalists compete with one another to fund. Rory Eakin, a co-founder ofCircleUp, which connects consumer brands seeking financing with potential investors, says none of the entrepreneurs he works with want to deal with the headaches and restrictions. He worries about adverse selection, with Regulation A becoming a fallback used only by companies passed over by experienced investors.
But some entrepreneurs say average investors are a better fit for their business than big financiers seeking outsize returns. Phil Paisley is the president of Interbill, a 43-year-old company in Rohnert Park, Calif., that makes billing software for lawyers. The company — “a small business hoping to be large,” in Mr. Paisley’s words — has sales of $1.5 million a year and is operationally profitable, he says. He would like to expand nationwide and is preparing a Regulation A offering to raise up to $15 million.
Living on the outskirts of the Bay Area, Mr. Paisley is surrounded by venture firms and private investors, but they are not interested in slow-growth, midtier businesses like his.
“They want Googles and Groupons,” he said. “Some of these angel investors have been very spoiled in being able to invest in something that can go from zero to $1 billion in just a few years. That’s not this business. Our average client is with us for 17 years.”
Mr. Paisley plans to market his offering with a direct-mail campaign to thousands of lawyers and paralegals, the kinds of potential investors he thinks will understand his business and its prospects.
Like Mr. Harrington, he is hoping to find a few patient, enthusiastic sharks.