Seeking Capital, Some Companies Turn to ‘Do-It-Yourself I.P.O.’s’
Flying back to California, empty-handed, after one last investor pitch in late 2011, Brahm Ahmadi was ready to call it quits. Despite a track record, a clear market opportunity and a loan pledge, he had not been able to attract a single investor. He called his lawyer and told her, "We hit a wall."
Mr. Ahmadi, the founder of People's Grocery, a nonprofit focused on food justice issues, hoped to open a commercial grocery store that would offer fresh produce in West Oakland, Calif., a so-called food desert, meaning its 25,000 residents have few healthy food options. A public-private loan fund, California FreshWorks Fund, had issued a letter of intent to lend Mr. Ahmadi two-thirds of the $3.6 million he needed to open the People's Community Market. There was just one condition—he would first have to raise the remaining $1.2 million from investors. Mr. Ahmadi spent a year pitching to angels, social investors and private equity firms, but most were looking for double-digit returns and a clear exit strategy.
Mr. Ahmadi's lawyer, however, suggested an alternative, something known as a direct public offering, or D.P.O., which is a way to raise money from the public without the inconvenience and expense of going public on a stock exchange. The term direct public offering does not have a precise legal definition, but it is used to describe a public securities offering similar to an initial public offering, or I.P.O., but with one big difference: There is no need to hire an investment bank. In fact, D.P.O.'s are known as "do-it-yourself I.P.O.'s."
Although obscure, they have been around for decades. Most famously, in 1984, two young entrepreneurs raised a first round of capital for their fledgling ice cream company in an intrastate offering. With the slogan "Get a scoop of the action," Ben & Jerry's raised $750,000 from 1,800 ice-cream-loving Vermonters, allowing them to build a new plant and expand, and setting the stage for a $5.8 million initial offering the following year. Annie's Homegrown, the maker of packaged macaroni and cheese, raised $3 million in 1996 through a direct offering, advertising the offering in coupons tucked into each box. And more recently, tight credit markets and the rise of social media have fueled interest in the alternative financing system, especially among companies that have enthusiastic customers who can be converted into shareholders.
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In a typical initial public offering, a Wall Street underwriter markets shares to wealthy clients and institutional investors, taking a cut of the proceeds. In a direct offering, shares are marketed directly by the issuing company, typically to customers, supporters and, these days, social media followers. The companies may advertise the offering freely and accept funds from an unlimited number of unaccredited, or nonwealthy, investors. And the companies are not subject to the quarterly reporting requirements and comprehensive registration process that come with an initial offering.
On the downside, business owners must be prepared to invest a substantial amount of time and effort in the process and to deal with hundreds or even thousands of small investors. And most direct offerings require assistance from a knowledgeable lawyer. Not surprisingly, however, cutting out the middleman and streamlining the process lowers the cost considerably. A direct offering might cost around $25,000 in legal fees, while a formal initial public offering can cost $1 million or more. That makes direct offerings an increasingly attractive option for companies that need a substantial amount of capital — typically between $500,000 and $5 million — but not enough to justify the cost of an initial public offering.
With traditional sources of capital still out of reach for many small businesses, and with the future of investment-style crowdfunding uncertain, direct offerings can offer a compelling alternative. In recent months, companies including pickle makers, department stores, food cooperatives and service firms have found a ready market. "There's a huge trend of people wanting to invest locally, and people are looking for ways to make that happen," said Jenny Kassan, president of Cutting Edge Capital, an Oakland, Calif., consulting firm that has helped seven companies raise money this way since 2010, including People's Community Market. California has some 150 to 200 direct offerings annually, Ms. Kassan said.
Direct offerings were a hot topic at a Business Alliance for Local Living Economies conference held in Buffalo in June. "I'm seeing a huge disconnect between the investment products available and the desires and values of investors," said Michelle Long, executive director for the organization, a network of 30,000 entrepreneurs and community leaders. "D.P.O.'s represent an opportunity to put your money into something real and tangible."
Companies typically qualify for a direct offering under one of three federal securities exemptions, each with its own parameters and considerations. The exemptions include Regulation D Rule 504, for offerings up to $1 million; Regulation A, for offerings up to $5 million (scheduled to be raised to $50 million under the JOBS Act); and the intrastate exemption, for companies that do business primarily in a single state and limit the sale of securities to investors in that state. The offerings are filed with state securities regulators and are subject only to state regulations, which can vary greatly. (In addition to these three main exemptions, there are also exemptions for nonprofits and farmer cooperatives.)
After about eight months of preparatory work, People's Community Market introduced its direct offering campaign last November, offering shares of nonvoting preferred stock with a minimum investment of $1,000. In return, investors were promised an annual 3 percent dividend plus an annual store credit equal to 1 percent of their investment. Because the grocery business is cash-intensive and Mr. Ahmadi wanted to ensure enough operating capital, the deal was structured so that accumulated dividends would be paid to investors in a lump sum after the seven-year term of the loan. Investors have the option to sell their shares back to the company with 60 days' notice.
The offering has yet to close, but People's Market has raised more than $630,000 from more than 150 mostly unaccredited investors—and potential customers. "We have a critical following," said Mr. Ahmadi, who plans to use the money to build the store, purchase inventory and open by fall 2014 (details are in the prospectus). "Ultimately," he said, "it's about leveraging social capital and turning it into financial capital."
Direct offerings seem to be popular among food companies. In addition to People's Market, others that have conducted such offerings recently include Farm Fresh to You, a farm in California's Capay Valley, and Arroyo Food Coop in Pasadena, Calif.Real Pickles, in Greenfield, Mass., recently raised $500,000 in just two months to finance a transition to a worker-owned cooperative. Why food? One reason, Ms. Kassan said, is that "people are passionate about food, so it's a pretty easy sell." But, she added, "I believe this can work across many industries." Her firm, for example, Cutting Edge Capital, recently raised $150,000 through its own direct offering.
Or take GruntWorks, a business based in Portland, Ore., that acts as a concierge for homeowners in need of anything from housekeeping to plumbing to roofing services. GruntWorks solicits bids from its network of 120 or so vetted service providers and guarantees every job.
Since opening last year, GruntWorks has grown quickly. It generated $500,000 in sales its first year and expects to double that this year. To finance its expansion, Scott Fouser, the founder, has applied to Oregon's state authorities for a direct offering. By engaging his customers and turning them into shareholders, Mr. Fouser said he would be free from having to rely on search engines and other marketing.
"I think it's a terrific vehicle to engage the community and bring some profitability back to your supporters," he said. "That's the real juice here."