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.
(Read more: 10 big businesses founded by BFFs)
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.
(More from the New York Times:
Learning to hire at a growing company
Bezos brings promise of innovation to Washington Post
The opt-out generation wants back in)
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."
(Read more: Detroit bottom could spell boom for Motor City entrepreneurs)
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."
