How-To Buy An Existing Business: Direct Public Offerings

Take your business–and your quest for funding–directly to the public by selling shares in your company.

What It Is: Direct public offerings (DPOs) are the direct sale of shares in a company to individual investors. After the shares are sold by the company, investors may or may not trade on a stock market or exchange.

Appropriate for: Direct public offerings work better with established companies, but they can also be used for startup and emerging companies. One of the most important characteristics a company should possess for a successful direct public offering is a strong affinity for its customers, the surrounding community or the industry in which it does business. In a direct public offering, these affinity groups become the company’s shareholders.

Supply: Vast. For years, individual investors have heard about the millions, and in some cases billions, of dollars being made by venture capitalists through investments in companies in their formative stages of development. These same investors would like the chance to play venture capitalist, and your DPO may give them that opportunity.

Best Use: Financing the expansion of profitable operations. Direct public offerings can be used to finance research and development, but public investors often become impatient during long periods of product development. When they are unhappy, they can cause problems for the company later as it tries to raise money to finance the marketing and rollout of the product or service.

Cost: Expensive. A direct public offering is less expensive than an initial public offering (IPO) with an investment banker, but only moderately so. The absence of an underwriter’s commissions is sometimes more than offset by the marketing expenses a company must bear in a direct public offering. In addition, like a conventional initial public offering, the company must surrender a significant hunk of ownership to its direct public offering investors.

Ease of Acquisition: Difficult. Any transaction that involves securities is challenging. The absence of an underwriter can make the process at once easier and harder. Easier because the company can call the shots without recrimination. Harder because an underwriter has experience with IPOs, and a company typically does not.

Range of Funds Typically Available: $500,000 and greater.

First Steps
A direct public offering is not for the faint of heart. It takes time, money and persistence. Entrepreneur Michael Flynn at Flynn Labs talked to more than 700 potential investors in the course of finishing his DPO. In addition, he spent more than $100,000 in the process. Entrepreneurs must evaluate whether they have the chutzpah to see a DPO through. If you think you do:


  • Ensure that you have a way to corral your affinity groups. Direct public offerings don’t work well without a large group of investors that has some sort of connection with the company, its product or its service. A publishing company, for instance, not only has a large base of customers but also has a lot of information about them and can easily contact them by mail or e-mail, through its own media, or via the telephone. On the other hand, in a somewhat frustrating arrangement, successful restaurants have a steady stream of customers but almost no information on them.For companies facing this dilemma, salvation depends on whether or there is a way to access rudimentary information about members of the affinity group, and, once accessed, whether the affinity is strong enough to make a deal. For instance, a restaurateur can easily purchase the names of people who have dined at fine restaurants. So what? Just because someone has dined at a restaurant doesn’t mean he or she has is an affinity for a specific restaurant.

    However, there are lots of ways a company can find information about people who would be naturally interested in them. Flynn, for instance, was able to buy the names of people who had purchased homeopathic medicines from list brokers. Other possible scenarios:

      1. A pet-care company might fruitfully prospect among the members of PETA, or People for the Ethical Treatment of Animals.
    2. An environmental-services company might pitch the members of the Sierra Club.
    3. A company making sailboats could send direct mail to the readers of Sail magazine.
  • Hire an accountant. If you don’t have one, get one. If you do have one, start negotiating for some extra work. To raise money, you need a set of financial statements, period. Internally generated financial statements are helpful, but to bring in outside investors, you must have financial statements prepared by an outsider as well.Even though many companies have long-standing relationships with accountants, the production of a full set of financial statements, with notes, is often the kind of thing that falls through the cracks. This can be debilitating when you’re talking to outside investors.

    The beauty of most direct public offerings is that they do not require audited financial statements. If your plan is to start in the lower depths of the market and eventually “graduate” to the Nasdaq stock market or the American or New York Stock Exchange, you will eventually need them anyway.

    Finally, owners of startup businesses often think they don’t need financial statements. Here’s why, in most cases they do. First, if there has been some kind of lump-sum investment either from the founder or some other investor–a strong selling point for meeting with new investors–the financial statements will irrefutably document its existence.

    Second, if the founder is forgoing salary he hopes to recapture when the company gets on its feet, the financial statements are the perfect place to document the company’s growing liability to its founder. To raise such an issue three or five years down the road and out of the blue might strain relations between a company and its shareholders. Putting items such as forgone salary or loans to the company on the table at the outset can save trouble down the road. And there’s no better way to put them on the table than by putting them in a set of financial statements.

    By now the message should be clear: Without financial statements, you won’t get far along the path to raising money.

  • Hire an attorney. Securities laws are perhaps the most complicated laws in the land. There are three reasons for this: They are antiquated, they exist at the state and federal level, and they are carried out by perhaps the most tenacious of all bureaucrats.Even if you decide to take advantage of the many exemptions from state and federal securities laws, you still need an attorney to make sure you are in compliance with these exemptions. And, of course, if you structure your offering so that state and federal securities laws come into play, hiring an attorney is also standard operating procedure.

    According to Flynn Labs’ owner, “It’s important that you seek an attorney with not just experience in securities matters, but with some facility in the direct public offering arena as well.”

    As for the attorneys, according to Joel Marks, a veteran investment banker, the person you hire should have a minimum experience of five deals. If these offerings are more than five years old, then it makes sense to find another attorney or, if you can afford it, bring in co-counsel, he adds.

    In addition to experience, Marks says, look at the firm’s Martindale Hubbell ratings. Martindale Hubbell, a publishing firm, produces the most prominent directory of law firms in the United States. Rankings, according to Marks, have a Legal Ability component (A for preeminent, B for very high and C for fair to high) and a General Recommendation component (V for very high, or unrated).


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