What are the options for entrepreneurs who want to raise capital for their companies instead of trying to go public? It's an important question, because the market for initial public offerings (IPOs) in 2010 is a fraction of what it was a decade ago; and the reporting requirements for public companies add tremendous cost and responsibility to a company's management team. IPOs force management to focus on short term results -- often at the expense of long-term strategic objectives.
David H. Fater, who has spent the last 40 years of working with entrepreneurs and small businesses, and is author of Essentials of Corporate and Capital Formation (Wiley, 2010), outlined a number of alternatives to going public. He notes that "investors are primarily motivated by two emotions: fear and greed. Do not hesitate to take advantage of investors' fear that they will miss out on something valuable if they don't invest in your concept and/or possibly lose their original investment if they don't invest more. Then you need to convince them that your enterprise will provide them with an extremely attractive return on their investment with minimal risk."
With that in mind, Fater notes these alternatives to IPO.
Angels
If the original investment sought is less than $3 million, then friends, family, and/or angel investors are the best option. Approaching these sources requires a much less formal process than that required of a private placement; venture capital and private equity funds aren't interested in providing such small amounts. It's essential that the appropriate documents are completed to protect you, your company, and the investor -- and to be sure you remain within the limits of the securities laws.
If you've decided angel investors are right for your enterprise, here are some sources that may be able to help you find them:
- Local Chamber of Commerce and/or Small Business Development Center
- Banker, accountant, attorney
- Area venture capitalist
- Regional/state economic development group
- Local business publication
- Fellow entrepreneurs
Venture Capital
Before settling on working with a VC, speak with at least one chief executive in your industry who has raised money using a VC. Learning their experience will help you decide whether this route is for you. Venture capitalists are a tough crowd to get in front of as they're bombarded daily with business plans. Once you've decided a VC is the route for you, the first step is to do your research to identify an appropriate fund. That said, generally speaking, VCs don't look at a plan submitted by anyone they don't already know, so the key here is a personal introduction to a fund's partner.
VCs expect a detailed and scrupulously accurate business plan. In addition to the basics, plans for VCS require special emphasis on the following three factors:
- Management team: intelligence, experience, temperament, entrepreneurial skills, technical training,
- R&D sophistication, and expertise in production, distribution, marketing, finance, and administration -- as required by the particular venture
- Size and attractiveness of the market: dynamics, competition, barriers to entry
- Uniqueness of the venture: what some call the USP or unique selling proposition
Private Placements
While many entrepreneurs dream of going public -- not just as a means of raising capital, but also for the prestige associated with being a public company and significant financial gain early investors are often able to realize -- timing is a major consideration. While going public may be feasible eventually, what can the company do now to obtain financing? An exempt offering -- more commonly referred to as a private placement -- may be the answer. The "exempt" refers to the fact that the company is not required to file a registration with the SEC, which is a considerable. Plus it enables you to eliminate a ton of paperwork, and saves precious time and money. "Private" refers to the private group of investors -- versus the general public -- to whom the stock or debt will be offered. Generally, private placements involve no more than 35 unaccredited investors and an "unlimited" number of accredited investors (typically fewer than 100), and do not involve general solicitation or advertising.
As privately-negotiated transactions, private placements may be designed to meet specific needs, and can involve debt, equity, or a combination of the two. As such, the private placement market includes a wide array of corporate finance transactions, including senior and subordinated debt, asset-backed securities, and equity issues. Finding private placement investors is usually handled by a broker or financial advisor.
There are at least three groups of investors with an interest in private placements:
- People who are familiar with and respect the company, and/or are involved with the company in some way, as in a vendor relationship, for example.
- Investors interested in purchasing shares of small companies as a means of participating in their growth and the price increase that accompanies companies as they approach a public offering.
- Venture capitalists
Whatever the source, the key to identifying the right source is to make sure they have the same outlook for the company's growth, development, and eventual exit strategy as current management. Private placements are presented to potential investors in the form of a private placement memorandum (PPM), which is similar to a full business plan tailored to disclose the circumstances of the company and reasons for the offering, and with the necessary disclaimers for the securities being offered, confidentiality, and accuracy of projections.
So think about these three IPO alternatives: Angel investors provide a relatively easy means -- minimal amount of legal documentation and effort -- of raising capital. Venture capital costs more and takes longer. Private placements may be accomplished with or without a placement agent, and enable companies to obtain significant amounts of capital. Only you can determine which source is best for you.