From the December 1996 issue of Entrepreneur

One of the world's hottest trends is the Internet. Now its usefulness in helping early-stage companies raise money is beginning to dawn on entrepreneurs and financiers. Though still in its formative stages, the Internet may well be one of the most promising tools entrepreneurs have at their disposal for raising the capital they need to grow their businesses.

Perhaps the first person to see the opportunities the Internet offers capital-hungry entrepreneurs was one Andrew Klein, a securities attorney-turned-brewer-turned-investment banker.

The tale dates back to late 1992, when Klein, then an attorney with law firm Cravath, Swaine & Moore in New York City, took a few months off to travel with his wife. While in Holland, he was introduced to wit beer, which was brewed with wheat and spiced with orange peels and coriander. "Wit beer," says Klein, "was so popular in Holland, it had captured 5 percent of the market." And when Klein learned that wit wasn't available anywhere outside Belgium or Holland, he sensed opportunity.

It knocked on his door several months later when, back in the United States, Klein received a phone call from a Dutch brewer he had previously contacted who had cashed out on the sale of his company. Was Klein interested in teaming up to brew wit beer in the United States? By January 1993, just six months after his summer sabbatical, Klein had left his law firm (with 13 partners as investors) and was the newly minted president of Spring Street Brewing Co. in New York City.

Klein feels he had all the luck an entrepreneur could hope for starting out. Local bars could not get enough of his wit beer, there was lots of media hoopla, and distributors from across the country were calling offering to sell the product. "But when opportunity knocks," says Klein, "it usually wants money. Our initial $800,000 of capital, which seemed like a lot when we started, quickly turned into a grossly inadequate amount."

So in the fall of 1993, Klein set out to raise $2 million to $3 million from "angels" and venture capitalists. "The process was encouraging but too drawn out to satisfy the capital requirements of [my] company," recalls Klein. Running low on funds, he put together a quick private placement of $450,000 at the end of 1993 and, the following year, turned his attention back to selling beer.

In December 1994, realizing he needed an avenue to raise lots of money on a continuous basis, Klein decided to sell stock directly to the public. In the midst of borrowing an idea from ice cream manufacturer Ben & Jerry's, who early on sold stock to the public by advertising the deal on their packaging, Klein hit upon the idea that launched a thousand ships: If exposure was the name of the game, why not put his prospectus on the Internet and open the company to millions of potential investors?

Just The Mechanics, Please

The mechanics of Klein's revolution were basic: Spring Street Brewing Co. simply put its offering prospectus on its Web site (http://witbeer.com). Potential investors could visit the site, learn about the company, download subscription documents and, if they were interested in investing, send a check to Spring Street.

Because it was the first deal of its kind, Klein's single press release about an Internet initial public offering (IPO) earned it a tornado of publicity in the national news media. With the publicity came visitors to the Web site, some 500,000 of them, and with the hits came the good stuff--checks in the mail.

Initially, the pace was furious, and Klein recalls taking in as much as $85,000 a week. By the end of 1995, Spring Street Brewing Co. had raised $1.6 million from 3,500 investors over the course of 10 months.

The Securities and Exchange Commission (SEC) quickly and easily gave Klein approval to post the prospectus and other offering documentation on the Internet. But the regulators were not at all pleased when, in March, Klein designed a series of bulletin boards that would allow shareholders to trade Spring Street common stock among themselves. After news of Spring Street's foray into Internet trading hit the national business media, which had a field day because of the implications of bypassing established stock markets, Klein found himself on a conference call with 11 SEC attorneys.

Critical Issues

The importance of trading cannot be underestimated as it relates to the formation of capital for early-stage enterprises. "There's no doubt individual investors have an appetite for investing in early-stage companies," says Klein. But problems arise because individual investors, unlike large institutions and venture capitalists, need to be able to sell their shares from time to time. They need the liquidity that trading provides.

While the Nasdaq stock market and the American Stock Exchange (Amex) have both made well-intentioned overtures to provide trading liquidity for what amounts to public venture capital for early-stage companies, it's difficult to say they've met with success. Amex's Emerging Company Marketplace was quietly closed down. The lower tiers of the Nasdaq stock market, such as the Pink Sheets or the Bulletin Board, though available to very tiny companies, often introduce a new set of challenges that ultimately prove disruptive to the process of building the business (see "Raising Money," June 1996 ).

"We were approached by several securities firms that wanted to make a market in our stock when the deal was done," says Klein, "but many small companies' [stock] either languishes in the market or the price whipsaws--both of which distract management, make it difficult to raise additional capital, or both."

Zig vs. Zag

Upon review of the situation, the SEC ultimately allowed Spring Street to continue operating its Internet trading service--but under conditions that, for Klein and Spring Street, carried too much liability. Rather than cave, and in the true spirit of an entrepreneur, Klein formed Wit Capital Corp., an investment banking firm that will use the power of the Internet to raise money for emerging companies, particularly those concentrating on new media and Internet content.

At its core, the idea is simple: Wit Capital will operate a discount brokerage firm and, through those accounts, market IPOs. So far, Klein has raised $3.5 million for the venture and has been joined by a host of investment bankers from Wall Street firms, as well as securities-processing technology gurus such as Chris Keith, former chief technology officer of the New York Stock Exchange.

The emphasis on securities trading technology is hardly surprising. To address investors' need for liquidity while overcoming the structural challenges today's stock markets face, Klein will launch a new electronic marketplace next year called Wit Trade.

"The theory goes that the closer together you bring buyer and seller, the more efficient a market will be," explains Klein. "With the Internet, we have a way to bring people together that wasn't possible before."

Specifically, Klein refers to the middlemen on the New York Stock Exchange and the Nasdaq stock market who match buyers with sellers. Most of the time, these individuals provide an invaluable service. However, their unavoidable insertion between buyer and seller, combined with their own profit motive, sometimes corrupts the process to the detriment of investors and issuers.

But the Internet means buyers and sellers can meet electronically without a middleman. While the absence of this person brings challenges as well as opportunities, to Klein's way of thinking it brings more of the latter than the former. "This way, liquidity could develop slowly and fairly for public venture capital," he says.

When that happens, more investors can get into the market and get behind tiny emerging companies. And when the average Joe or Joanne has the opportunity to make venture capital investments, the amount of money available to entrepreneurs will make today's venture capital funds look like chump change.

Contact Sources

Wit Capital Corp., (800) 948-8988, http://witcap.com.