Direct Hit

The Time Is Now . . . Maybe

San Francisco attorney Drew Field, author of a new how-to book titled Direct Public Offerings (Sourcebooks Inc.) and advisor to Quinn on his DPO, says the time is ripe for companies to sell their shares directly to the public. The reasons are diverse: Disillusionment with traditional Wall Street offerings, more uniformity in state securities regulation, and increases in savings and investments all play a part. "But mostly," says Field, "we are in the early part of a period of taking more responsibility for our lives. Because of this, individuals are more willing to invest in companies they do business with or have an affinity [for]."

Field says that while a DPO is no less complex or challenging than a traditional initial public offering (IPO), it is a more manageable way to go. "With a DPO, entrepreneurs do not have to accommodate or rely on investment bankers to get the job done," says Field. "You can manage a direct public offering just like you would any other project."

But in addition to possessing the required skills for handling a DPO, entrepreneurs must also be able to grow the company within the limitations intrinsic to this technique. Specifically:

  • Absence of liquidity. Companies that, in addition to raising capital, must provide an immediate exit for earlier investors or accurate valuation for estate planning purposes will find that DPOs fall short in helping them reach their ultimate objectives.

  • Limited use as currency. Companies that need to go public so they can use their common stock as a currency to acquire other companies should not use a DPO.

  • Little personal gain. It would be all but unheard of for the founder of a company to sell his or her shares to investors in a DPO. In addition, with no active trading market, there's little hope of selling the shares on the market after the deal is done.

But even for companies that can operate within this framework, a DPO still may not be viable. Success requires certain traits that not all businesses possess. Field says viable candidates will fulfill the following criteria:

  • The business is easy to understand. Individuals who participate in DPOs tend not to purchase shares in companies they do not understand. And because they are individuals, not brokerages or institutions with research departments, the scope of what they understand is much narrower.

  • The company is established and profitable. The DPO process, which involves little direct selling but a lot of reading and evaluation on the part of would-be shareholders, tends to attract cautious investors.

  • The business is exciting. DPOs require a lot of motivation on the part of the investors because of restrictions placed on the company's securities marketing activities. As a general rule, it's difficult for more mundane enterprises to inspire the required level of action among investors.

  • The company has natural affinity groups. Customers, clients and the community in which the company does business all have an affinity for the company. And it's through this relationship that much of the DPO is sold. One of the fundamental questions entrepreneurs face is whether the affinity they perceive is mutual and strong enough to motivate prospective investors to consider their offering.

Based on these criteria, some companies are good DPO candidates; others are not. For instance, a manufacturer of stained-glass windows for homes is a likely candidate; a biotechnology company still in the research stage is not. An agricultural cooperative is a good candidate; a manufacturer of industrial abrasives probably is not. A lawn-care company is a good prospect, while a business that provides "correctional" services to governments probably is not.

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This article was originally published in the June 1997 print edition of Entrepreneur with the headline: Direct Hit.

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