From the April 1998 issue of Entrepreneur

n the five years it took to develop energy-efficient lighting technologies and build Lumion Corp., a Wilmington, Delaware, holding company whose operations are in Toronto, co-founder Terry Mocherniak managed to raise a dollar or two. After an initial seed investment of $150,000 by Mocherniak, his brother and his father, he raised $600,000 more through two government grants. Another $1.7 million came from an institutional venture capital fund.

This money allowed Lumion to fund its production line, but by the summer of 1996, the company had shifted away from manufacturing toward a strategy of licensing its technology for electronic ballasts and lighting control systems. "The upshot was that to do this," says Mocherniak, "we needed $750,000 to $1 million to bring the technology to its completion."

Mocherniak had found that venture capital investors wanted too much hands-on involvement--they wanted to control the company's financial management--so he decided not to take that route again. With relatively modest capital requirements and a track record to match, a traditional public offering wasn't feasible, either.

"Our best bet, in light of Lumion's stage of development and the amount of capital we needed," says Mocherniak, "was to raise money through an exempt public offering."


David R. Evanson, a writer and consultant, is a principal of Financial Communications Associates in Ardmore, Pennsylvania. Art Beroff, a principal of Beroff Associates in Howard Beach, New York, helps companies raise capital and go public.

What's The Deal?

The exempt stock offering--also known as a Regulation D offering--Mocherniak utilized deals with state and federal securities laws. At the federal level, stock offerings to the public of $1 million or less in a 12-month period are exempt from these laws.

"The importance of this exemption cannot be underestimated," says Douglas Lurio, principal of Lurio & Associates, a Philadelphia law firm specializing in securities law. Specifically, he says, filing a registration statement to comply with stock sales under the Securities Act of 1933 and the periodic reporting associated with the Securities and Exchange Act of 1934 requires legal and accounting expertise (read: fees) that are unrealistic for most early-stage or smaller companies. To take advantage of the federal exemption for small offerings, companies only have to file a Regulation D Form, a simple fill-in-the-blanks affair that can be completed in 15 minutes.

Each state has securities laws, too. But like the feds, states also offer exemptions for small public offerings. By taking advantage of exemptions at the state and federal levels, companies like Lumion can raise capital directly from investors without the stifling demands of legal and accounting compliance that only larger enterprises raising a large amount of capital can reasonably afford and negotiate.

What's tricky is that while the federal exemption allows for the sale of up to $1 million of securities to an unlimited number of individuals, exemptions offered by the states are more restrictive regarding the number of investors who can buy shares and whether the company can advertise its offering, for example. (For more on state exemptions, visit http://www.carrollpub.com, which contains an index of state Web sites you can search.)

According to Tom Stewart-Gordon, publisher of the SCOR Report monthly newsletter, there are several options companies can use for an exempt offering. Texas companies, for example, can take advantage of the federal exemption but can register their shares using a single uniform filing in 46 states with what is known as a SCOR (Small Company Offering Registration) form.

However, the SCOR form is just as complex as the federal registration, which many companies were seeking to avoid filling out in the first place. The best bet, according to entrepreneurs like Mocherniak, is to avoid registration in your state, if possible, and structure an offering that is compatible with whatever exemptions are offered by the states in which you plan to sell stock.

For instance, with Lumion, Mocherniak took advantage of the federal exemption, as well as the exemptions offered by Florida and New York, to raise $750,000 by selling common stock at $1 per share to investors in those states only. (Lumion also sold stock to foreign investors--sales that are also exempt from federal securities laws.) Contact an attorney well-versed in exempt stock offerings before attempting this option.

Manifold Benefits

Reflecting on the offering, Mocherniak says the exempt offering structure was the perfect vehicle for Lumion to raise capital at its stage of development. First, he says, the fact that Lumion did not have to rely on investment bankers or brokers to get the deal done was a big plus. "With direct access to investors offered by the state and federal exemptions," he says, "we were able to tap our own networks of friends, family and business associates to get the deal done."

Mocherniak adds that by completing an exempt public offering, Lumion was able to hold down the costs of raising money. "[Not needing] audited financial statements to do the deal was a big plus," Mocherniak adds. "Overall, our audit and legal expenses were $60,000--not trifling, but a far cry from the $500,000 we might have spent on a full-blown IPO."

Mocherniak also found the due diligence associated with exempt stock offerings more compatible with the time constraints of running a company. "We created a comprehensive offering memorandum telling prospective investors just about everything they might need to know about the company." The memorandum, combined with conversations with investors, was all Lumion needed to raise capital, he says. By contrast, the due diligence conducted by his earlier venture capital investors, says Mocherniak, "left me feeling bruised."

Another advantage was that Lumion's new investors, although serious about making money on their investment, are essentially passive and rely on management to build value. Mocherniak's venture investors were at the other end of the spectrum. "Overall," says Mocherniak, "I found their hands-on style intrusive."

Looking For Liquidity

One of the greatest challenges of raising capital has to do with liquidity. For many investors, the test of whether to invest hinges not just on the future success of the enterprise but also on the ability to get their money out of the deal. For this reason, some form of resale mechanism, no matter how primitive, can increase the likelihood of successfully raising money.

Exempt public offerings can accommodate this need by trading on Nasdaq's Bulletin Board stock market. You can enjoy this benefit without being required to provide the audited financial information that Nasdaq National Market or SmallCap Market denizens must. Another option is to have a stock broker keep a "book" of potential buyers and sellers and try to match them when orders materialize. This is more rudimentary than the Bulletin Board and, as a result, less helpful when trying to raise money.

Since most states have restrictions on the resale of unregistered securities, trading an exempt stock offering deal on the Bulletin Board isn't a slam dunk. But Colorado, Florida, New York and Washington, DC, allow for the resale of shares; as a result, some companies sell a small amount of shares to investors in those states, commence trading on the Bulletin Board, and use this rudimentary aftermarket mechanism as a selling tool to raise additional capital from investors in other, perhaps more restrictive, states.

Lumion used the absence of a restriction on the resale of unregistered securities in New York and Florida to get his company's shares offered on Nasdaq's Bulletin Board. "Once trading commences, we can purchase coverage in journals such as Standard & Poor's Corporation Records to gain clearance for investors in nearly 30 other states to buy shares that are already trading on the market," says Mocherniak. After companies publish their trading information in investment journals, restrictions on sales are lifted.

Mocherniak says he doesn't entertain any illusions about how active or liquid the market for Lumion common shares may be. But he feels the existence of a trading market, no matter how fundamental, will assist the company in raising capital later.

"We hope to conduct a larger public offering within two years," Mocherniak says. "Whatever following we can develop now will help."

Though Mocherniak appeared to move Lumion through the complexities of securities law exemptions with relative ease, he advises would-be followers in his footsteps to get good legal counsel. "The exemptions are there to help ease the task of raising capital, and they do work," he says. But with 51 regulating bodies--the federal government and 50 state governments--the task is still fraught with challenge. If you're in the viewing audience, he says, "You definitely don't want to try this at home."

Contact Sources

Lumion Corp., 4101 Weston Rd., Toronto, ON, M9L 1W6, CAN, (416) 745-6178, ext. 229

Douglas Lurio, c/o Lurio & Associates, (215) 665-9300, doug@luriolaw.com

Tom Stewart-Gordon, tsg@scor-report.com