Private Matters

Zigging & Zagging

For entrepreneurs living in the here and now, a challenging IPO market means that one of the trends for 1999 will be an intensified focus on private equity capital, according to Ric Klass, a managing director of Harmonic Research LLC, an investment banking and brokerage firm in New York City that focuses on emerging growth companies.

Klass says that IPOs are not out of the picture altogether, but the screen is so fine, only a few firms will make it through the process in the coming year. The real opportunities for entrepreneurs, and to a degree for investors, he says, "will be in the market for private capital from individual and institutional investors."

Happily, the former group, known as angel investors, is emerging in abundance, with more formal paths to their doors than ever before. Perhaps one of the most promising avenues of approach is the growing momentum of ACE-Net, the Internet-based matching service that puts companies seeking capital in touch with accredited investors looking for deals.

One of the benefits of ACE-Net, as well as the other electronic matching services that are proliferating on the Net, is that, like the public stock markets, they have the power to put buyers in front of sellers. "One of the historical challenges of raising money privately," says Klass, "was that the buyers and sellers didn't know where each other were. The market was very inefficient. But now that's changing."

One example of how the private equity markets are getting more user-friendly was the 1998 unveiling of what is known as the ACE-Net short form. This is a streamlined version of the Small Company Offering Registration (SCOR) short form that was once required for a company to list its investment deal on ACE-Net. According to Greg Dean, assistant chief counsel in the SBA's Office of Advocacy, the new filing makes the use of ACE-Net a feasible alternative for any company raising money. "With the short form and the nominal fee to post an offering, entrepreneurs have absolutely nothing to lose through ACE-Net, but perhaps very much to gain," says Dean.

Klass says another twist to look for in the coming year is perhaps an increasing number of reverse merger transactions, in which small, private companies become acquired by more or less dormant public ones and, in the process, go public. "A reverse merger does not raise capital per se," says Klass. "But a public company, even one that doesn't actively trade, can much more readily raise capital from investors than a purely private one can."

The reason for this seeming contradiction is quite simple. More than outright failure, many private investors fear that once they've invested in a company, there will be no way to get their money back again unless the company goes public or is acquired. Therefore, says Klass, there's a preference among investors to choose companies that have already crossed the divide into public ownership in some fashion. "These investors know that even if the company succeeds, it's still difficult to go public. If a company has already gone public, however, success means there's a greater likelihood it will be able to create the kind of active trading market that will provide an exit for investors."

But Klass says reverse mergers also have a cost. "They don't guarantee an active trading market, and sometimes these kinds of transactions are looked at askance by sophisticated investment and brokerage firms," he says.

Another trend that may emerge this year as a result of the stumbling IPO market is a focus on direct public offerings (DPOs), according to Drew Field, a San Francisco securities attorney and consultant. So-called DPOs are just like conventional initial public offerings, but instead of orchestrating the deal through an investment banking firm, in a DPO, the company sells the deal directly to clients, members of the community, vendors or any other constituency that has a stake in the company and its success.

Drew speculates that the market volatility and the downturn in equities in general may have left many individual investors suspicious of traditional Wall Street fare. "I think that during the coming year, companies and investors will both be looking inward and will begin to rely more on their own instincts and judgment rather than on that of others."

When thinking about the public equity markets, it's important to remember they're not unidirectional, but cyclical. "In 1975, there were only 15 initial public offerings done," recalls Adduci. "But six years earlier, there were more than 1,000. Markets come and go. When it comes to raising money, successful entrepreneurs simply learn how to roll with the punches."

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This article was originally published in the January 1999 print edition of Entrepreneur with the headline: Private Matters.

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