Stock Options

More entrepreneurs are now choosing to sell private stock offerings. And in saying no to IPOs, they're reaping the benefits.

When Jeff Behrens thought about expanding his Newton, Massachusetts-based computer systems management firm, he knew he'd need a cash infusion. "We're doing about one and a half million in annual sales, but cash was always tight," says Behrens, president of The Tulluride Group Inc., who discovered that private sale of stock could be a low-cost source for growth capital and expertise.

Public vs. Private

Entrepreneurs are often lured by the appeal of selling stock on the open market: Instant cash realization with no debt to repay. But most are not in a position to go public with the complexities of a public offering-especially in an uncertain market, when a successful IPO is far from guaranteed.

A more practical option is selling private equity stock to a few people who have confidence in your product. There are no investment bankers or financial consultants to worry about, and you can maintain the control associated with a privately held company, all while reaping the advantages of instant cash and no debt. An added bonus is the potential to bring others' expertise to your venture. "In addition to raising expansion capital, selling stock to private individuals allowed me to tie the investors tightly to the company and benefit from their advice and counsel on growing the business," says Behrens, 34.

Why would an investor choose your private stock over a hot IPO? Their direct access to you and your company puts them in a much better position to effectively evaluate the risks and rewards of their investment.

To Sell or Not to Sell

You should ask yourself two questions to determine whether a private equity sale is right for your company. First, is there any market for your stock? Understand that investors will want to know specifically how you intend to use the money and what type of return to expect, as well as a timeline.

of investment industry professionals say the Enron scandal has prompted them to increase their due diligence.
SOURCE: Wall Street Reporter Magazine.

"Selling stock is a great way for a growing company to raise money it needs to succeed," explains J. David Washburn, a Dallas attorney who advises entrepreneurs on practical and legal issues surrounding selling private stock. "But your company must be in a growth position in order to attract private investors."

Washburn says plans to inflate your own salary or pay off old debts with investors' money will not snag any investors. Rather, you must first bring the company to a level where the investor will have confidence in the potential rewards from the investment.

Second, are you willing to give up a little control in exchange for equity? Selling private stock also carries responsibilities for your new shareholders. They will have the right to elect directors of the corporation, inspect books and records, and, depending on the set agreements, vote on major corporate decisions, such as selling assets.

"Raising money sets certain expectations about future company growth and plans," says Behrens. "[Once outside investors are involved,] it is no longer a personal lifestyle business-the owner now has fiduciary responsibilities to the investors."

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This article was originally published in the May 2002 print edition of Entrepreneur with the headline: Stock Options.

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