Raising Capital

Old-School Crowdfunding: Meet the Direct Public Offering

Amy Cortese | September 17, 2015

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Equity crowdfunding and Regulation A+ grab the headlines. So it may be news to some that investment crowdfunding was around long before the JOBS Act was a gleam in Patrick McHenry’s eye. It just went by a different name: the Direct Public Offering, or DPO.

And in spite of the new crowdfunding options ushered in by the JOBS Act, the old school DPO is still going strong.

“DPO” is not an official term. But it’s been used for decades to describe securities offerings that rely on pre-JOBS Act exemptions to sell securities to the public (or, more accurately, to the issuing company’s network of customers and supporters). DPOs can be structured as debt, equity or revenue-sharing, and most have low minimum investments geared toward smaller investors—in some cases as little as $100. But like any crowdfunding campaign, a DPO requires a lot of marketing on the part of the issuer—one reason they are often called the “Do It Yourself” IPO.

Like all securities offerings that fall short of a full initial public offering (IPO), DPOs must rely on federal exemptions. The most commonly used DPO exemptions are Rule 147 (the intrastate exemption) and Regulation D, Rule 504.

Let’s take them separately and explore how they are used in a DPO.

Rule 147

This rule offers a “safe harbor,” in SEC speak, for offerings that fall under the federal “intrastate offering exemption.” As the name implies, intrastate offerings are confined to a single state, with a locally-based company raising money from state residents. There are no limits on the amount that can be raised, or the number or type of investors, as long as they all reside in the state (and this is not to be taken lightly: if just one single investor is found to be a nonresident, the entire offering may be in violation).

Ben & Jerry's raised $750,000 in its 1984 DPO. (Photo by Luigi Novi)
Ben & Jerry’s raised $750,000 in its 1984 DPO. (Photo by Luigi Novi)

Many of the intrastate crowdfunding laws that have been enacted in the past few years are based upon the intrastate exemption. But they typically take it a step further and eliminate the need for issuers to register with the state, which brings down the overall cost. To limit investor losses, many states have capped the amount that companies can raise (usually at $1 million) and the amount that unaccredited investors can invest under their new intrastate laws.

Still, Rule 147 has always been a viable option for local companies. And you don’t have to be in a state with a crowdfunding exemption to make use of it. Ben & Jerry’s used Rule 147 for their DPO back in 1984, almost three decades before Vermont enacted its Vermont Small Business Offering Exemption!

Reg D, Rule 504

Much of the focus in the crowdfunding world has been on Regulation D, Rule 506(b) and the new 506(c). The latter, also known as Title II of the JOBS Act, allows companies to advertise their offerings to the public, as long as the securities are only sold to accredited investors. Crowdnetic tracked more than $765 million of these deals since the 506(c) rule went into effect almost two years ago.

Less known is Rule 504, sometimes known as the “seed capital” exemption. Under this rule, companies can raise up to $1 million in a 12-month period. Generally, they cannot publicly advertise the offerings, except under certain circumstances—and that’s where it gets interesting.

The advertising ban is lifted if the company registers its offering in a state that requires registration and disclosure to the public.

A company can also offer securities in additional states that do not require registration and disclosure as long as it provides all investors with the disclosure documents required by the primary state where the offering is registered.  So Rule 504 makes it relatively easy to piggyback additional states onto your offering.  This is one reason that states are looking at Reg D as the basis for a regional crowdfunding framework.

Another benefit is that issuers are freed the restrictions of Rule 147, including the requirement that 80% of their revenues and 100% of their investors be based in a single state.

Regulation A

It hasn’t been very common, but you can do a DPO under Regulation A— Spring Street Brewing used this exemption back in 1995 to raise more than $1 million from the public.  Reg A, then and now, is rigorous and similar to an IPO process, although simplified forms may be used. Issuers can publicly advertise and sell shares, as in an IPO, but they are not subject to ongoing reporting requirements. And they may “test the waters” before taking the plunge.

Title IV of the JOBS Act directed the SEC to update Reg A. The newly revised “Reg A+” rules, which went into effect in June, allow for much bigger raises—$50 million up from the previous $5 million. They also create a more streamlined review process.  So, Reg A is likely to become a more common way to raise capital. And as a true public offering—meaning that anyone can invest—it can arguably be called a DPO.

DPOs are likely to grow alongside JOBS Act-enabled crowdfunding (even Title III when that becomes final, which we hear may be soon!)

In addition to those three main federal exemptions, there are special exemptions for nonprofits and for farmer cooperatives that can be used for DPOs.

So what does it take to do a DPO?

You’ll likely need a knowledgeable lawyer to assist with a DPO, which can cost up to $25,000 or so, depending on how many states you want to sell in (state laws can vary dramatically—some may require audited financials or ongoing reporting.)

A DPO may be equivalent to or more than the cost of some crowdfunding campaigns, mainly due to state registration and review, but much less than an IPO, which can run to a million dollars or more. Still, John Katovich, president of Cutting Edge Capital, an Oakland, Calif.-based consulting firm that specializes in DPOs, says the benefits of a direct public offering outweigh the costs. Those benefits include the personal connection between companies and their investors that DPOs tend to inspire, and the credibility and rigor that come with a state review.

After a wave of DPOs in the late 1980s and early 1990s—including Ben & Jerry’s and Annie’s Homegrown—DPOs began picking up steam again a few years ago, helped along by the financial crisis and credit pullback. And they are likely to grow alongside JOBS Act-enabled crowdfunding (even Title III when that becomes final, which we hear may be soon!)

Cutting Edge Capital has shepherded nine DPOs over the past few years, with another 16 or more in the works. On its CuttingEdgeX platform, 8 DPOs are currently listed, including Green City Growers, an urban farming company in Boston, Sunspeed Enterprises, which makes renewable energy powered charging stations, and Maker’s Common, a San Francisco-based artisanal food market.

The firm, an early advocate of and leader in DPOs, runs a six-week boot camp where a cohort of companies prepare for a DPO together. The bootcamp covers everything from structuring the offering and putting together a prospectus to complying with laws and marketing the offering. The next one starts Sept. 24.

As the crowdfunding evolves, distinctions between public and private, DPO and crowdfunding are blurring. We will need new nomenclature, but for now, these three letters—DPO—are still indispensable.

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