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Biz@dvantage Biz@dvantageSM features one-stop access to Dun & Bradstreet's popular financial and credit reports along with patents, trademarks, and articles from thousands of brandname business, news, science and technology publications.

Equity Finance Solutions

Editor: William Cate


This newsletter will suggest equity finance strategies that could solve your business capital development problems. We'll cover theory and explore specific strategies. In this issue, we'll discuss SCOR and MIDI Underwriting. My comments come from 16 years experience designing and implementing equity finance solutions. The American bias in this newsletter is a byproduct of the fact that American equity finance standards are applied everywhere. So far, Internet equity finance efforts have heavily relied upon American Securities Law and a single American "exempt securities" equity finance strategy.

The Greed Response

Greed is the emotion that drives the Equity Finance Industry. If you don't convince underwriters and investors that they'll earn huge profits from investing in your project, you'll fail to attract their support. There are three primary ways to develop a greed response:

1. Investors risk their money on people. If you share the investors' values, social history, create guilt, do something that investors admire, or are favorably known by the investors, you are more likely to attract risk capital. This statement is particularly true with private investors. Among brokers, fund managers, and underwriters, the people issue becomes a management team question.

The evaluation of people is a subjective process. It's easily manipulated. Equity finance attracts many sales people. They enter the Industry as entrepreneurs and retail stock brokers. Their people-skills allow them to initially succeed. If they offer nothing more than salesmanship, they fade after a few deals.

2. The proposal is the focus of the investment decision. Financial Analysts created an industry around audited financial statements, company history, industry projections, etc. The proposal is the basis for your company's credibility in the Marketplace. Anyone can easily falsify the data in a proposal. You need look no further than Bre-X or the many lawsuits against accounting firms for proof.

There are two subjective aspects of your proposal. Are you in a fad industry? Computers, the Internet, and biotechnology are among the industries in fashion. Chemical plants and cigarette manufacturing are currently out of fashion in the States. The other subjective question is will your company appeal to the imagination of investors. The Industry uses the term "sizzle." It comes from the sales advise to: "Sell the sizzle, not the steak."

3. The package is the primary concern of underwriters and market professionals. It answers questions about liquidity and short-term profitability. In its simplest form it is a statement in a business plan that the company will go public at some point in the future. At its most effective, it's a plan to create what underwriters call a "Hot Stock." A Hot Stock is a stock in which there will be a strong and immediate demand for the shares at a higher price in the secondary market. Look at Netscape's Initial Public Offering (IPO) as a "Hot Stock" example. Your goal is to create a hot stock.

If you want to attract equity capital into your company, consider your people, proposal, and package before you approach an underwriter.

The other policy you should adopt is the need to ask four basic questions about any equity finance strategy. What does it cost? How much money can be raised? What are the odds of success? How long will it take? I'll try to answer these questions in whatever strategies we discuss.

The most popular equity finance strategy in the United States is to do an Initial Public Offering (IPO) To answer our four basic questions about doing an IPO. Excluding brokerage fees, the average cost is about US$750,000. The gross revenue from the average IPO is around US$7 million.You have less than even odds of ever getting a penny from the IPO. (Over half the companies that start the IPO process don't complete it.) It will take you 12-24 months to complete the process.


SCOR vs. MIDI Underwriting

This is a discussion of two basic methods of doing equity finance for startup companies. These companies are difficult to fund because they lack credible proposals. They lack credible proposals because they don't have an operating history. They are an entrepreneur's idea about how to make money.

SCOR and Regulation A Underwriting

Motivated by the costs involved in doing an IPO, Full Disclosure exemptions exist under American Securities Law. Two popular exemptions are SCOR (Small Corporate Offering Registration) in which a business person files Form U-7 with the State in which the money is to be raised. This allows the private company to solicit up to one million dollars from the public. Reg A offerings allow your company to raise up to five million dollars. Any type of exempt security offering entails restrictions on who can use the funding strategy. Who can risk money. How much money they can risk. There are limits on the frequency of use of the strategy, etc. There are limits on the liquidity (trading) of the "exempt securities" being issued.

In the December 1996 issue of Inc. Online it's observed in the article "When Mom & Pop Go Public" that only 27% of SCOR underwritings meet their minimum subscription level. Usually, the minimum subscription level is US$200,000. The remaining 73% of SCOR offerings fail to raise any money.

Two types of American business people can beat these odds. Keep in mind my axiom that private investors invest in people, not proposals. Any business person who has the investor contacts and verbal interest from their friends to fund their company should do an "exempt securities" offering. They should file the forms to protect themselves from complaints should anything go wrong with their business proposal. It will cost them less than US$500. They can raise up to US$5 million. It will take 30-60 days. Their odds of success exceed 80%.

Entrepreneurs with good sales skills and the ability to relate to private investors should consider this strategy. To gain access to private investors they should hire someone with private investor contacts. Costs will be $500 to $25,000 and often an equity position in your company. It depends on the broker you select. You can raise up to US$5 million. It will take 4-6 months. The odds of success depend upon your sales skills, but are about even.

Internet SCOR Offerings

The Media-reported success of Spring Street Brewery created a tidal wave of Internet interest in SCOR & Reg A offerings. Spring Street reported raising 31.25% (private communication) from Internet response. My unanswered question is: what percentage of investors relied solely on the Spring Street Website to make their investment decision? My guess is less than 10%.

The U. S. Securities and Exchange Commission (SEC) is using the Courts to limit the use of the Internet to fund SCOR and Reg A offerings. I doubt the newborn industry will survive the ire of the SEC.

It's worthwhile to ask our four questions about doing an Internet SCOR offering. The service fees are US$100,000 plus an equity position in the company. Using the Inc. Online data, the average underwriting will be US$200,000. The odds of success are 27%. My guess is it would take 4-6 months to fund your company.

Another way to look at this offer is to say that you have one chance in four of recovering your service fee. If you get your service fee returned, you've lost equity in your company. There are many underwriting offers made in the States and elsewhere that make less economic sense than an Internet SCOR offering. Few business people ever ask relevant questions.

MIDI Underwriting

To find high-risk brokers and underwriters in Canada, you'd go to Vancouver (British Columbia) or Calgary (Alberta). To find them in the States, you'd go to Salt Lake City (Utah), Denver (Colorado) or Boca Raton/Orlando (Florida). To find them in Western Europe, you'd go to the Mediterranean. Midi is a French word that formally means the South of France. Informally, it refers to the Mediterranean Basin.

This Spring, I helped a public company client, sponsoring spin-offs, develop a MIDI underwriting syndicate. If you don't know about spin-offs, see my article in Time Magazine's online business periodical Time Vista. Cate Article In essence, my public company client will take startup companies public (OTC & NASD Bulletin Board) in the States and raise net US$675,000. They offer this service to private companies anywhere in the World. The MIDI interest comes from the packaging of the underwritings. This means, if you change the package, you won't get the Private Placement financing.

Here are my answers to our basic four questions about this strategy. It costs US$80,000 (price includes underwriters' non-accountable expense front fee) and equity in your company. It will raise US$675,000. The odds of success exceed 80%. It will take 4-6 months. The downside to this strategy, and many others, is the need for any public company to maintain a strong share price. If you succeed in managing your share price, later MIDI private placements are possible.

Editor: William Cate

U.S. Mailing Address:

Post Office Box 276
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Phone: (650) 879-0654
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*Reprinted from ZDNet Inc. October 2000, with permission. Copyright (c) 2000 ZDNet Inc. Content originally appearing in Ziff Davis Smart Business is the copyrighted property of Ziff Davis Publishing Holdings Inc. Copyright (c) 2000. All Rights Reserved.

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