Non-Public Sources of Capital

The best way for you to raise significant capital is the easiest, quickest and cheapest way that really works. The real challenge is to raise any capital. There are many stories from corporate managers and owners where they have given up after investment community promises to raise capital were not fulfilled. And there are as many ways to raise money as there are people that you personally know. But first we should look at the main possibilities to raise money being offered today and then consider the advantages and disadvantages of each.

Banks and other institutional lenders may assist you with debt capital to grow your business in the early stages. However, few of these lenders will make you a loan without collateral and personal guarantees that makes them seem more like personal loans. In addition to your house, other assets and first-born, they will look appropriately at the assets being funded. However, the cost, restrictions and personal commitment for such loans usually will only take the business far enough to get started. In addition, there are requirements for audited financials and strong collateral to increase the loan amounts to what you really need.

Most institutions like banks are not in the business of providing risk capital to anyone no matter how solid the business unless as the old saying goes that you dont need the money. Small Business Investment Companies (SBIC) and other local and national government programs can assist you when they have money available but they also require special circumstance and compliance from the borrower that meet their rigorous standards.

Experienced entrepreneurs and company founders know that the time and effort it takes to raise money from private investors and deal with private investors many of which are friends and family is exhausting.

There is another level of greater effort that may yield somewhat larger dollar amounts known as a Private Placement. This approach to raising capital will require all the proper legal document such as the Private Placement Memorandum PPM created by an attorney. Further, any time an attempt is made to directly raise capital from the public, you have entered an area of securities law and regulation even if an offering appears exempt from SEC registration. And entrepreneurs who have ventured down the path of securities law to legally prepare a private offering themselves know that you can lose sight of your business goals. The results may be a delay the business launch by trying to do it all including the legal work. However you can hire it done by a lawyer, but the cost of Private Placement Memorandum legal work can approach the cost of legal work for a public stock offering Prospectus.

Another possibility is the straight Private Placement of your stock with an institution like a venture capitalist or private equity fund. However, their requirements for a substantial ownership share of the company and/or Board/management control usually leaves most entrepreneurs with too little of their operating business to be interesting. Private Placements of this type are usually better suited for the development company in bio-technology and other high technology plays that involve high risk of total loss offset by an occasional large win for the venture capital types.

Another possibility is obtaining capital as a public stock company. Although you are required to do the legal preparation for such a company including the creation of audited financials and SEC filings, the process for raising public capital can open up many new doors to financing the current and future growth of your company. There are several main strategies that have worked over the past years with pros and cons associated each as follows

Reverse Merger is where your private company is merged into a public shell (inactive public company) to change the private company to a public company. Although the popularity of reverse mergers has grown over the last few years, the problems associated with them have also grown and the problems are reaching a point that makes reverse mergers very difficult to impossible to do in any reasonable time.

The Securities and Exchange Commission (SEC) has moved to control and restrict the use of reverse mergers as a way to go public. by creating new rules. The changes basically say that you will need audited financials and the equivalent of an SB-2 registration within four days of the merger to be in compliance with the law. The rules are intended to protect investors by deterring fraud and abuse in securities markets through the use of shell companies. The reverse merger also known as the back door exchange act can actually take longer to do than both an IPO registration with a clean start and a business development company spin-out or partnership.

Beyond the regulatory issues, a reverse merger has potential problems for the private company going public from the undiscovered and/or undisclosed history of the shell company. Old investors and/or old creditors of the shell company may come forward with financial claims when they see the new life and new resources of the merged companies. And litigation for the newly merged company can be devastating to the share price of the company. Therefore, the unknowns along with the other legal and compliance issues have limited the acceptability of reverse mergers with public shells.

See the exhibit at the end of this section:

Is a Reverse Merger, IPO or Business Development Company Spin-Out the best way for you to raise significant capital?

Initial Public Offering (IPO ) is where an investment banker member of the FINRA arranges for a group of in-house broker representatives or an independent group of FINRA investment bankers to form a money raising syndicate (group) to sell your shares to primarily individual investors.

The first and greatest challenge with the IPO is that the size of your deal may be too small to justify the amount of effort the investment bankers will need to make it worthwhile. Of course the catch-22 is that although you would probably take all the money you could get for your business, the larger amounts cannot be justified by your current size and business plans today, Also, if you receive too large an amount of money, you could lose control of the company.

As a practical matter, the IPO simply is not viable for a company raising only a few million or less due to minimum up front cost required and the lack of FINRA licensed investment banker interest in doing small deals. An IPO deal has to be sold to at least several hundred investors to get started with a reasonable shareholder base to make a trading market. This simply requires too much effort for the investment banking community relative to their cost and the minimum compensation they need to get their sales system started.

Even the currently promoted Mini-IPOs require a commitment of several $100,000 up-front from you and leave you with too few motivated shareholders to make a difference in the value of your publicly traded shares. Therefore, an IPO for an initial money raise less than several to ten million dollars is not possible and/or generally not the best solution for you.

See the exhibit at the end of this section:

Is a Reverse Merger, IPO or Business Development Company Spin-Out the best way for you to raise significant capital?

Spin-Out is where a public Business Development Company (BDC) takes a private portfolio company in which the BDC has a mutual fund investment, to public status through a stock dividend to the BDC shareholders.

The issuance of the private portfolio company shares to the BDC shareholder as a stock dividend along with the filing of a Registration Statement by the portfolio company will allow the portfolio company shares to be traded. Essentially the Portfolio Company has acquired the same shareholders as the BDC. In this way, the Portfolio Company has gone public

Under the current interpretation of the law by the SEC, using a method of spin-off through a Super Corp or non-BDC parent company is no longer acceptable as a means of avoiding the standard registration process for the distribution of shares of a new public company. However, there is a very particular exception for the use of spin-out involving a strict procedure created by Congress in 1980 as an improvement to the 1940 Investment Company Act designed to help American businesses gain access to capital.

See the exhibit at the end of this section:

Is a Reverse Merger, IPO or Business Development Company Spin-Out the best way for you to raise significant capital?

Pros & Cons of Reverse Merger