How to Raise Business Funds Without Going Public
The alternate path provides an IPO onramp for small- and mid-sized businesses
on February 20, 2019
Updated on June 28, 2022
Being listed on the New York Stock Exchange is the dream of many small- and mid-sized businesses, but one that is often financially taxing or even unattainable. However, legislation signed in 2012 has provided an alternate path to the traditional initial public offering (IPO); it’s called private placements, and securities and corporate finance attorney Cyrus Rajabi, at Jones & Keller in Denver, says it allows companies to grow steadily—perhaps to one day go public.
Private placements allow a business to receive capital from friends, family, and other members of the public without ever needing to fully launch into the public entity sphere. This strategic option came about as a result of the Jumpstart Our Business Startups ACT, or JOBS.
“Part of what they did is create an IPO onramp, of sorts. It eliminated the sense that you either had a non-public company or a public company—this light switch-type of transition that really wasn’t easy for most companies to execute on,” Rajabi says.
Another Small Business Fundraising Option
“If you want to sell a security—that’s any stock, membership interest, or partnership interest—you either have to register the security or you have to qualify for an exemption from registration,” he continues. “If you don’t do that right, you’re in violation of federal securities laws. These private placement exemptions effectively allow people to go to groups of people either they know directly or that broker-dealer organization that they retain relationships with. The idea is you can raise money from groups of people known to you or your affiliates without going through a public registration process.”
Going the IPO route is expensive for several reasons—risk management and financial reporting among them. Several private companies that believe they have a good track record, Rajabi says, find out along the line that they weren’t complying with generally accepted accounting procedures (GAAP). These procedures, which are required in IPO, “can be expensive to implement, and can make your financials look very different than they did before.”
The law also allows for advertising your private placement. However, you must ensure the investors you select are accredited. These are people with significant assets or income—not the “mom-and-pop investors who are at risk by unscrupulous people,” Rajabi adds.
“If you get it wrong and sell a security to a non-accredited investor, you’ll blow your exemption. That means you’ll be in violation of federal law and, two, since you didn’t disclose that, you’ll be guilty of security fraud.”
A Safer Way to Raise Capital for Entrepreneurs
Many of the things that can get you in trouble as a public company are the same that can get you in trouble as a private company; you’re just under more scrutiny when you’re in the public sphere.
“I see a lot of people who would have previously considered going public wanting to stay private—one, because of the cost, but also because of the personal liability when you have to sign off on disclosures,” Rajabi says. “The officers and directors have to file certifications as part of the disclosure process when they are publicly registered. People don’t want to do that because, even if you feel all the disclosures are correct, there isn’t a good way to fully guarantee that unless you do everything yourself. There’s always a risk that someone on your team dropped the ball.”
Business Owners Still Need Legal Advice for Crowdfunding
Naturally, this means ensuring you have the right people behind the scenes is key. While the private placement route is less expensive and more easily navigable, Rajabi maintains that anyone considering it should seek reputable legal counsel.
“That part, I would say, is critical. And it’s not just your legal counsel that you’ll need, it’s other compliance officers and teams,” he says. “These are consulting firms that provide compliance advice and assistance, and your accounting office and outside accounting firm. As you make the transition to dealing with other investors’ money, it’s easy to get lost in the weeds. You have fiduciary duties and obligations to ensure you’ve created an environment that minimizes the potential for the loss of those funds; and you’ve created transparency so, when you say what you’re going to do with those funds, they can rely on it and know you’re not abusing it. Once you create that culture of compliance with the proper policies and procedures, and the structure that aligns the interests of the company with those of the investor, once you create that skeleton, the meat on the bone is the money coming in and fleshing out the goals and targets you’ve set.”
Long story short: Private placements are an easier, more natural transition for growing companies.
“What you’ll usually see people do is start with friends and family, then angel investors and institutional investors, and then they can go through periods of building on operations, increasing revenues, and creating a track record of success,” Rajabi says. “Just because you take your company public doesn’t automatically mean it will be successful. Part of what you’d like to see is a strong track record, and going through this onramp process means you spend less on legal fees and consultants at a time where your money is better spent on growing your business and serving your customers.”
For more information about this area, read our securities and corporate finance law overview.