Traditional public offerings are prepared by Wall Street lawyers, sold by Wall Street brokerage houses, to institutional investors. Unless the deal is a real dog, small investors never get first crack at those deals. There is no way a small company can economically do an offering that way.

The best thing a small company can do is let the elephants dance to their hearts content on Wall Street and conduct his business on Main Street where the costs aren’t as high. On Main Street, the deal is not as important as the person running the company. That is because, on Main Street, the investor has the opportunity to meet the company’s management, to see the plant, restaurant, or whatever.

SCOR has not been an easy sale. Statistically, only one company in three and a half has raised enough money to do what it planned. While those aren’t great odds, they are better than anything else. Venture capital companies look at a thousand companies a year and may take five or six deals. Matching services may have 100 investors looking at 600 deals and do 20 or 30 deals a year.

One in three and a half may sound like lousy odds, but they are better than any other game in town. The reason direct public offerings succeed at the high rate they do is because the company is selling to people who know its products and personnel. DPOs which attempt to ask strangers for money are panhandling and rarely succeed. Most of a successful company's investors live within 50 miles of the company. Put another way, just because you can register in almost every state in the Union doesn't mean you should.

A successful direct public offering is the result of a great deal of disciplined thought and planning. That thought and planning is, oddly enough, also the reason for the 65% failure rate. The questions in the U-7 Form are designed to present clearly information the investor wants. That, oddly enough is one reason why the odds of a SCOR succeeding are so low. A number of companies elect to do a SCOR offering as their last choice. They have been unable to find money any where else. Venture capitalists wouldn’t look at them. Business angels couldn’t be bothered. But once they get the U-7 through registration, they are telling a story investors can understand and they become queen of the prom.

A number of companies who try a SCOR offering get offers from investors who either want to buy the company outright, or to make a significant investment so the direct public offer is cancelled and counts as a failed offering.

A second reason so many SCOR offerings fail to sell is that the issuing company waited too long before it attempted to do the offering and ran out of money before it could raise any more. A SCOR offering is inexpensive relative to a full blown IPO, but it is not free. Furthermore, it will take far longer than you would think to get the offering through registration and on the street. And, if you have not done your homework, it will take a lot longer to sell that offering than you would like to believe.

For our purposes, we will ignore the possibility of a buyout or a major investor stepping in and work from the premise that the offering is going to be sold to the general public.

The first thing the company has to do is to identify its public. Who is going to buy the stock? The tempting thought at this point is to forget about doing the hard work of identifying a market by telling yourself, "this is such a great investment, the stock will sell itself." WRONG WRONG WRONG

Drew Fields, the San Francisco lawyer who helped Real Goods Trading do its SCOR has some sobering thoughts on selling stock. He tells his clients that if 10% of the people who told you they would buy stock in your company buy 10% of what they said they would, the company is doing better than average.

Issuers don’t believe this until the offer has been on the street a couple of months and nothing has happened. Then they have to scramble to come up with a marketing plan for the stock. The first thing to keep in your mind is that the object of the exercise is not to get the offering through registration. The object is to sell the offering after it has been registered.

You have three tools for doing that. You have the quality of the financial statements you are going to show potential investors. That is why a number of people who have done SCORs recommend that the company have audited financials.

The second tool is the U-7 itself. Is it believable? Does it make sense? And, neatness does count. Word processing and excellent laser printers are available at every Kinkos in the country if you don’t have a computer of your own.

The third selling tool available to the SCOR issuer is the credibility of the company’s management. Is it reasonable to suppose from the material presented in the U-7 that the management can do what it says it plans to do? Your company’s future to a great extent depends on your past. Don’t be shy about your accomplishments if they prove that you can do what you say you can.

Brokers disparage SCOR offerings because there is no readily apparent secondary market for the securities. If you buy stock in GE or General Motors, or any other company listed on a major exchange or the Nasdaq NMS, you can probably sell it the next day if you wish. The small corporate investor must look forward to holding on to his investment for several years. The whole idea behind small corporate offerings is to give the man in the street a chance at venture investing returns. Those returns don't occur overnight. It takes years to build a young company to the point that it commands astronomical prices. Small corporate offering investors can afford to wait for that to happen because they live close to the company and can watch it closely.

There are three ways in which an investor can realize a profit from his small company investment:

The company can be sold;
The company can do another, much larger, offering and become listed on an exchange; or
Management will get tired of having to answer to the investors and buys them out.

Small corporate offerings differ from large companies in another important way. People investing in small companies are generally buying the right to belong to that company. Belonging takes several different forms depending on the nature of the business. With brew pubs and restaurants, belonging entails bragging rights. The investor, in addition to the hope of eventual profits, is buying the right to tell people that he owns a piece of the place. A clever issuer reinforces that feeling by special treatment to shareholders. That may take the form of a free beer, immediate seating without reservations, or in the case of several golf courses, the ability to reserve a tee time, several days in advance and a special rate on greens fees. Several catalog companies have attempted to foster a sense of belonging among their shareholders by giving them discounts on whatever they buy. It isn't that costly. Rinaldo Brutoco, founder of the Red Rose Collection, pointed out that shareholders buy three times more than non-shareholders.

Another difference your stock and the stock of a company on the New York Stock Exchange is that most people have never heard of your company. There is a big difference between what you can do and what you should do. The Securities laws say you can register your SCOR offering in 47 states and the District of Columbia. You can register it in Puerto Rico or Guam if you want. But should you? The answer to that question depends on whether or not you have any customers, clients, suppliers, friends or acquaintances in other states, and if yes, how many?

If you don’t know anybody in a state, don’t register in that state. Sounds simple, but a while ago I got a call from a fellow in New Mexico who had "registered" his offering in New York because there are more people in New York than there are in New Mexico. His plan didn’t work and he called me to see if I had any ideas. All I could tell him is that asking total strangers for money is not the most efficient way to raise capital. Fortunately, he was able to raise money from other sources and didn’t need to do a public offering.

Some companies have to do multi-state offerings because their customers and potential investors are all over the country. Real Goods Trading Co. and The Red Rose Collection are two catalog companies which successfully sold multi-state SCOR offerings. Both put notices that they had stock for sale in their catalogs and attracted investors.

If you shouldn’t try to sell securities to people who don’t know you or your company, that leaves only those you know, or who know your company, its products or services. The next question has to be, do those people have the money to invest and are they likely to? Not asking that question was the mistake Zoophonics made.

The company's product was loved by the teachers who used it. Unfortunately, at the time California had a practice of substituting suitability for analysis. It would register any deal, just as long as the company agreed to sell only to very rich people. To get registered, Zoophonics had to agree to sell to people with more income than the teachers who were its natural constituents. They were forced to price themselves out of their market, and the offering failed.

Selling to people who know the company and its products is not revolutionary, but it is sensible. Peter Lynch, the fund manager who raised Fidelity’s Magellan fund to the most successful mutual fund in history, described his stock picking strategy as "if I like the product, I buy the stock." Selling to people who know and like the company is the most successful selling strategy we have found in reviewing the performance of almost 2,000 offerings. Is is closely allied to the second successful selling strategy.

Small companies offer the investor something big companies cannot hope to offer--the chance to meet the management and talk about the business with those that are running the business. We have noticed that a number of investors are really buying the chance to become involved with the company.

That is a lesson Jim Bernau learned early in his career. Bernau did everything wrong at the start, but learned fast from his mistakes. He did a SCOR offering which he registered in several states including New York because it was easy to do. Since the winery he was planning to start was in the Willamette Valley of Oregon, he didn’t get much interest from New York. Just when Bernau was at the end of his resources, he managed to sell enough stock to break escrow. He built his winery and his shareholders now gather the grapes, and help sell the wine. They get restaurants to buy it and they bring it to them. Some have even gone to the trouble of becoming registered wine servers so they can pour wine at various festivals in Oregon.

Many of Bernau’s investors are retired and look on their investment as recreation as well as a good investment. The company is listed on the NASDAQ Small Cap.

Bernau used what he learned about small corporate offerings with the vineyard to successfully sell Regulation A offerings for microbreweries in Seattle, Portland, Los Angeles, Denver and New York. As a matter of fact, he has raised so much money using Regulation A that he exceeded the $5 million a year limit and had to do an SB-2 offering for the Seattle brewery.

Bernau's secret is that 90% of his investors live within 50 miles of his facility. He does very little direct advertising, but courts coverage in the local business press.

Get as much news coverage as you possibly can.

Brutoco used another strategy to help him raise money. As a catalog company, he had customers in almost every state. It would have been ruinous to register in every state, so he registered only in those states where he had a number of customers and used a private placement exemption to collect investors in other states. That exemption allows the issuer to approach a limited number of people with whom he has a previous relationship, either friendship or business. The limit is usually 35 people per state, but some states permit fewer. The exemption is usually self-executing. but check with the regulators before attempting to make a sale in a state in which the offering is not registered.

Everything we have talked about so far seems to refer to ongoing companies, but most of it is applicable to startups as well. Of coarse a start up company won’t have a product or service which potential investors would like. Therefore you must rely on the reputation of the company’s management. That is what Philip Johnston, president of Digital Recorders, did to launch his company. Johnston had been in the electronics business for years, knew a lot of people and kept a database of his professional acquaintances.

Johnston claims the secret to selling a SCOR offering is database marketing. He used a word processing program to customize his pitch to the interests his database said the prospect had. The secret to selling a SCOR offering is to know your potential market, whether you record information in a database or merely file it in your mind, or on three by five cards, the more you know about what motivates a prospect, the better your chance of making a sale.

It is hard work which would have been done over years. Buying lists of prospects is a poor second since no commercially available list will have the degree of definition that personal contact produces.

However, absent a lifelong habit of recording information about people one has met, buying lists is the only viable alternative for a startup company. The lists should pinpoint as nearly as possible the interests that are likely produce investors. Forget about buying lists of doctors, attorneys or accountants just because they are supposed to have money. That is what everybody else does. The potential investor will have to have some interest in the company, product or service, or he won’t bother with the letter.

Most entrepreneurs attempt to lure wealthy investors. Bernau doesn’t. He points out that there are very few whales and they are hard to catch. There are much more trout, and bass, and they are much easier to net. Translation: Don’t waste your time looking for the one big investor. You would do much better off collecting smaller amounts from a lot of investors. However, since you will have to keep track of all your investors, it is a good idea to establish a lower limit to the size of the investment you will accept. Most offerings have a $2,000 lower limit, although we have seen some with $100 limits.

One of the problems with Main Street marketing is that some potential investors might not be able to come up with $5,000 in cash. That is the problem which faced Cylex, a South Carolina software company. The company offered investors a time payment plan and then sold the loans to a bank at a discount. As a result, the company got most of the money up front. The bank got some consumer loans and the investors got stock in a company which has successfully rolled out its first product.

A Word About Brokers

Not all successful SCOR issuers believe in Main Street marketing. Michael Briggs, a lawyer in Topeka, Kansas, who has helped three Kansas companies, two restaurants and an indoor soccer team do successful SCORs, says the secret is to treat a SCOR like a private placement you can advertise. That is, to find a broker who is willing to handle the offering, provide him with leads and let him sell the offering.

The key to that strategy is to have enough quality leads for the broker. Brokers are not likely to use their own customers since the broker makes his living from trades and a SCOR investment is likely to tie up money for years.

The problem with this strategy is finding a good broker who will undertake the offering. Most brokers who have done so, have done it as a favor for a good customer, out of curiosity or because they were so desperate for fees that they would undertake anything. In a booming stock market, it is unlikely that many reputable brokers will bother with something that takes as much work as selling a SCOR.

Recent steps by the NASD(R) and the SEC to tighten the listing and quoting requirements for OTCBB stocks are expected to make disreputable brokers reluctant to take on DPOs.

Internet Marketing

The Internet is very good at delivering documents, but it is not a "closer." Even since November, 1994, a number of companies have attempted to use either their, or a third party, web site to sell securities with varying decrees of success.

The states, after initially attempting to block the use of the Internet, have rushed to make amends for their initial reaction. Almost all of them have adopted the so-called "Internet Exemption" which says they will not attempt to regulate the offer as long is the Internet announcement makes it clear that the securities can only be sold in states in which they are registered.

In doing this, the states have fixed two problems with one measure. In addition to opening the door to the Internet, they have opened the door to testing the waters, the practice of seeing if anyone is interested in the securities before the issuer goes to the trouble and expense of making a registration.

Any discussion of the Internet must start by dispelling a prevalent myth. The new defunct Spring Street Brewery did not raise $2 million on the Internet. The company spent $400,000 to raise $1.6 million. Much of that money was spent on print ads in regional editions of the Wall Street Journal and local newspapers.

The Internet was opened by Nucleic Assays of Research Triangle Park, North Carolina, which put its offering documents on the Internet in November 1994. Because the offer was registered in only North Carolina, regulators in other states and the SEC threatened to fall upon the pioneering company from a great height. Since fighting regulators was not the best use of investors' money, Nucleic Assays pulled its documents.

By the time Spring Street came along, the regulators had seen the error of their ways.

While Nucleic Assays was fighting with regulators, Direct Stock Market, on the other side of the country, was recruiting companies for its web market place. The idea being to be a locus of offerings, a place to come to find small companies looking for investors. Clay Womack, DSM's creator, managed to slip any regulatory punches and encouraged a reversal in the regulators' thinking.

While Womack's company has expanded far beyond the original bulletin board approach, the bulletin board is still there. Womack says, for the present, the benefit of listing on his site is lead generation, not sales. Sales will still have to be earned.

Emerson was completely wrong when he said, " build a better mouse trap and although you may live in the middle of deep forest, the world will beat a path to your door."

If you build a better mouse trap, you have accomplished the easy part. You still have to convince people that it is better. And once convinced, you have to get them to buy.

Selling securities in small, largely unknown companies means getting people to know the company and understand its potential. It means one-on-one communication.

Stewart-Gordon Associates, Inc.
P.O. Box 781992
Dallas TX 75378-1992
voice (972) 620-2489
fax (972) 406-0213
e-mail Tom Stewart-Gordon