A small business, as the Small Business Administration defines it, has gross annual receipts of no more than $2.5 to $21 million, depending upon the business. Selling stock to raise funds for small business has particular advantages, while some of the disadvantages can be reduced with a direct public offering or through private placement. The DPO has unique advantages for small businesses.
Selling stock is an efficient way to raise funds. Depending upon the offering method, the amount raised for a small business can vary from under $500,000 to several million dollars. While borrowing funds increases operating costs by the interest amount, a stock offering does not. An aura of success surrounds a stock offering -- it signals to the business community that others have confidence in your company's future. This can make doing business easier.
When you sell stock, you give up some rights to your investors. If your business plan calls for several quarters of losses while you expand your business, for example, you may believe the eventual rewards justify the plan. Your investors, however, may not. If they lose faith in your leadership, your company's stock price may fall, hurting your company's image. Investors may vote in board directors who oppose you. Eventually, you can lose control of your company.
Selling stock through an initial public offering is costly. Regulatory, legal and auditing expenses required by the Securities and Exchange Commission will cost at least $1 million. George Jenkins, a venture capitalist quoted in a Bob Brooke Communications article on IPOs, says that to make an IPO work, the amount raised needs to be at least $10 million. For smaller IPOs, getting the interest of an underwriter -- the investment bank or similar institution that the SEC requires to manage an IPO -- is difficult. Underwriters commonly get from 3 to 10 percent of a public offering. The regulatory, legal and auditing costs of remaining public after an IPO run a yearly minimum of $200,000.
The DPO has advantages of an IPO at lower cost. Companies can qualify for a DPO under SEC regulations providing regulatory exemptions in three tiers: offerings up to $1 million, $5 million and offerings limited to investors in a single state. These approaches eliminate the underwriter requirement and can keep offering costs under $50,000. After going public, a DPO company operates with substantially lower regulatory costs than an IPO company. With a DPO, you can sell stock directly to your customers, giving them a stake in your success. When you report to local investors, you are also advertising your business. Selling stock through a DPO can increase sales and customer loyalty. Ben & Jerry's raised its initial funds through a DPO. Private placement of stock is a another way of raising money. It has disadvantages, such as high placement cost and restriction of sales to SEC "qualified investors," but it also has regulatory advantages similar to the advantages of DPOs.