Private or Public? Funding Options for Growing Businesses

By Christopher S. Wrolstad

You have successfully started your company with seed funding from friends and family, but your business needs have grown beyond what Uncle Joe can handle. Congratulations on reaching the next level of equity financing.

Depending on the size of your company, cash flow, the industry you're in and the amount of capital you need, you may be ready for a private placement.  Eventually you may even be ready to take your company public.

Following the initial contribution of capital by founders, most companies raise additional money through one or more private placements of their securities.  Private placements allow companies to raise millions of dollars, remain privately held and avoid registering the sale of their securities with the Securities and Exchange Commission ( SEC ).  Companies rely on a federal securities law exemption – Regulation D – for such issuances.

Regulation D Offerings.  Regulation D offerings can be used to raise anywhere from a small amount to millions of dollars.  Depending on the exemption relied upon (Section 504, 505 or 506), investment may be limited to accredited investors.

The starting point for any business is the business plan.  No reasonable investor will invest without a clear understanding of the business, its strengths and weaknesses, the competitive landscape and the outlook for profitability.  The business plan is typically incorporated into a private placement memorandum (PPM), which is closely scrutinized by potential investors.

In addition to explaining the business, the PPM tells investors the material terms of the offering – including how many shares are being sold, whether they will have preferred or common ownership, what the price of each share will be, whether the securities are convertible or redeemable, and what voting rights and other investor rights, if any, accompany the securities.

While companies can conduct their own private placements, most engage a placement agent (i.e., investment bank).  Although this increases the cost of capital, a good placement agent can simplify the fundraising process by refining the company's message and by providing access to a network of qualified, interested investors.

Traditional IPO vs. Reverse Merger.  If your company succeeds, you may be confronted with the decision to "go public."  Most executives are familiar with a traditional underwritten initial public offering (IPO), but fewer are familiar with another alternative – the reverse merger.  This alternative is popular because it typically takes less time, has fewer regulatory burdens and costs less than an IPO.  The reverse merger is available to smaller companies that may not be able to attract a well-known underwriter for an IPO.

To execute a reverse merger, the shareholders of a private company sell their shares to a public company in exchange for shares in that company.  The public company is typically a "shell" company (with no operating business) that issues enough shares to provide the owners of the private company with control of the new public company.

The quality of the shell company is important.  Due diligence is needed to ensure that there are no problems or undisclosed liabilities.  If the shell's SEC filings are up-to-date, the private company may avoid some of the expensive, time-consuming review that would otherwise be required.

Whether you raise capital though a private placement or "go public," an experienced law firm and investment bank can shepherd you through the process and help you avoid costly mistakes.  Choose advisors that have worked with businesses similar in size and needs to yours.

Christopher S. Wrolstad is a principal and co-founder of Aspenwood Capital , an investment bank based in Golden, Colo.   He has more than 20 years of experience in investments, corporate operations and business development.  Most recently, he was with Keating Investments, LLC of Denver .  He began his career in investments at PaineWebber after earning his bachelor's degree from Gonzaga University .  He is a registered representative with Series 7 and Series 63 licenses.