The Decision to Sell
Of all the decisions you will make on the road to selling securities, perhaps the most difficult, and important, is whether or not selling securities is the right financing tool for your business.
Unless you can comfortably answer "yes" to all of the following questions, you will find it difficult to sell your company's securities.
Is Your Company Ready?
Is your company properly formed and organized? If not, any structural changes should be made before you file your offering, not afterwards.
Do you already have a well-defined and stable business plan in place? Without a good business plan, it will be difficult to draft a disclosure document that satisfies regulatory requirements or potential investors.
Does your company have current financial statements prepared in accordance with Generally Accepted Accounting Principles (GAAP)? Depending on the size and type of offering, audited statements may be required. Even if reviewed or audited statements are not required, it is often advisable to have a CPA help you prepare the financial statements.
Are You and Your Management Ready?
Can you afford to spend a significant amount of time away from your normal business operations to prepare your offering? Many are surprised at the amount of time it takes.
Are you prepared to invest a significant amount of energy in actually selling your offering, especially if you will not be using a securities broker to sell the offering? Meetings and presentations to potential investors will often be required.
Are you willing to give up a portion of your profits to provide a return to investors? You must be ready to share the rewards as well as the risks.
If you are successful with your securities offering, others will own a share of your business. They may desire a say in how things are run. Shareholder relations may take up significant amounts of your time.
You will have ongoing responsibilities after the offering, such as preparing and distributing an annual financial report to all of your investors.
Investors look for liquidity. Though investments in small business should be viewed as long term, even long term investors need to see some light at the end of the tunnel. Will your company ever be large enough that a trading market could develop for your stock?
Investors want a share of the profits. If your company has profits, what are your plans for distribution? Will investors see any of the profits, or will you give it all away in big salaries or bonuses to key employees?
Will investors have any control? If things don't go as planned, investors will want some power to do something about it, such as representation on your board of directors.
Do potential investors feel an "affinity" with your company? Investors in small offerings are frequently attracted to the offering because they have an interest in the product or service that the company provides. For instance, people that are interested in wine may be more interested in investing in a winery.
One Final Caution
Securities laws place heavy constraints on all parts of the securities selling process in order to protect you and your investors. The process is complicated, and you are wise to consult an experienced securities attorney early on even if you later decide to do some or all of the preparation yourself. Never attempt to hide anything about your business from your attorney, securities officials, or potential investors.
Anyone who thinks a securities offering is a one-size-fits-all proposition is wrong. The best offerings are tailor-made to specific financial needs and goals. Once you have decided to proceed, then you have to figure out what kind of offering is best for you and your investors.
Choosing What Kind of Security to Offer
- Common Stock. Selling common stock means selling shares in the equity of your company. This is the security most often offered. It does not require you to make any promises or guarantees regarding return-on-investment and is, therefore, usually the most appropriate choice for start-up or developmental stage businesses.
- Debt. With debt, you agree to pay your investors interest, plus principle, on the money they loan you. In order to obtain regulatory approval for a debt offering, the company must be able to demonstrate the ability to repay the debt based on current earnings.
- Preferred Stock. Preferred stock is a hybrid between debt and common stock. If it has the characteristics of debt, such as a specific rate of return, the Securities Division will apply standards similar to those applied to debt offerings. If it's structured more like equity, it will be treated more like common stock.
- Limited Partnership. Limited Partnerships are another form of security. They are typically used for obtaining certain tax advantages and may be subject to many special rules. Once again, it's best to obtain the services of an experienced securities attorney.
- Limited Liability Company (LLC). LLC's are unincorporated entities that combine the limited liability features of corporations with the pass through taxation and structural flexibility of general partnerships.
Choosing What Type of Offering to Pursue
The type of offering you choose depends on several different factors.
- How much money do you need?
- How many investors do you think will be necessary to raise that amount?
- Do you want or need to sell to investors in other states? If so, it will be necessary to determine how to comply with federal securities laws and those of the state(s) in which offers or sales may be made.
- Do you need to advertise or otherwise engage in "general solicitation" to obtain investors?
- How important is it that the securities be freely transferable immediately upon issuance? Keep in mind that, even if the securities are freely transferable, it is extremely unlikely that any type of active trading market will develop in the foreseeable future.
- How much time do you have to devote to the preparation process? There are "fill-in-the-blanks" forms available that are capable of being completed by company management with the assistance of the company's attorneys and accountants. The preparation time, however, can be lengthy. Can you take the time away from running your business to do this preparation?
The responses to these questions will help determine the type of offering to pursue. Please see "Options for Small Business in the Securities Market" in the Small Business Assistance Section of this Web Site, for a discussion of the specific registration and exemption alternatives available to issuers of securities.
Preparing the Application
Piecing together a well-prepared offering package requires a lot of time and expertise in many areas. Consulting with an experienced securities attorney and a qualified accountant early in the decision making process is strongly recommended. Even if you decide to prepare the bulk of the application yourself, attorneys and accountants can offer invaluable assistance with many general business planning issues and with determining what type of offering to pursue. It is also a good idea to contact the Securities Division to obtain the rules and forms for the filing(s) that you are considering. Much of this information is located elsewhere on this Web Site.
Take time to read the applicable rules, requirements, and instructions. Make sure you will be able to fully comply. Seek a determination from the Securities Division as soon as possible if you are unsure of the requirements or if you foresee a problem with complying with a particular requirement. If you have any questions, please call 360-902-8760 and ask to speak to a staff member in the Small Business Assistance Section.
Consider a Pre-Filing Conference
Taking advantage of a Pre-Filing Conference offered by the Securities Division is a good idea, particularly if you are considering an offering utilizing the "fill-in-the-blanks" form (SCOR). Here you will be able to obtain answers to questions you have about your offering, including how to fill out the various forms and disclosure document and how the rules governing the offering will be administered. You are welcome to bring your attorney and/or accountant, but before you arrive, please be sure you:
- Make an appointment with the Securities Division by calling 360-902-8760 and asking to speak to someone assigned to the Small Business area.
- Come prepared with a list of all your questions. Have on hand as much information as possible about your business, including your business plan.
If you anticipate discussing a particularly difficult or complicated subject or problem during your pre-filing conference, please notify the Securities Division beforehand so any necessary background research can be conducted before the actual conference.
The disclosure document is the most important part of the application, so take the time to prepare it carefully. The information that you gathered in your pre-filing conference, and from your attorney and accountant will:
- Make sure the section on your company's existing and proposed business is carefully and thoroughly answered.
- Disclose in detail how you plan to utilize proceeds from your offering.
- The section on risk factors will be carefully scrutinized, so be sure it is properly prepared. It's a good idea to double check arithmetic and percentage calculations.
- Avoid inconsistencies and material omissions within the document.
- Add footnotes, if needed, for further explanation.
- Your final document should be easy to read and understand.
Preparing Your Application Package
Along with a completed Disclosure Document, you'll also need to include several additional items in your final Application Package:
- Review the list of exhibits to be sent with your application, and make sure that everything is included. You'll find a complete listing in the rules and instructions for your particular type of offering.
- Include a cover letter explaining why any missing items were omitted and naming the contact person at your company or your law firm.
- Make sure your application/Disclosure Document is properly signed.
- If you plan to have officers conduct sales, the required Agent Application should be submitted as early as possible. Application approval is often delayed because company officers have not been properly registered.
- Don't hesitate to send along any additional supporting information you believe will be helpful to the Securities Division. It is always a good idea to include any document which is referenced in the offering circular such as employment agreements, licensing agreements, and stock option plans. Your cover letter should indicate whether any of this additional information will be provided to potential investors. If so, it should be listed as an exhibit in the table of contents in the Disclosure Document.
Securities laws vary from state to state. If you plan to conduct your offering in more than one state, you must register or utilize an appropriate exemption from registration with both the federal Securities and Exchange Commission and with each additional state in which the offering will be conducted. Information on filing requirements can be obtained from the SEC and each state's Securities Division.
The Review Process
Reviewing a securities offering is a time consuming process for the Securities Division. In the course of a review, certain revisions to your documents will probably be required. Making these revisions quickly and accurately can greatly reduce delays.
When your application is received, it is assigned to a lead analyst who will act as your contact at the Division. In addition, other staff members may be involved in the review.
How Long Does it Take?
The "average" filing takes 4 to 6 weeks to clear. Naturally, the more complete and thoughtfully prepared your offering is, the shorter the review time. If your file is particularly complex, or has some unusual problems, it will usually take longer for the Division to review and longer for you to make necessary changes prior to clearance. The initial review usually takes place within two weeks of the receipt of your application. This initial review will normally center on "deal killers" - substantive problem areas that, unless resolved, will kill an offering regardless of the quality of the disclosure. Typical "deal killers" include:
- Excessive amount of promotional shares;
- Inability to service debt consistent with Division regulations;
- Affiliated transactions/conflicts of interest;
- Excessive selling expenses; and
- Problems with financial statements.
Common Problem Areas
- Promotional Stock. This problem arises when insiders have received too many shares for too little consideration compared to public investors. Usually this problem is solved by insiders agreeing to escrow some shares until the company has adequate earnings to justify release, although in extreme cases, shares may have to be canceled.
- Inability to Service Debt. If you will be offering debt securities, you must be able to show the ability to service debt on a pro-forma (not projected) basis. It is extremely difficult for an unprofitable or start-up company to demonstrate this ability. Regulations used to measure debt service ability are available from the Securities Division and on our website (WAC 460-16A-200).
- Inadequate Minimum or Excessive Maximum Offering. The minimum amount to be raised by the offering must be adequate to actually accomplish the purposes of the offering. For example, if the primary purpose of the offering is to expand production by purchasing certain equipment, the minimum offering must provide sufficient funds for the equipment to be purchased. The maximum offering must also be justified. The issuer must be very precise regarding how all proceeds from the offering will be used. If the issuer is incapable of such precision, then it is likely that the maximum offering is excessive.
- Omissions, Discrepancies, and Organization. A surprising number of disclosure documents contain an inadequate description of exactly what it is a company does or plans to do. Also, the list of risks connected with the offering is often incomplete. Although issuers are reluctant to discuss their company's weaknesses, such disclosure is mandatory.
- Inconsistency. Many offering circulars also lack internal consistency. Statements made in one part of the offering conflict with those made in other parts of the offering. It is also not uncommon for the capitalization table to conflict with the financial statements. Another frequent problem occurs when the circular discusses certain projects or activities that it plans to undertake upon the conclusion of the offering, but the use of proceeds table contains no allocation of offering funds for such activities. For offerings that specify minimum and maximum offering amounts, it is important to discuss the consequences to the company of selling only the minimum offering, as well as the maximum offering.
For offerings utilizing the question and answer format (SCOR), it is important that each answer be a complete response to the question to which it pertains. It is equally important, however, that the response remains tightly focused on the question and does not stray into other areas.
- Prior Sales of Securities. It is not uncommon for the Securities Division to discover, upon routine examination, that prior sales of securities have been made outside applicable securities laws. If an improper prior distribution was made, it must be corrected before any further offerings can take place. The Securities Division can provide guidance on what must be done.
- Erroneous or Misleading Financial Statements. The best way to prevent errors, omissions, or discrepancies in your financial statements is to have your accountants help. In some instances, an independent CPA must audit or review the financial statements. All financial statements must be prepared according to Generally Accepted Accounting Principles (GAAP). When the Division finds mistakes, further inquiry is required and statements must be corrected before the offering can proceed. Choose your CPA carefully, inform the CPA up front that the statements will be used in a securities offering in which the CPA must consent to the use of his/her name.
- Forecasts and Projections. Contact the Securities Division if you are contemplating the use of projections or forecasts. Unless there is a reasonable basis for the projections, it is unlikely that they will be permitted. In particular, companies that have been in business for a limited time will have difficulty demonstrating a reasonable basis for projections. When projections are allowed, they must include a detailed description of all underlying assumptions and the rationale behind them.
Completing the Review Process
The Division's comments are typically communicated in writing to the contact person identified in the application. In certain instances, the Division may also suggest a meeting. The applicant is also free to request a meeting.
To expedite subsequent reviews, the Division often requests that comments be responded to in numerical order and that changes to the offering circular be underlined.
Until all comments have been resolved, the Division frequently requests a waiver of automatic effectiveness of the offering due to statutory requirements. It is not uncommon for an offering to undergo several rounds of comments and revisions before it is ready for clearance.
When all issues have been resolved, the Division will issue a printed permit and the offering can begin.
As soon as your offering goes effective, you'll be issued a permit package which includes a permit copy, agent licenses (if any) and any other forms or documents you'll need. The permit may contain escrow and impound provisions and sometimes other conditions. If you have questions or discover errors, contact the analyst that issued the permit.
Of course, it would be nice if once your permit is issued, investors would show up on your doorstep with money in hand. In reality, however, marketing your offering is one of the toughest tasks of all. During the offering period, you will continue to have obligations to the Securities Division.
If changes are to be made at any time to the offering which are material to investors, the Securities Division has to be notified and your Disclosure Document has to be amended.
A copy of every advertisement for your offering has to be reviewed and cleared by the Division before you can use it. Remember that private placement offerings can't engage in "general solicitation," including advertising.
Certain offerings, including SCOR, must file quarterly reports during the offering period showing sales to date, material changes, and the company's financial condition.
Release of Impound
If a minimum offering has been specified, all investor funds must be immediately placed in a bank impound account and may not be released until the minimum offering amount has been raised. The Securities Division must authorize all releases from impound.
Termination and Final Report
Notify the Division when your offering is completed, even if no sales took place. This will enable the Division to update its records.