The Independent Counsel

Finance


Conducting a Stock Offering Over the Internet


BY WARREN E. AGIN

Of the many kinds of transactions now migrating to the Internet, the marketing and sale of stock offerings could be of special benefit to the rapidly growing company.

The new era dawned on February 26, 1996, when Spring Street Brewing Company, a micro brewery, announced its successful completion of the first initial public offering (IPO) over the Internet, This was followed by the announcement by the Securities and Exchange Commission (SEC) on May 9, 1996 that it had approved the Internet as a medium for the electronic delivery of securities information, including prospectuses. SEC Release No. 33-7288.

Dozens of companies have sought SEC approval since then for Internet aided offerings, and almost as many companies have sprung into existence to assist them.

Why use the Internet for an offering?

A primary advantage of using the Internet in a public stock offering is that it can, in what is called “disinter-mediation,” eliminate the high fees paid to Wall Street underwriters and broker/dealers that ordinarily serve as middlemen between the selling company and the investing public in an offering.

The enormous printing expenses typical of a public offering may also be reduced. These cost savings can improve the viability of a smaller offering, and may also eliminate the need for venture capital in some instances.

The Internet may thus make stock offerings feasible for companies that, because of lack of capital or a track record, could not attract the interest of reputable underwriters to conduct traditional offerings.

What type of company is best suited for an Internet aided stock offering?

Offerings of stock directly to the public (known as direct public offerings, or DPOs), began to be conducted without Internet aid during the 1980s by smaller, consumer oriented, companies that could use their own product packaging and distribution to solicit interested buyers. This pattern appears to be continuing in Internet aided offerings, in which solicitations on product packaging can now include references to an offeror's Web page, from which the investor may download a prospectus.

For example, Spring Street Brewing Company and Annie's Homegrown, Inc., an organic food marketer, solicited their beer and food consumers as investors. Logos Research Systems, Inc., an electronic Bible publisher whose Regulation A offering went effective in November 1996, solicited its readership.

How to conduct an offering over the Internet?

Successful Internet offerings to date include full registrations on Forms SB-1 and SB-2, limited public offerings pursuant to Regulation A, and exempt offerings under Regulation D, Rule 504 of the Securities Act of 1933. The method chosen depends on the amount of capital needed. For example, proceeds from an exempt offering or offerings under Regulation D, Rule 504, may not exceed $1,000,000 in a given year, while a Regulation A offering subject may to yield up to $5,000,000 in proceeds.

For any offering where SEC registration is needed, the company prepares a preliminary offering circular or prospectus with the help of a securities lawyer and then submits it to the SEC for approval. Pending approval, the preliminary document, or a summary, is posted on an Internet Web page (and perhaps also described on product packaging) to elicit indications of interest from the general public. Current IPO oriented Web sites include www.witcap.com, www.directipo.com, and www.direct-stock-market.com.

Once approval and an “effective date” are obtained from the SEC, the company delivers its final offering circular or prospectus to interested investors, via either the Internet or conventional means, or both, and may then actively solicit offers for its stock. The company will usually employ a transfer agent to actually issue the securities. A useful guide, now available from Bowne & Co., is SECURITIES REGULATION IN CYBERSPACE, H.M. FRIEDMAN (1997).

Are there disadvantages?

Internet aided public offerings still appear extremely risky, and most Internet aided IPOs appear not to achieved all of their goals. Though Spring Street Brewing Company raised more than $1.6 million in its IPO under Regulation A, it later canceled a planned secondary offering. Annie's Homegrown, Inc. initially offered up to 600,000 shares of stock at $6.00 a share in its IPO beginning in September of 1995, but ended up selling only 256,490 shares by the time it finally closed its offering nearly a year later on July 31, 1996.

In another example, the SEC granted National Specialty Networks, Inc., which organizes health care management networks, effective status for its Form SB-2 offering on August 16, 1996 but few shares of stock were subscribed, and the company later canceled the offering in favor of private financing.

Even a successful Internet aided IPO may take several months to complete following its effective date, as contrasted with a traditional public stock offering conducted through underwriters that obtain purchase commitments beforehand, and then close on or about the effective date.

Internet aided IPOs also remain costly. Experienced legal counsel must still see to the offering's filing with the SEC and with the securities divisions of all states where stock will be offered, and it is preferable for credibility purposes that a widely known accounting firm prepare audited financial statements. A Web page developer must construct and maintain the offering site. There also may be substantial financial printing costs.

The company must also assign and train its own staff to do the underwriters' job of receiving and responding to expressions of interest, and offers to purchase stock, a process that may consume more time than anticipated because of the lack of a foreseeable closing. Finally, a transfer agent will still be needed to collect funds and distribute securities. Overall IPO costs, though lower than those of a traditional offering, may total in the $150,000-$200,000 range.

Conclusion

Precedent favors Internet aided public offerings by established companies with loyal customer bases. Furthermore, investors that normally rely on known underwriters to screen IPOs for them may view Internet aided offerings either with skepticism or, more likely, not at all. There also may be a higher risk of lawsuits alleging securities fraud down the road.

Bearing these risks in mind, however, a start-up with a good story to tell ought to at least consider using the Internet to assist in raising limited amounts of capital, perhaps through an exempt securities offering under Regulation D, Rule 504.

Comment: An Internet aided stock offering is worth considering among capital raising alternatives. Though such offerings remain relatively rare, and the risk of failure can be substantial, the Internet does offer an alternative route where standard methods of raising capital are unavailable.

© ASSOCIATION OF INDEPENDENT GENERAL COUNSEL 1998; (all rights reserved). This article is not intended as legal advice. Consult a qualified attorney for assistance concerning a specific issue or problem.