Thinking of Raising Capital? A Direct Public Offering Could Cut You Some “Slack”

By Anthony R. Caruso

Recently, in contrast to the vast majority of tech companies that go public using an initial public offering (IPO), Slack used a direct public offering (“DPO”). Before that, Spotify went the DPO way. Could this be the beginning of a tech trend?

With a DPO, small businesses can file with the SEC in a much more simplified fashion than an IPO, and raise substantial capital without using brokerage firms acting as underwriters. Less money is needed to pay underwriters and other costs totaling as much as 20 percent of the capital raised, thereby freeing up capital for other necessary expenses like sales and marketing.

How does it work? Read my lips-No New Shares! In a DPO, shareholders are given the option to sell their shares directly into the stock market. So, no new shares are offered, thereby allowing the company a more streamline method to go public. In an IPO, a company seeks to raise capital by selling new shares, and shareholders are usually restricted from selling shares for six month after the offering. Thus, a DPO makes it much easier for employees and early investors to cash out as soon as the first day of trading.

It should be noted that a DPO can be risky. Some of the more prevalent risks pertain to whether the Company is relatively unknown, or is desperate to raise more capital, or does not have a significant amount of employees or investors eager to sell their shares in the stock market.

Ultimately the key benefit of DPOs is the low cost attained by eliminating the underwriter. This removes the need for an underwriter to undertake “road shows” with institutional investors and to purchase the securities from the issuing company to re-sell (which creates the IPO market for the issuer’s securities). Yet even in a DPO, the issuing company has to find market-makers, FINRA registered broker-dealers who quote prices for the company’s securities in the trading market, creating the “bid” and “asked” needed so that liquidity is provided for the company’s securities holders. That liquidity is one of the reasons for going public in the first place. It creates not only a way for the company’s shareholders who wish to do so to sell their shares, it also provides a currency in its shares that the company can use to reward employees with options on its shares, or that it can use to buy other companies.

So, while substantially less expensive, DPOs do require the company to engage attorneys, accountants, auditors and transfer agents, and to make EDGAR, SEC and State Blue Sky filings. Most importantly, any business making a securities offering, whether public or private, IPO or DPO, will need an experienced securities lawyer. Even with the flexibility and reduced regulatory restrictions that DPOs provide, there are still federal and state rules applicable to these offerings. The issuing company and management could expose themselves to risks of lawsuits, substantial fines, civic penalties and investor rescission obligations if they are without proper legal guidance.

Before determining whether a DPO is right for your small business, it is important to make certain preparations. DPOs, like IPOs, require disclosures to investors and regulators of the material information concerning the company, its business and management, with heightened emphasis on financial statements and risk factors. A company considering a DPO should arrange to have its financial records reviewed early in the preparation process. While future projections are to be considered, particularly when valuing the company for pricing of the offering, past financial results must be reported, usually showing the financial results for at least the prior two fiscal years.

These are just some of the requirements and benefits of DPOs for small businesses that you should consider. A DPO is just one example of the new opportunities available to raise capital as a result of recent technological advances and creative thinking by the regulators.

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