March 5, 1995 in Business

Quasi-Public Stock Offerings Can Help Small Firms To Grow

Paul Willax
 

OPM or “Other Peoples’ Money,” is the fuel used by many firms to fund growth and development. Only rarely can a rapidly expanding venture generate sufficient cash from routine operations to support burgeoning inventory and receivables financing and a spreading overhead.

So, absent a compliant bank or an infusion of expensive venture capital, the founding entrepreneur has to find outside investors.

Q. My firm has been growing steadily for seven years and is outstripping my ability to provide the cash it needs to take advantage of its good fortune. My sales are approaching $4 million. Am I too small to do a “public offering” of stock?

A. A full-blown, SEC registered securities offering probably wouldn’t be cost-effective given the maximum capital infusion a company of your size could justify. An alternative might be a quasi-public offering under SEC Regulations A or D, provisions which allow a company to sell stock to the public without the expensive and time-consuming federal registration process.

Rule 504 of Reg D has been the most popular vehicle for this purpose, although it limits a firm’s aggregate sale of stock to $1 million or less and restricts the numbers and types of investors who can participate.

In the late 1980’s the process of offering shares to the public became cheaper and easier with the introduction of the Small Company Offering Registration. With “SCOR” any entrepreneur and his or her lawyer can utilize a simple fill-in-theblanks disclosure statement/ registration form to launch the stock sale process.

The amount that can be raised this way is limited to a maximum of $1 million and each share must be priced at $5, at least. Stock sold this way can be aggressively marketed and freely traded. Company officials can sell their firm’s shares themselves or they can retain a securities firm to help.

Consider the latter approach, since few busy entrepreneurs have sufficient time to divert to a task of this magnitude. It’s worth the commission to get the professional assistance and access of an established brokerage firm, assuming a broker can be attracted to an offering of the size and risk you propose.

Among the states adopting the SCOR technique are Washington, Montana and Idaho.

To avoid future personal liability to disgruntled shareholders (if, heaven forbid, your firm should not meet expectations) it is important that you make full and forthright disclosure of all relevant facts at the time of the initial offering and in subsequent reports to your investors. An experienced attorney can help you avoid the pitfalls involved with getting strangers involved in your business.

Q. My partner and I have built a nice little business over the past twenty years and are just now considering buy-sell agreements to protect us and the business if one of us dies.

Neither of us has a lot of money outside of the business, so a survivor will need time to buy all the stock from the dead partner’s estate. How long should an installment agreement be?

A. I’m not in favor of long-term payouts like you suggest to facilitate the settlement of estate tax obligations. The government usually wants such taxes paid within nine months of the date of death. If a decedent’s business represents a significant portion of his estate, there is a provision for paying estate taxes over a period of up to 14 years.

However, it’s best to retire this kind debt as soon as possible. The IRS is an unrelenting collector and the surviving partner may not be able to consistently generate the after-tax dollars necessary to pay off the dead partner’s estate if the business falls on hard times in future years.

The best way to fund a buy/sell agreement is through life insurance, assuming you are both still healthy enough to obtain coverage. Then, when one partner dies, the proceeds of the policy can be used to immediately fund the acquisition of shares from the decedent’s estate. The estate, in turn, can use these proceeds to meet its debt to the IRS.

Each partner should own a policy that covers the other partner. Don’t have the company own the policy with the intention of having the firm using the death benefit to buy back the departing partner’s equity. The cash value of such a policy will be on the company’s books and is vulnerable to company creditors.

Furthermore, upon an owner’s death, the policy will simply work to increase the taxable value of each owner’s interest. Also, if the firm buys back the departed owner’s shares, the value of the surviving owner’s expanded stake in the company will increase dramatically.

While this sounds acceptable, in reality the survivor’s tax basis in his stock will not change, thereby unnecessarily increasing his future estate tax liability.

See your life insurance agent about policies that are specifically designed with buy-sell funding in mind.

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