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Raising Capital in a Direct Public Offering

“Raising Capital in a Direct Public Offering”

Big corporations can raise capital through IPOs, but what options do smaller businesses have? This Quick-Read explains the ins and outs of direct public offerings.


In 1983, the U.S. Securities and Exchange Commission (SEC) created several new kinds of stock offerings, together often called "direct public offerings" (DPOs), that let small companies raise small amounts of capital. With these rules, a company could sell stock without going through the entire rigorous process of doing an Initial Public Offering, but a number of restrictions applied. The option still exists today, but it has proven more expensive and time consuming than many originally thought.

The DPO process is not cluttered with the middlemen of the IPO process: There is no investment banker or broker/dealer. Of course, this means no one will champion your securities. It can be difficult to find investors, especially because in some DPO structures, you are not allowed to advertise your offering.

In this Quick-Read you will find:

  • The kinds of DPOs available to small companies.
  • The kinds of companies best suited to using the DPO tool.
  • Risks and rewards of DPOs.


Types of DPOs

You may offer securities (stocks) for sale in several different ways that are exempt from standard SEC registration. A brief description follows:

  1. Intrastate Offering Exemption. If you want to raise capital within your own state, you can qualify for this exemption. You must be incorporated in the state where you want to offer the stock, you must do at least 80% of your business in that state, and you may only offer stock for sale to residents of your state. There is no limit on the size of the offering or the number of purchasers, but these are restricted securities that may not be traded on the secondary markets.
  2. Regulation A. If you want to raise no more than $5 million in any 12-month period, this may be for you. These securities can be freely traded in the secondary market, but the registration statements are simpler and don’t need to be audited. You still must offer a circular that is similar in content to a prospectus. You may also "test the waters" by advertising your offering before you file with the SEC.
  3. Regulation D. This regulation establishes three exemptions for SEC registration, called Rule 504, Rule 505, and Rule 506. Each of these rules has different provisions; but basically, they allow you to sell a limited number of securities, often to a limited number of investors who are qualified at certain income levels. You may not advertise Rule 505 or 506 offerings. Your investors can freely trade the securities if you register the sale in the states where you will sell the securities and provide a substantive disclosure document to investors. Regulation D securities are viewed as the most solid by serious investors.

DPOs were very popular when the SEC first created them. Small companies saw them as a way to escape the costly and time-consuming process of filing an IPO. Today, the interest in them has waned considerably.

Davis Wright Tremaine, a large Pacific Northwest a law firm with offices in several major cities, has not assisted a client with one for five years. David Baca, a partner in the firm, says it is quite difficult to do a DPO without professional assistance. "It’s more difficult than you might think, and you have to do a full disclosure, even in a small offering," he says.

Costs for legal services alone can push $40,000.

Best bests for a DPO

When can DPOs work? They work best when there is a significant overlap between customers and investors. The company needs what one successful DPO user calls an "affinity group." Consumer-products companies often have affinity groups: wineries and breweries are two industries that have successfully used DPOs. A brewery offers stock for sale, and as an added benefit, investors get a free pint each week and the chance to say, "That’s MY brewery."

Some DPO advocates say a DPO can work whenever a business is willing to build an affinity group, even if one isn’t apparent. For instance, a printing company owned by a black entrepreneur might be able to bring together African-American customers who want to see the printer succeed.

You will also need to find investors interested in the long-term value of your securities because some kinds of DPO securities can’t be sold on the secondary market. They will need to be committed to you and your company for reasons other than short-term gains.

Risks and rewards

The SEC is quick to point out that all securities transactions, even exempt ones like DPOs, are subject to the antifraud provisions of federal securities laws. You and your company will be responsible for false or misleading statements, whether spoken or written. And just because you may be exempt from SEC registration does not mean you’re home free. Each state has its own securities laws, and some of them require registration for DPOs every bit as rigorous as the SEC’s.

If your company is able to find a strong and supportive affinity group, willing to follow state and federal rules, and ready to spend the time and money to proceed, a DPO can provide your company with the capital to grow. Because you don’t need to pay underwriters from the proceeds of your offering, you will be able to keep more of what you raise.


Jim Bernau owns one of Oregon’s largest wineries, in a state known for its small, boutique wineries. Willamette Valley Vineyards, with revenues of $6.7 million last year, sells more Oregon wine in Oregon than any other state winery. He launched and grew the company primarily on four direct public offerings, raising $5.3 million in the process.

In addition to the money raised by DPOs, Bernau has also leveraged traditional debt from agricultural lenders. He has $15 million in debt and equity invested in the company. If you take away $3 million in depreciation, the company has a net book value of $12 million; but its market value is much higher.

As he made the offers, he sought out those who loved Oregon wine and who got a kick out of hanging around a winery. Stockholders were invited to work in the tasting room, which they did for free. It was "their" winery, after all. Some stockholders have carried the wine on trips to Japan. They are ambassadors for the company, helping to spur sales both domestically and internationally.

Bernau made his most recent DPO for the winery in 1993, but he is intending to use it as a tool in the future, as needed.

"I’m convinced it can be a very important tool, but investors have to understand what it really does for them."

DO IT [top]

  1. Talk with your financial advisers. Because DPOs haven’t been popular since the early 1990s, your advisers may not be experienced with this form of stock offering. You may need to seek additional outside assistance from someone experienced with DPOs.
  2. Line up prospective shareholders. Think about your company’s products and customers. Is there a strong affinity between the two? Would your customers want to own a piece of your company for the long term?

  3. Get a business plan in place. You’ll need to lay out at least the next three years of activities an
    d budgets, both to determine how much money you need to raise and to report to shareholders. You’ll find tips on writing the plan in the Edward Lowe Foundation Business Builder "How to Develop and Use a Business Plan."

  4. Prepare to be audited. You’ll need to file audited financial statements. Do complete end-of-year inventories. Eliminate activities that auditors and potential shareholders might question; e.g., if you’re loaning personal property — such as a vehicle or equipment — to the company, let the company buy it from you or get it from another source.
  5. Once your financial statements are in order, estimate the dollar value of the company. You’ll need it both to determine the number and price of stock shares to issue and to report to shareholders. You’ll find tips on getting started at valuation in the Quick-Read "How to Value Your Company."
  6. Check with your state securities office to learn about the specific laws about DPOs in your state. Incorporation and securities are usually regulated by the Secretary of State’s office. Make contact through the directory at the State and Local Government on the Net Web site. The office personnel will answer a lot of questions and reduce your expensive dependence on legal counsel.
  7. With a lawyer experienced in DPOs and with full understanding of what both the SEC and your state will require of you, do a cost-benefit analysis before you proceed. How much will it cost you to do a DPO? How much can you reasonably raise from your affinity group within current market conditions?
  8. What other options do you have? Perhaps you can raise what you need by bringing in a few private investors, through angel investors, or by talking to your banker. Compare the cost and benefit of these other options to that of the DPO.



Going Public: Everything You Need to Know to Take Your Company Public, Including Internet Direct Public Offerings, by James B. Arkebauer with Ron Schultz (Dearborn Financial, 1998).

Internet Sites

Journal articles

"Internet Offerings — Is Spring Street the Start of Something Big?" by Mark J. Astarita. (1996). FindLaw.com.

"Real Legacy of Spring Street Brewing," by Susan Greco. Inc. (September 1999): 54-5+

Web articles

Information for Small Businesses. U.S. Securities and Exchange Commission.

Private Offerings — Reg D, SCOR and Other Exemptions for Raising Capital. James B. Arkebauer, Venture Associates.


Article Contributors

Writer: Kathy Watson