“Mini-IPOs” Present Risks to Investors and Businesses
June 2015
IN THIS ISSUE
— Mini-IPOs: Another Tool For Small Investors
— Buyer Beware: The Risks of Acquiring Shares in a Private Company
GREETINGS!
Welcome to the June edition of our newsletter! In this issue, we’ll examine how proposed “mini-IPOs” can be navigated, by both investors and the businesses seeking funds, to minimize risk.
MINI-IPOS: ANOTHER TOOL FOR SMALL INVESTORS
As we’ve previously discussed, in recent years various regulations and pieces of legislation have been enacted to create greater safeguards for small investors, while also attempting to create greater access to new opportunities. As alternative investment methods like crowdfunding have grown in popularity, regulators have responded with rules meant to help manage what can often be a “Wild West” frontier.
A recent proposal by the U.S. Securities and Exchange Commission would expand this approach to privately-held companies looking to sell their shares to the investing public — without fully going public on an exchange. These transactions, dubbed “mini-IPOs”, have yet to catch on — while 22,000 private companies sold shares to “accredited investors” last year, only seven filed the necessary paperwork, under Regulation A, to sell their shares on a more general basis.
BUYER BEWARE: THE RISKS OF ACQUIRING SHARES IN A PRIVATE COMPANY
What is an “accredited investor”? The general guideline is someone with annual income of $200,000 per year and investment assets of $1 million or more. The Regulation A rules to democratize access to private capital also mandated that companies looking to raise that capital must file an exhaustive offering statement, which investors would then be able to peruse (most likely with the aid of a financial adviser and possibly an attorney.) The SEC recently increased the amount of capital that can be raised under Regulation A transactions, from $5 million to $50 million, as an incentive to motivate more companies to file the offering statement.
Yet private companies contain significant risks, even when well documented up front. In our experience, some companies — even once taken public in a traditional manner — can be run like fiefdoms, with a strong chief executive (often the company’s founder) hand-picking executives without any regard for the capital of outside investors, treating the company as though it was still his own startup. While small investors are unlikely to retain due diligence consultants, financial advisers who think their clients would benefit from “mini-IPOs” might do well to have the principals researched before suggesting any such deal to their clients.