An offering made by a company without a professional underwriter. In other words, the offering is self-underwritten.

Most companies rely on offering exemptions to conduct their DPOs without registering the offering with the SEC. The offering exemptions typically relied upon are:

Rule 504 under Regulation D - with a $1 million offering cap (see more @ Rule 504) , or
Regulation A - with a $5 million offering cap (see more @ Regulation A).

In addition, several companies have registered DPOs with the SEC on Form SB-2. See more @ who has conducted DPOs.

Do employees of a company conducting a DPO have to register as brokers?

No - so long as these employees truly are employees of the company and they are not directly compensated for working on the DPO.

There also are other conditions, such as not being affiliated with a broker (or not performing broker tasks for the company within 12 months of this DPO).

Source: Rule 3a4-1 of the Securities Exchange Act of 1934 sets forth the limits of what employees can do in a self-underwritten offering and avoid having to register as a broker.

Why would a company want to conduct a DPO?

Not using an underwriter arguably can save a company a significant portion of the offering's gross proceeds - and now it's easier and cheaper to locate investors online. Electronic delivery can further reduce printing and mailing costs.

However, many companies that conduct DPOs are forced to conduct them since they can't entice an underwriter to assist them. They don't want to forego an underwriter since a company arguably could not raise nearly enough to offset the savings of the underwriter's fees without an underwriter's reputation behind its offering. See more @ why companies conduct DPOs.

Note that without an underwriter, issuers have privity with the purchasers - and thus have potential Section 12(a)(2) liability for misleading disclosure (whereas an underwriter normally would have been liable).

Source: The U.S. Supreme Court in Gustafson v. Alloyd, 513 U.S. 561 (1995) held that issuers can only have Section 12(a)(2) liability in a public offering.

How does the SEC treat DPOs?

Even though they lack a professional underwriter, the SEC does not single out DPOs for special review.

Many DPOs are made under Rule 504 - which are not filed with the SEC or reviewed by the SEC staff. However, these 504 offerings are filed with state agencies in the states where the company intends to sell the DPO (unless a state has special filing arrangements, such as a regional coordinated regulatory review - see more @ state agency contacts).

Note that the mere posting of offering materials on a Web site subjects the company to the laws of every state - but most states have exempted online offerings if certain conditions are met, including the lack of sales within that state. See more @ registering online offers with state agencies.

DPOs offered under Regulation A are filed with the SEC and likely will be selected for review by the Office of Small Business in the SEC's Division of Corporation Finance (since Regulation A offerings typically are the first SEC filing that a company has made).

Even though DPOs are not treated differently than other types of offerings by the SEC - the SEC review process can be a difficult hurdle for companies, particularly if they are not well organized or do not have complete financial statements. See more @ Regulation A DPOs.

Companies that are already listed on an exchange or Nasdaq rarely conduct DPOs. Their DPOs typically are registered with the SEC - and are exempt from state law registration requirements. These DPOs are subject to possible SEC staff review, just like any other registered offering - but it's less likely that a registered secondary offering would be selected for SEC staff review compared to an IPO. See more @ SEC staff review of online public offerings.

B. How to Conduct a DPO under Rule 504

How can a company conduct a DPO under Rule 504?

Rule 504 - known as the "seed capital" rule - is useful for companies that need to raise less than $1 million and do not yet file reports with the SEC.

This exemption allows a company to avoid the SEC registration process - but companies still must register with the state agencies for the states in which it intends to make sales - and these state agency staffs likely will review the filing (some states cooperate with each other and essentially take turns reviewing filings under a coordinated review framework).

This state registration process may or may not be more burdensome than the SEC registration process.

Source: Rule 504(b)(1) requires registration with at least one state agency for the securities to be freely tradeable.

How can companies "generally solicit" online under Rule 504?

To be able to post an offer on a Web site or in e-mails, it must be able to "generally solicit." See more @ what is "general solicitation."

Rule 504 does not allow a company to "generally solicit" unless either:

the offering is registered under a state law that requires registration and delivery before sales are made. If a company intends to sell in a state that does not have this type of law, the offering must be registered in another state that does - and the disclosure document must be filed and delivered before sales are made in either of the states; or
the securities are exempt under state laws that permit general solicitation - so long as sales are made only to "accredited investors." See more @ accredited investors.

Investors are not restricted from reselling the stock they buy in the DPO if a company meets one of these two conditions. Otherwise, the stock is restricted and must be held for at least one year.

Note that most companies conducting off-line Rule 504 offerings do not bother to meet either of these conditions - so the stock is restricted until it's available for resale (normally resold under the safe harbor in Rule 144).

Source: Rule 504 (b)(1) was amended in Release 33-7644 (April 7, 1999) to add these "general solicitation" restrictions.

How is the $1 million cap calculated under Rule 504?

Up to $1 million, less the aggregate offering of all securities - debt and/or equities - sold within 12 months before the start of a Rule 504 offering.

For example, if a company sold $400k in securities in a private placement during the prior 12 months, it still can raise up to $600k in a Rule 504 offering.

Source: Rule 504(b)(2) sets forth the limits on the aggregate offering price.

What must a company disclose to investors in a Rule 504 offering?

Although there are no specific disclosure requirements under Rule 504, a company must follow the disclosure requirements of each state in which the DPO is offered.

In addition, the federal securities laws impose an antifraud standard on Rule 504 offerings - there should be sufficient disclosure so that there are no material omissions or misstatements.

Note that the vast majority of states have adopted the SCOR registration scheme. SCOR coordinates the Rule 504 exemption with state registration requirements - and allows companies to use a streamlined form, Form U-7. Form U-7 is quite simple and even can be completed in a Q&A format.

"SCOR" stands for NASAA's Small Corporate Offering Registration program and is adopted by almost every state - some officially and some informally. The Direct Stock Market has a list of states that have adopted SCOR and state regulatory contacts at www.dsm.com/direct/state/par.

How many investors can buy securities in a Rule 504 offering?

An unlimited number - but the $1 million cap limits a company's flexibility. See more @ how to calculate the $1 million cap.

C. How to Conduct a DPO under Regulation A

How can a company conduct a DPO under Regulation A?

Under Regulation A, a company does not "register" securities with the SEC - but it still must file a disclosure document with the SEC for possible staff review (an "offering circular" on a Form 1-A that the SEC staff "qualifies").

The SEC filing and staff review process is the same as registering a public offering - but a company's potential liability in a Regulation A offering is not as great as in a registered offering.

Compared to registered offerings, Regulation A allows companies to provide streamlined disclosure in the offering circular - including only two years of financial statements (which can be unaudited if audited data is unavailable - but most state laws require audited financial statements anyway).

Note that a company that conducts a Regulation A offering does not automatically become a SEC reporting company. It's required to file ongoing periodic reports with the SEC only if it otherwise triggers the periodic reporting obligations (i.e. over 500 stockholders and $10 million in assets at the end of its fiscal year).

Source: The periodic reporting obligation threshold consists of two parts. Section 12(g)(1) of the Securities Exchange Act of 1934 sets forth the threshold of 500 equity holders and Rule 12g-1 sets forth the $10 million asset threshold. Note that Regulation A is pronounced "Reg. A" for short - not to be confused with "reggae" music.

How is the $5 million cap calculated under Regulation A?

Up to $5 million, less the aggregate offering of all securities - debt and/or equities - sold in another Regulation A offering within 12 months before the start of a new Regulation A offering.

For example, if a company sold $2 million in securities in a prior Regulation A offering during the prior 12 months, it still can raise up to $3 million in a new Regulation A offering.

Source: Item 251(b) of Regulation A sets forth the limits on the offering aggregate price.

How can companies "test the waters" under Regulation A?

By sending out "feelers" to determine if investors are interested in a company's offering.

Since any medium can be used to test the waters, this is an innovative way for companies to determine whether investors are interested in an offering - before incurring the expense of conducting an offering. This flexible component of a Regulation A offering is particularly Internet-friendly.

Before filing an offering circular with the SEC, a company can "test the waters" by soliciting indications of interest through the distribution of preliminary materials - which must be limited to factual information and include a brief description of the company's business and the CEO's experience (as well as state that no money is being solicited or accepted at this time).

"Test the water" solicitation materials must be filed with the SEC before or on the date they are used - except for pure oral solicitations.

A company cannot "test the waters" once an offering circular is submitted to the SEC staff - and a company must wait 20 days between the last day it used solicitation materials and the date of first sale (which cannot occur until the SEC staff has qualified the Form 1-A). However, the failure to submit solicitation materials does not disqualify the company from relying on the exemption.

However, most states have not adopted a similar concept - effectively limiting the ability of companies to "test the waters," unless waters are tested in the handful of states that have such laws.

Source: Testing the waters is permitted under Item 254 of Regulation A.

D. What to Consider Before Conducting a DPO

Why are some DPOs not successful?

There has been a high failure rate for DPOs - probably due to the questionable quality of companies that attempt them.

Companies conducting DPOs often have been unable to attract an underwriter willing to offer their securities - or may be attempting to publicly sell securities at an earlier stage in their business cycle than they normally would.

It's rare for institutional investors to participate in offerings that do not have underwriters - probably because these investors rely on underwriters to act as "gatekeepers" to ensure an offering's quality by:

conducting due diligence on a company before agreeing to underwrite an offering,
using their professional judgment to evaluate and price an offering, and
acting as market makers after the offering to maintain a liquid secondary market.

What are factors that indicate that a DPO may be successful?

DPOs appear to have a greater chance of success if they have one or more of the following characteristics:

strong affinity group support (i.e. family, employees, customers)
simple, easy to understand business strategy
one tangible exciting product
novel marketing concept to attract investors to a Web site that contains offering materials

Examples: Thanksgiving Coffee Company had one product and combined off-line marketing (offering information on coffee bags) with its online Rule 504 offering. Similarly, Annie's Homegrown Inc. had a simple business strategy (one line of pasta products), many loyal customers and used tombstone ads on its macaroni boxes.

How do companies conducting DPOs meet their delivery obligations?

By electronic delivery in most cases. See more @ electronic delivery.

An issue to consider is whether state securities laws permit electronic delivery. Companies relying on Rule 504 do not have federal delivery obligations - but probably have state delivery obligations. No state has addressed whether electronic delivery satisfies their delivery laws - but no state appears to have objected to electronic delivery.

Source: Companies conducting Regulation A offerings have a delivery obligation under Item 251(d)(2)(b) of Regulation A. Although the SEC specifically has not applied its electronic delivery guidance in the Regulation A context, it recently acknowledged that its guidance is applicable to all documents required to be delivered under the federal securities laws in footnote 38 of Release 33-7856 (May 4, 2000).

E. Who is Conducting DPOs

What types of companies typically conduct DPOs?

Small businesses that need to raise relatively small amounts of money - and can rely on offering exemptions enabling them to avoid registering their offerings with the SEC.

In addition, a handful of larger, established companies have directly offered tranches of offerings online to a relatively small number of institutional investors - such as the January 2000 World Bank offering (which is an exempt issuer, so there was no required filing with the SEC).

Although investment banks clearly provide a service, larger, established companies - with established market valuations and ample liquidity - theoretically could easily conduct an online offering without an underwriter. This has not happened - and may not happen (since the demise of the underwriting profession has been incorrectly predicted many times before).

How many companies have conducted DPOs?

The actual number of online DPOs is difficult to determine - because many companies conducting DPOs typically do not have SEC filing obligations (by relying on the offering exemption of Rule 504 of Regulation D).

Before the emergence of the Internet, not many offerings were made without an underwriter. After the highly publicized 1995 Spring Street Brewery online DPO, commentators speculated that there were several hundred DPOs during 1996, 1997 and 1998.

This trend slowed somewhat in 1999 after the SEC amended Rule 504 to require that companies register DPOs with state agencies before it could generally solicit - until the first quarter in 2000 when the number of DPOs increased again. See more @ types of companies that typically conduct IPOs.

Source: Tom Stewart-Gordon's newsletter "Scor-Report" is one of the best resources for DPO trends - it's available at www.scor-report.com. Interestingly, despite its worldwide publicity, Spring Street Brewery never actually sold any stock online - its offering circular was posted after funds were already raised via off-line methods.

How can companies interested in DPOs get assistance?

There are numerous service providers - many of whom have different service approaches such as:

Essentially provide underwriting services
Just provide marketing advice
Qualify accredited investors for private placements
Provide do-it-yourself kits, such as software to draft offering circulars or prospectuses
Act as investment clubs that rely on members closest to the company to conduct due diligence

Some service providers also establish a secondary bulletin board exchange to increase secondary market liquidity.

Source: The SEC staff has issued three secondary bulletin board exchange no-action letters stating that "off the grid" trading systems do not have to register as brokers or investment advisors or register the securities under the Securities Act of 1933. The SEC staff has stated that others can rely on these letters and that they will not issue any new letters, unless novel issues are presented. These letters are: The Flamemaster Corp. (available October 29, 1996), PerfectData Corp. (available August 5, 1996) and Real Goods Trading Corp. (available June 24, 1996).

Who are DPO service providers?

They include:

Three Arrows Capital Corp. (www.threearrowscapital.com) - in Rockville, Maryland, one of the leading placement agents for DPO offerings - its Web site has a list of companies that have done DPOs
dpocentral (www.dpocentral.com) - portal of DPO information that includes a list of companies conducting DPOs (does not charge companies to be listed) and offers consulting services such as preparing or marketing an offering
VirtualWallStreet (www.virtualwallstreet.com) - with offices in NYC, Los Angeles and San Francisco, it has a DPO service for "virtual IPOs" and acts as a placement agent
Direct Stock Market, formerly known as "ScorNet"(www.direct-stock-market.com) - has a lot of information regarding DPOs but does not act as a placement agent
Rule506.com, formerly IPONet (www.506.com) - acts as a placement agent by using a matching service for accredited investors
ACE-Net (www.sba.gov/ADVO) - SBA operated matching service run by universities and other types of entities nationwide (see more @ ACE-Net)
elysiangroup (www.elysiangroup.com) - in Monarch Bay, California, acts as a placement agent and is not afraid to post what it charges for its services
IPO Factory (www.ipofactory.com) and Fairshare (www.fairshare.com) - combined, these two sites act as a placement agent by using a matching service for accredited investors

Note that potential customers should conduct due diligence on these providers to ensure they can provide the particular services desired - since many of them have different approaches to conducting DPOs.

How does the federal government act as a DPO service provider?

It operates ACE-Net (i.e. the Angel Capital Electronic Network) to assist small businesses that have outgrown other sources of financing - but are too small to attract venture capital. ACE-Net (www.sba.gov/ADVO) is sponsored by the U.S. Small Business Administration's Office of Advocacy.

ACE-Net is a nationwide Internet-based listing service that provides information to accredited investors regarding companies seeking $250k to $5 million in equity financing - it does not provide investment advice or matching services.

Under the ACE-Net framework, numerous universities, non-profit and other entities operate an electronic listing service to list small corporate offerings. Under no-action relief from the SEC staff, these entities don't have to register as a broker - nor does ACE-Net have to register as a broker, an exchange or an investment adviser.

Source: ACE-Net obtained a no-action letter (available October 25, 1996) regarding whether it had to register as a broker or exchange under the Securities Exchange Act of 1934 or as an investment advisor under the Investment Advisers Act of 1940 or whether the other participants had to register as a broker under the Securities Exchange Act of 1934.