Corporate Necessities
A major reason for incorporating a business is to protect its owners and managers from personal liability for company activities and debts. For purposes of examining various capital sources, we have assumed that your business is incorporated under the laws of one of the fifty states, the District of Columbia or a US territory; however, being a corporation is not essential to the ability to borrow money or attract investors.
In order to benefit from the form of capital procurement now about to be explained -- the sale of shares of stock in a business corporation --your business must be incorporated and able to issue shares of stock.
A stock corporation is an incorporated business with legal authority to issue capital stock, ownership of which is vested in individual shareholders who by purchase of the shares become owners of the corporation. The company is also authorized to pay its profits to these shareholders in the form of dividends.
Common stocks are issued to shareholders who have the right to elect members of the board of directors, share in profits, and in a final distribution of assets if the company is dissolved. Preferred stocks are held by investors who may have superior rights to dividends and assets upon dissolution, but usually have no voting powers. In a small corporation, state law will require a minimum number of shares of stock to be issued and they may beheld by a single owner, or by a small number of owners.
Corporations raise huge amounts of capital through the public sale of shares of their stock, the value of which depends upon what an investor is willing to pay for each share. All the factors we have discussed that are of concern to any lender also apply to investors -- cash flow, profits, management, future prospects and the potential return on investment, in this case in the form of dividends paid on the stock owned.
A Costly Web of Securities Laws
Unfortunately for the small business person, federal and state laws governing the issuance and sale of corporate stocks require a costly and complicated ritual of paperwork and procedures, even before outside capital investment can be solicited. This complex legal process has to be followed even before you can call a friend or relative to offer them shares in your business. Failure to comply with such laws can result in heavy personal civil fines and criminal penalties.
Generally, corporations, shares of which are not listed or traded on a public stock exchange, are called "close" or "privately owned" companies. Close corporations privately offering shares to a small number of people may be exempt in limited ways from some federal and state laws controlling stock issues, but expert advice should be obtained to find out if your company might qualify. Usually issuance of shares to the original incorporators of the company are exempt from registration. The Securities Act of 1933 (Rule 504) gives states the power to regulate most offerings of stock valued under $500,000 in a twelve-month period, so state laws should be carefully checked.
Public Sale of Stocks
The right to solicit funds from the public by the issuance and sale of stock comes with certain minimum requirements, which include the state and federal filing of a registration statement concerning the securities to be sold, along with lengthy disclosure documents about the company with detailed information for potential investors, as well as current financial statements. All of this information must be made public. Issuing a public offering of stock also requires advice and assistance from attorneys and stock underwriters, and a possible audit by accountants, which can be very expensive. In addition, there must be compliance with state laws governing persons associated with stock sales including stock brokers and dealers, investment firms and individual investment advisors.
If you can get beyond the technical complexities of stock sales, selling shares in a business may be an excellent way to raise capital -- if certain factors are present. Obviously the company must have investor appeal, so all the requirements any lender or investor would want to see must be present-- good management, appealing products, a record of earnings, profit, cash flow and a good future.
Hope for Small Business that Can "SCOR"
In recent years there have been state legislative attempts to simplify securities laws for small businesses wanting to sell stock to the public. While this still means the expense of lawyers, accountants and paperwork, it has eased the situation somewhat.
Called "SCOR" - Small Company Offering Registration (also known as ULOR, for "Uniform Limited Offering Registration") -this legal method is now available in over 30 states, and the rest are likely to have the legislation soon.
Once a company registers in one of the named states, stock sales can also be made in Delaware, the District of Columbia, and New York. For a current list of eligible states, contact the North American Securities Administrators Association at (202) 737-0900. Even if your business is not based in one of these states, you may still register and sell your securities in the states which have adopted SCOR.
Many small companies have successfully used SCOR to sell stock without using a securities underwriting firm. This works particularly well with an established customer base or other supportive source of investors. One of the success stories of SCOR is Real Goods Trading Co., a Ukiah, California, mail order retailer which made an 11-state, $1 million offering to its15,000 customers. Within less than a year the firm sold $800,000 in stock to more than 600 investors.
Check with your lawyer to see if SCOR might be the way for your company to raise needed capital.