Private placements can be ideal for successful startups.

Q: My husband and I own an aquatic furniture business where we sell unique and
customized waterfalls and aquariums. We began operations in April 2001. We’ve
made moderate sales, which increase as the word gets around about our product
line. However, we are about to attend our first home and garden convention and need
additional funding to present the business in the best possible light. We are finalizing
our business plan to solicit the financial assistance of our loved ones. We want to
offer incentives such as loan repayment with high interest and also profit sharing.
Contributions could range from $500-$5,000? What percentage of the business
should we award them in exchange for their investments?

— Name withheld

A: It sounds as if your venture is off to a promising start. As you correctly assumed,
friends and family are often the most receptive investors for small startups. Provided
you run your business with the highest professional standards, these investors are
far less likely than venture capitalists to put the squeeze on you if your business
doesn’t meet their expectations within 18 months.

Given the small size of your firm, you may want to explore a private placement offering
under the SEC’s Regulation D. It will allow you to raise money without registering your
securities at the federal level, which will save you quite a bit of paperwork. I’d suggest
opting for a Rule 504 offering, which will let you raise up to $1 million during any
12-month period. It places virtually no limit on the number or the nature of the
investors that may participate in the offering. Not every state allows companies to
raise capital under Rule 504 — regulations vary — so it’s essential to meet with a
lawyer who is well versed in these matters for help in getting started. (If you don’t know
an attorney in your area who can help you, your banker should be able to suggest
one.)

Without detailed financial information about your business, I can’t determine how you
should value shares in a private placement. Here again, a good attorney should be
able to assist you in making the right call; you may also need to consult with an
accountant. Many business owners provide outside investors with a large percentage
of their firms in exchange for startup capital, only to realize years later that they gave
too much away. Make sure you get expert advice from someone who has been down
this road before, and you’ll have no regrets later.

Attorney Andrew Sherman is a capital partner at McDermott, Will & Emery in
Washington, D.C. He is the author of many business books, including Raising Capital
(Kiplinger’s Business Management Library) and Fast-Track Business Growth
(Kiplinger Books). Write to him at [email protected] .

Fortune Small Business
Tuesday, April 16, 2002
By Andrew J. Sherman

http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=207349