Conduct a Series of Securities Offerings

Conduct a Series of Related Securities Offerings to Raise Capital—by Using Hybrid Securities to Maintain Voting Control and Equity Ownership. You can raise sufficient capital without giving up substantial common-equity interest through the issuance of hybrid securities. This includes—but is certainly not limited to—convertible preferred stock, convertible notes, convertible bonds, non-voting common stock with married put options, participating preferred stock, notes with equity kickers, cryptocurrencies, or through issuing royalty financing contracts. In the current market environment, convertible-participating-callable, preferred equity with an attractive—stated dividend, participative dividend (participation of net income), conversion ratio into the common voting equity, with a call protection date that is four to five years away from the date of issuance is very attractive to investors.


Selling cryptocurrencies for block chain platform development with just an idea will become increasingly difficult as companies with real applications compete in this space. In addition, the foreign and domestic regulatory landscapes for Initial Cryptocurrency Offerings (ICOs) will continue to shift and the last thing you want is to be a regulatory “crash test dummy” or worse, be accused of securities fraud by investors, a criminal offense. Selling common equity in the early stages of a company’s existence generally results in selling out the company’s most precious element—common-equity ownership—for too little, too soon. In the world of finance, there exists what is known as “cheap” money and “expensive” money. Nevertheless, it is relative and changes. For instance, bank debt with a high-interest rate seems like expensive money in the beginning. However, if your company is successful, bank debt becomes cheap money relative to selling common voting equity because that equity will become more valuable over time, and, inherently, it becomes the real expensive money. For example, if you borrowed $1 million at a 10% interest rate for five years, that is $100,000 a year in interest or a total of $500,000. In this scenario, bank debt seems expensive. Yet, if you sold 30% of your Company’s common stock for $1 million, and your Company’s worth $5 million at the end of the fifth year, that is a value of—or a net expense difference of $1 million (the $1.5 million value of 30% of the Company versus $500,000 in bank interest equals $1 million net difference). The common stock is technically lost forever, so the net cost may be more as your Company continues to grow. That’s really expensive money.


Let’s look at it from an investor’s perspective. To reiterate the point, it is very difficult and expensive when attempting to sell common stock in a corporation or membership/partnership ownership interest in an LLC at the early stages of a company’s existence. It is difficult because most try to sell a small amount of equity ownership for a relatively large amount of money. If there is very little cash or marketable inventory in the company, and an investor purchases 30% of the total ownership equity for $1 million, that investor just lost $700,000 due to dilution. An extreme dilution factor is very unattractive to any investor. In addition, if you assume success in your venture, selling any common voting equity in the early stages generally results in selling too much of your Company’s most precious element—common voting equity…too soon, for too little—which is a critical mistake made by most entrepreneurs. There are service firms that will charge you an outrageous fee to take your start-up or early stage company public (pink sheets or OTC bulletin board), which is one of the biggest mistakes a start-up or early stage company can make. Repairing this mistake can be done, but for most…it is a death sentence.


If you want to control the terms of the deal and maintain the vast majority of equity ownership and voting control in your Company, while simultaneously increasing the probability of raising substantial amounts of capital, you must conduct a series of related securities offerings compliant with federal and state(s) securities laws, rules, and regulations. These offerings would include using hybrid securities (that have little or no dilutive repercussions for investors). Searching for capital in any other fashion generally results in everyone attempting to change the terms of the deal, which always results in loss of time and money. Thus, the alternative becomes an extremely frustrating endeavor.


The most successful capital-raising structure for start-up and early stage companies are illustrated as follows:



  1. The process begins with conducting a “seed capital” round, ranging from $100,000–$1,000,000. An ample amount of seed capital is necessary to launch a successful development or expansion capital-raising effort. Seed capital is generally raised through the issuance of one-, two-, or three-year “seed capital-convertible bridge notes.” Producing this deal structure and the related securities-offering documents is relatively quick and inexpensive.
  2. Seed capital is best used to protect investor interests by further protecting the company’s assets—i.e., intellectual property or “IP”; b. sustaining (not expanding) basic business operations; c. most importantly, A portion of the seed capital is used to produce and promote the next securities offering for “development capital.” Hiring the right professionals to continue the process of raising capital through a series of related securities offerings with the issuance of hybrid securities in compliance with federal and state(s) securities laws is often the only alternative to seeking substantial amounts of capital from financial institutions.
  3. Development capital is best used for hiring employees, especially additional management- team members, capital expenditures, and (most importantly) for generating sales and increasing the revenue stream. For most entrepreneurs, development capital will be sought out in the local community using the general media to solicit the securities. You can qualify for public solicitation through the general mediaunder SCOR, through provisions in California Securities Code (Section 1001 or 25102(n)), Regulation D, Rule 506(c), or Regulation A or A+. Because of the issuance of convertible participating preferred equity, development capital should be kept at a minimum. If one assumes success, due to its income participation and conversion features, said form of capital could get expensive. A portion of development capital is often used to produce and promote the next securities offering for “expansion capital” for fast growing companies. Raising development capital is easily done through “public solicitation” of the private entity’s securities.
  4. Expansion capital is best used for expanding sales and customer service operations; acquiring additional capital assets; expanding the administrative employee base; and executing acquisitions of entire companies or their assets. You can qualify for public solicitation through the general media, in the same manner as development capital (noted above). Additionally, expansion capital can be sought after in a few different ways. Due to the issuance of common or convertible preferred equity and/or traditional or convertible debt, expansion capital should be kept in balance, but be sufficient to expand your Company through acquisitions to increase market share and further profitability.

More on Expansion Capital. Under Regulation D, Rule 506(b) private or Rule 506 (c) public, you can use expansion capital for the acquisition of other companies and/or assets to increase revenue, reduce cumulative overhead expenses through consolidation, or both. Using the convertible participating preferred equity deal structure, one can acquire assets or entire companies by issuing a specific “series”—i.e., Series B, C, or D—of preferred-equity offerings directed at that acquisition. Normally, assets are acquired, thereby relieving you of the acquired company liabilities—disclosed or otherwise. In addition, by acquiring all the assets of a company—as opposed to all the stock of a company—your Company can depreciate or amortize the acquisition thereby reducing taxation. That convertible participating preferred equity would be secured against the acquired assets, while allowing the previous owners to share in the profits of the [entire] newly created consolidated company.  Furthermore, they will receive a stated dividend higher than they could get elsewhere. In addition, you can create the convertible participating preferred equity with a one-hundred-dollars-per-share par value price and discount it to defer capital-gains taxation to the previous owners. For instance, if the negotiated purchase price of the acquired assets is $10 million and the previous owners have a cost basis of $6 million, you could issue 100,000 shares of preferred stock at $100 per share, which equates to $10 million. However, you would price it at a sixty-dollar cost basis with forty dollars of unrealized appreciation per share (40% discount) on your Company’s—as well as the selling company’s—balance sheets (accounting records), as opposed to the $100 per share. Ultimately, this will defer the previous owners’ capital gain until they sell their newly acquired shares. By conducting your securities offering in this manner, you may be able to negotiate the acquisition price to a lesser amount because the discounted, preferred-security can defer capital gains, but more importantly it can provide far more net cash flow than many other competing investments in the public marketplace. Think about it. If you issue at 8% stated dividend at $100 per share and discount it to the assets’ cost basis, of say 60%, (40% discount) then the cash flow is a net 13.34% ($8.00 stated dividend / $60.00 share price) to that investor / seller of assets.  Need more power in the negotiations? Consider listing the convertible preferred equity on a publicly traded securities exchange. Depending on the value of that acquisition deal, it may be worth spending the extra funds necessary for the exchange listing.

      Additional Benefits of Issuing Hybrid Securities. Other significant benefits of issuing (high-demand) hybrid securities include the following: (a) your common equity ownership and voting control is not diluted or lost; (b) hybrid securities are in high demand, so selling them to passive investor is relatively easy (preferred-stock dividends may qualify for the 50% to 65% “dividend exclusion allowance” essentially tax-free income on half the cash flow—for US corporate investors; (c) hybrid securities either mature or can be “called” or redeemed at a pre-set price, making this  form of equity capital temporary (at your option) and, thus, the least-expensive form of equity; (d) hybrid securities can be used as currency for asset or company-acquisition purposes—this is very important; and (e) more importantly, if these hybrid securities are listed on a publicly traded securities exchange, offering them directly to market makers at a discount (from market price) makes raising additional rounds of capital very easy.

Note: listing “common stock” on a publicly traded securities exchange too early is a major mistake for most early stage companies. Most publicly traded, small companies initially went public because someone “sold them” on the concept that once their common stock was traded publicly, they would be able to raise capital. Although they do raise some capital, it never is what they expect; essentially, the stock becomes a penny stock. At this juncture, the trading volume dries up, and the stock falls further in price due to the illiquid nature of the decrease in volume. When attempting to “float” (sell as secondary public offerings) additional common shares into the public market to raise more capital, the stock becomes further diluted as does the owners’ equity and voting interest. The securities regulators despise penny stocks, because they are fundamentally part of abusive sales tactics for “boiler room” operations. What the difference here is to list “hybrid securities,” such as convertible notes or preferred stock that have stable price structures due to face or par values. Imagine listing preferred stock on an exchange with an initial listing par value price of $100 per share. The preferred stock with a reasonably high stated dividend, you will naturally stabilize that price, making it more attractive to institutional, as well as individual investors.


When you’re dealing with “liquid securities” on a publicly traded securities exchange it is like turning a faucet on and off again. If you need more capital, “float” or sell more securities to market makers and other institutional investors—“turn it on.” When your capital needs are satisfied, “turn it off.” Once you understand the process of operating with publicly traded securities, it is not that difficult to manage your ongoing capitalization needs.


You must have ample funds (seed capital) to support the related sales and marketing efforts, whether you are selling securities privately or publicly—e.g., limited public placements internally—or engaging in a selling effort involving a FINRA Member broker-dealer. Offering $50,000 to $100,000 in marketing support to a FINRA Member broker-dealer should get the broker-dealer’s attention. If you do not have a sufficient amount of seed capital, first raise it through a seed-capital securities offering. Depending on your Company’s situation, $50,000 to $100,000 of seed capital should be sufficient to obtain the larger $3 million to $5 million amounts of development or expansion capital.


You may be saying to yourself, “That’s expensive money!”—you’d be right. All “risk capital”—and all capital is “risk capital” when it involves an investment in a start-up or early stage company—is expensive, but consider the cost of not obtaining it. Selling securities to raise capital is like selling anything else—it takes time, money, and a concerted effort. You are simply marketing and selling an intangible asset in a highly competitive and a highly regulated environment.  Ensure you only attempt to engage a broker-dealer when you need to raise a serious amount of capital; and your Company is producing enough cash flow that $50,000 to $100,000 for marketing support is not a big deal.


There are no guarantees when it comes to raising capital—only degrees of probability. The probabilities increase in direct correlation with the amount of seed capital available to promote expanded, capital-raising efforts. The more seed capital you have available, the higher the probability for a continued series of successful securities offerings. You are competing with financial institutions for individual investor funds. Therefore, you have to act like one.


Create a Finance Department


Seriously consider creating a Finance Department to Compete for Capital. If your Company is in the early or later-stage of development, and you are unable to engage a SEC-registered broker-dealer to sell your Company’s un-registered securities (private placement) consider creating an “in-house” finance department. Once you have raised sufficient seed capital or have ample cash flow from operations, a well-staffed finance department within your Company can compete with financial institutions for capital from individual investors. Staff it internally or hire someone from the securities industry with the skill set, investor contact, and ability to raise capital exclusively for your Company. This department is headed by your Chief Financial Officer (CFO) or vice president (VP) of finance. When working as a bona fide Officer or Director for your Company, no securities license is required for any executive to solicit and sell your company’s securities. How do you find these individuals? It is relatively easy, especially in today’s market, because of the securities industry’s high turnover rate and profit margin squeeze, due to online investing.


For start-up or early stage companies, hiring a CFO (or VP of Finance) from the securities/investment-banking industry that has a book of many qualified leads, (e. g. investors willing to invest in your company) would be appropriate and wise. To replace the VP of finance title, you may want to choose the title of CFO for the person you seek as long as it doesn’t create any ambiguity or resentment within your current management team—as the title and position of CFO has more cachet and power.


Remember, only SEC-registered FINRA Member broker-dealers or bona fide officers and directors of your Company can legally solicit and sell your Company’s securities. However, you cannot pay a bona fide officer or director a commission from the sale of securities. The beautiful thing here is, unlike an accountant or attorney, the CFO or VP of Finance is a self-funding expense with very little financial risk for your Company—if done correctly.  The CFO or VP of Finance’s job description must be in the nature that raising capital is an incidental part of that position. It’s often wise to arrange an employment contract whereby this is stated specifically.


The reason this part of the process may seem obvious to some but foreign to others is most entrepreneurs come from large corporations where the company has various departments, such as; human resources, production, operations, administration, and so on. Most large corporations have an accounting department, but it does not serve as a finance department. Normally, the financing function easily is outsourced to (or handled by) commercial or large SEC-registered FINRA Member broker-dealer/investment banks, because mid-cap to large-cap corporations have the overall financial strength—to sustain interest and dividend payments and, therefore, inherently have less risk.


Only officers and directors authorized by their corporation may communicate with prospective investors. Lower-level employees, equity holders who are not officers, directors, attorneys, or other corporation agents may not do so unless they are registered as securities broker-dealers.

Indeed, no officer or director may be specially compensated directly or indirectly for communicating with prospective investors. They cannot receive commissions.

They cannot receive success fees. No officer or director may have as his/her full-time job the position of communicating with prospective investors to obtain capital, unless that person is registered as a broker-dealer.

Generally, the federal and state definitions of a “securities broker” are purposefully broad to include persons who are not compensated for introducing an investor to an investment opportunity. Anyone who engages in the activity of finding potential investors is a broker. Thus, corporate officers and directors who communicate with prospective investors are also brokers. Federal law, however, provides an issuer-employee exemption for participation in one offering per year. Also, most states exempt these persons from being required to register as securities brokers, provided they are not compensated for their services as securities brokers—and so long as it is not their full-time duty to raise funds for the corporation.

Some people with histories of relevant, criminal convictions, injunctions, cease-and-desist orders, bars from the securities industry, or from being a public-corporation officer or director, or a penny-stock bar are automatically barred under federal law and the laws of most states from participating in some but not all categories of unregistered-securities offers.

In the world of raising capital, there are many rules for securities compliance. It is well known and accepted that hiring the right professionals (in-house or out-sourced) is truly the key to overall success. This certainly would include hiring the right accountant, attorney, and a CFO or VP of Finance—from the securities industry.


There are additional benefits of establishing and building an in-house finance department. An in-house finance department can manage future capital-raising efforts in-house or in conjunction with your SEC-registered broker-dealer, as well as manage franchise operations, the relationships with commercial banks, supplier-creditors, lessees and lessors, product lease options, investor relations, and so on. An in-house finance department can function as the catalyst for an exit strategy for the owners’ shares, when they are ready to divest their ownership positions. The point being, an in-house finance department is not a temporary department and on the contrary, if built correctly, it can be a cornerstone of your Company.


NOTE: To identify the executive position within the start-up or early stage company, we use the term and title “VP of Finance” throughout this course. We do this because most small companies already have a CFO—by title. The term “by title” means just that. They’re really not true CFOs per se. Some are from the accounting or commercial-banking industry and therefore incorrectly titled. A true CFO is responsible for capital attainment and the maintenance of a company’s capitalization structure. One with an accounting background should really be titled “controller” or “treasurer”—not CFO. For later-stage companies, where institutional financing (primarily bank debt) is an acceptable form of capital—e.g., real estate, hiring a CFO with a commercial banking background would be appropriate. However, start-up and early stage companies need someone as either a true CFO or VP of Finance, who can raise capital through a series of securities offerings compliant with state and federal securities laws, rules, and regulations to increase the degree of probability of successfully raising capital for their company. In our experience, every other effort is a complete waste of time, energy, and effort.


To attract a true CFO or VP of Finance you will need a final draft copy securities-offering document, just prior to completion to show these individuals so that they too have a clear understanding of the company’s plan and what types of securities they are going to be selling.


Do Not Rely on Others to Raise Capital. Most entrepreneurs believe raising capital is like selling real estate. They think capital-raising commission-based entities exist for their start-up or early stage Company. Essentially, they are called SEC-registered investment banks or broker-dealers, which must also be FINRA Members. However, they will not raise capital for start-up or very early stage companies—there are many reasons why. The primary reason is most start-up and early stage companies are simply too risky.


History shows us 80%[1] of all start-up and early stage companies fail or stagnate within their first five years primarily due to lack of sufficient capital reserves. In addition, there’s very little money in it for them because the deals are too small. If you want to pursue this route for your Company, be aware your Company may also need to invest in marketing support—approximately $50,000–$100,000 in additional cost—for a broker-dealer to be interested in an engagement contract with your early to later-stage Company. This is not mandatory; but without it, you stand very little chance of engagement. The expense associated with broker-dealer due diligence is separate. FINRA (the primary federal regulator for broker-dealers) mandates third-party due diligence be conducted prior to broker-dealer engagement. That due diligence process can be very expensive, depending on the nature of your Company and the dynamics of its operations. On top of those up-front out-of-pocket expenses, you will pay a generous commission—generally 5%–12% of monies raised—and depending on the market environment, you may also give up some equity through the issuance of warrants to the broker-dealer(s). In addition, you will be doing most of the work of actually selling the securities—through the proverbial “dog and pony shows.” There is nothing like the enthusiasm of company management-team members to garner investor interest—broker-dealers rely on that. This reality further justifies the hiring a VP of Finance…and conducting your securities offerings in-house.




Keeping a Proper Perspective. Raising capital for start-up and early stage companies in any economic environment can be difficult if not properly orchestrated. In good times, investors can expect good returns on their investment in the stock market, where the investment is easily accessible because one can sell (liquidate) their securities at any time. The resistance often lies in tying up money in an illiquid security in a private company. However, this can be overcome with a solid marketable deal structure along with proper securities marketing and selling techniques. In bad times, investors are always waiting for good times to reappear before they make any changes in their investment portfolio. When competing for capital in any market environment, simply compete on the basis of the following criteria:


  1. Relative safety of principal.
  2. Immediate return (yield).
  3. Long-term return (profit participation/capital gains).
  4. Liquidity


After you have beaten the competition from a deal-structuring standpoint, you simply need to maximize the number of investors you contact—legally. As with all sales, it becomes a numbers game. In any market environment, it is far more effective to raise small amounts from many investors by being able to compete directly with financial institutions in the fixed-income securities markets with high-yield securities.


In summary, consider creating hybrid securities, such as seed capital-convertible bridge notes or participating convertible-callable preferred stock (or Member Units for LLCs). Develop a five-year capitalization plan, which illustrates issuing one or more of a series of these types of securities over time. Oversee the training of personnel, to accomplish the task of raising the capital either “in-house” (with or without a Chief Financial Officer “CFO” or VP of Finance from the securities industry) or through a SEC-registered broker-dealer, when ready. By doing so, you further assure: 1. the capital structure does not become cost prohibitive—by implementing the rolling of re-financing techniques; 2. your Company maintains compliance with securities regulations and financial results are optimized; 3. you do not sell too much of your Company too early for too little; 4. more importantly, the capital is actually raised.