General Information about Business Finance

What is a security and why does it matter?

If something falls within the definition of a security under applicable law, it will be governed by extensive rules and regulations that can be quite complex and expensive to comply with. The definition of a security can be quite broad!

Over the years, many schemes for raising capital have been devised in attempts to avoid application of the securities laws. For this reason, the U.S. Supreme Court has stated that any “contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party” is a security. In other words, if someone gives money to someone else with the expectation of getting some kind of financial return, that person has purchased a security. Examples of securities include stock, LLC interests, notes (debt), and investment contracts.

In some states, the definition is even broader. Both the federal law and the laws of any state where you are trying to raise capital will apply. Many states apply the “risk capital test” for determining whether something is a security. This test considers whether

  • funds are being raised for a business venture or enterprise;
  • the transaction is offered indiscriminately to the public at large;
  • the investors are substantially powerless to affect the success of the enterprise; and
  • the investor’s money is substantially at risk because it is inadequately secured.

This definition is so broad that even things like pre-sales of memberships and gift cards could be considered a security. If something is a security, it may not be offered or sold without state and federal securities law compliance.

See more at: and

What is the most common way that enterprises raise capital in compliance with the law?

The most common way that enterprises raise capital in compliance with the law is by doing a private offering to all accredited investors. This type of offering is subject to much less regulation than others.

What is an accredited investor?

The definition under federal law is extensive, but generally it means (1) an individual with a net worth of $1 million excluding his or her primary residence or at least $200,000 in annual income (or at least $300,000 in annual income with a spouse), or (2) an entity such as a corporation or LLC with at least $5 million in assets. The Securities and Exchange Commission estimates that approximately seven percent of the U.S. population is accredited. For the complete definition, see

Venture Capitalists and Angel Investors are the main types of accredited investors.

What is a private offering?

A private offering is one where there is no public advertising or general solicitation. This means that there are no email blasts, notices on the company web site, media campaigns, etc. All offerings must happen through private communications. (Note that it is now possible to conduct offerings to accredited investors using public advertising – for more information about this, please see this blog post:

What are some of the problems with private offerings directed to accredited investors only?

From the entrepreneur’s perspective, it is very difficult to raise capital this way. Less than one percent of businesses are funded by accredited investors. This money is very hard to come by and “pitching” to accredited investors can be a very time-consuming and taxing process. And even if an entrepreneur is able to find enough accredited investors to raise the needed capital, the investors are usually in the driver’s seat because this source of capital is so hard to get. They often demand significant control of the business, which may even include the right to fire the founders at will. They also often demand very large and fast returns on their investment which may cause conflict for mission-driven businesses that care about more than just fast profits or an early exit.

From the investor’s perspective, as long as investments are limited to accredited investors, unaccredited investors are locked out of investment opportunities they might be very interested in. Many investors are looking for alternatives to the stock market, but they are excluded from investing in enterprises they might want to support.

What is a Direct Public Offering (DPO)?

A DPO is an alternative to the mainstream way of raising capital described above. Unlike private placements that are only open to accredited investors, DPOs are open to everyone.

DPO offerings can be advertised on the web, on TV, on billboards, at events, etc. There are no limits on the number of investors, accredited or unaccredited. (However, see this post regarding potential concerns with going over 500 unaccredited investors or 2,000 total investors in a single class of equity securities under some circumstances:

DPOs allow enterprises to:

  • Offer debt, stocks, and other kinds of investment opportunities to the public;
  • Advertise the investment opportunity to the public;
  • Accept as many investors as they want or need – both accredited and unaccredited; and
  • Do all this without violating the state and federal securities laws.

A DPO is a generic term that can involve several different legal compliance strategies, some of which are surprisingly simple and easy to do!

One benefit of DPOs is that once you complete the compliance process, you can generally use it to raise money perpetually. For more information on how DPOs can be used as a perpetual source of funding, click here:

For a recent New York Times article on Direct Public Offerings, click here:

How does this relate to the JOBS Act that was signed by the President in 2012?

In April 2012, the President signed the JOBS Act into law. One of the provisions was called the CROWDFUND Act. This provision was designed to make it easier for enterprises to raise capital from both accredited and unaccredited investors and to advertise to the public (but via a platform and not directly like in a DPO). The CROWDFUND Act still has not gone into effect because both the Securities and Exchange Commission and FINRA must complete a rulemaking process first.

The new crowdfunding exemption that will be put into effect under the CROWDFUND Act is often confused with DPOs. However, there are several important differences between DPOs (which are legal today and have been for decades) and the new crowdfunding exemption, the details of which are still unknown.

For more information, please click here:

For general information on the JOBS Act and the CROWDFUND Act please see:

What are some examples of successful DPOs?

  • Farm Fresh to You is offering loans to California residents – the interest is payable in credits for organic produce – they raised approximately $300,000 in the first year and renewed their securities offering permit so they could continue to raise funds indefinitely.
  • People’s Community Market is offering preferred stock to California residents to open a grocery store in Oakland – they have raised approximately $650,000 and renewed their securities offering permit so they could raise more.
  • Quimper Mercantile is offering common stock to Washington residents to open a community-owned store in Port Townsend – they have raised approximately $600,000 and renewed their securities offering permit so they could raise up to $1 million.
  • Real Pickles raised $500,000 in two months by selling non-voting preferred stock to Vermont and Massachusetts residents.

Can people invest their retirement funds in DPOs?

Yes. There is a tool called the Self Directed IRA that makes this a relatively simple process.

For Investors

Should I invest in a DPO?

All investments are risky. You should carefully read all the materials associated with a DPO investment before making a decision whether to invest. It is always possible that you could lose your entire investment – keep this in mind before making a decision.

DPOs are usually registered with state and/or federal securities regulators. However, this does not mean that the regulators evaluated the offering or endorsed it any way.

Although there is no magic formula for making successful investment decisions, factors you may want to consider include

  1. How long has the enterprise been in business? Does it have a history of success?
  2. Do you know the key players in the enterprise and does your experience with them lead you believe that they are honest and deal fairly with others?
  3. How much experience does management have in the industry and in business? How successful were the managers in previous businesses?
  4. Do you know enough about the industry to be able to evaluate the company and make a wise investment?
  5. Does the company have a realistic marketing plan and do they have the resources to market the product or service successfully?
  6. What are the details of the security being offered? How do investors get paid back and how long is it likely to take?

Will I be able to sell the investment?

This depends on the specific terms of the investment. In many cases, securities sold in DPOs are unrestricted, meaning that they can be re-sold, sometimes after a waiting period. However, this does not mean that you will be able to easily sell them to someone else. You should not count on being able to re-sell the securities as a way of getting your money out of an investment.

For Entrepreneurs

How much can be raised in a DPO?

Generally speaking, there are no limits. However, under certain circumstances it will be necessary to limit your raise to $1 million per year. Once you do one DPO, doing additional ones is relatively easy so that you can raise more when you need it.

What kinds of investments can I sell in a DPO?

This is completely up to you to decide. You can sell equity, debt, revenue share/royalty agreements, memberships, presale of goods or services, etc. You can even sell a combination such as preferred stock plus a discount card. For more information about these options, visit:

How much does it cost to do a DPO?

The cost can vary a great deal depending on the type of investment you choose to offer, which states you want to make your offering in, whether any legal clean-up work is needed, how much assistance you need preparing your prospectus, etc. Please click here to be connected with Cutting Edge Capital for more information.

Can start-ups do DPOs?

Yes. DPOs can be effective for both start-ups and established businesses and nonprofits.

How do I know if I am a good candidate for a DPO?

If you can answer yes to most of these questions, you are likely to be a good candidate for a DPO.

  1. Is your business something that might excite potential investors or appeal to a particular affinity group? For example, do you find that your customers love you and want to be your fan on Facebook? Does your business do something or operate in a way that has a positive impact?
  2. Does your team have a reputation for integrity and honesty? Is your past free of any “red flags” that might make people think twice about investing in your business?
  3. Do you have a track record of running a successful business?
  4. Is your business model easy to understand for the average person or at least to a decently-sized affinity group?
  5. Do you have a network of contacts and affiliations that could serve as a channel to get the word out about investing in your business?
  6. Are you comfortable with promoting your business to potential investors or do you have someone else on your team who can?
  7. Is there someone on your team with time to devote to a fundraising process? You may need to devote several hours per week to communicating with potential investors and completing compliance work.

How long does a DPO take?

This is common question and the answer is – it can vary based on several factors.

There are three stages of a DPO:

  • Preparation
  • Regulatory filing
  • Selling the investment opportunity

For more information on how long these steps take, click here:

How long can I raise capital once I complete the DPO compliance process?

Regulatory approvals for DPOs generally last for one year.

At the end of 12 months or upon reaching their funding goals, some organizations may choose to discontinue their securities offering.

Other organizations, however, may find that there are advantages to continuing to raise capital for more than one year. For example, Farm Fresh to You, a northern California food distribution business, offered “Green Loans” to its customers through a DPO. Through its DPO, Farm Fresh to You successfully raised over $300,000. Farm Fresh to You recognized that the Green Loans from customers were a great source of capital – low-cost and an effective way to get customers more engaged – so Farm Fresh to You decided to renew its DPO for another year.

Since the state regulators have already vetted the offering materials for the first offering, the approval process for an additional year is typically very fast (in most cases just several weeks).

Continuing to raise capital beyond the initial year of a DPO offering allows an organization to meet ongoing capital needs and to benefit indefinitely from the opportunity to allow its community, customers, and fans to become investors.

Is it a hassle to have a lot of small investors instead of one big one?

While more investors means more record-keeping, a larger number of small investors means keeping control of your company. And there are high-quality low-cost tools to help manage your investors. If you are interested in learning more about tools to help manage your investors, please contact us for more information.

Would VCs and Angels be deterred from investing in a later financing because you did a direct public offering?

One major advantage to raising capital through a DPO is that your company can define the scope of its offering in advance — i.e. choosing what investment instrument is most appropriate to your business, and how much you are willing to give up in return. You can also incorporate terms that may allow you to better prepare for a larger follow-on round later, or that makes a follow-on round more attractive to larger investors.

An angel investor or VC may decide to invest in your company (if you need them) via a DPO or later, but those investments are likely to be on terms more favorable to you because the nature of a DPO can rebalance your bargaining power with VCs and angels. By opening up your offering to non-accredited investors, who often have more realistic expectations for the return on their investment, you can level the playing field and bypass taking money initially from a very small pool of private wealthy investors — who often expect equity on terms favorable to them, big returns, and a fast exit, in exchange for a level of control over your company that could conflict with your vision or mission.

Also, if you do choose to raise capital from traditional sources later, having managed a successful DPO can make your company more attractive to potential angel investors and VCs by showing that there was strong interest from the public, and that your offering was validated by a larger group of supporters.

For more information about whether it is best to raise capital from VCs and angels or using a DPO, click here: and here:

More Resources

Jenny Kassan talks about investment crowdfunding at the 2013 Social Venture Network conference:

Top ten reasons to use a DPO to raise capital:

Securities law resources: