Direct public offerings, free writing prospectuses, Vonage, and SOX

Cite this Article
Bill Sjostrom, Direct public offerings, free writing prospectuses, Vonage, and SOX, Truth on the Market (May 30, 2006),

Back in 2001 I published an article entitled Going Public Through an Internet Direct Public Offering: A Sensible Alternative for Small Companies? DPOs had been (and continue to be) touted as a financing alternative for a small company that needs capital but can’t attract angel or VC financing or an underwriter to take it public. I concluded that, except in limited circumstances, small companies should view DPOs only as a financing option of last resort (although it probably ranks above going public through a reverse merger). The big problem, of course, is that it is very difficult to attract investors when, among other things, there is no underwriter backing the deal with its reputational capital, established sales force, and aftermarket support and federal and state securities laws greatly limit permissible marketing activities. DPOs generally make sense only for a company with a strong affinity group (e.g., a micro-brewer or maker of organic pasta).

There have been a number of significant changes to federal securities laws since 2001. Two changes are of particular relevance to the advisability DPOs, one for the better and one for the worse. For the better is the advent of the free writing prospectus (FWPs). The recent Vonage IPO demonstrates the possibilities of FWPs. As discussed here, Vonage emailed all of its customers an FWP notifying them of the chance to get IPO shares through Vonage’s directed shares program. It then followed up the email with a voicemail blast along the same lines (unfortunately for Vonage, it failed to cross some “t�s and dot some “i�s (see here)). This was possible because Vonage has email addresses and phone numbers for all its customers. Think of the DPO potential for a company like myspace or facebook that has email addresses for millions and millions of loyal users (although neither would likely need to turn to a DPO).

The change for the worse is SOX. With its new regulatory burdens it is now much more expensive to be a public company. And small companies, i.e., the ones most likely to consider DPOs, are the hardest hit by SOX. While increased regulation has always been a disadvantage of going public, SOX greatly magnifies the disadvantage, especially for small companies. Hence, even with the advent of FWPs, DPOs are probably less advisable for small companies than they were five years ago.