RAISING CAPITAL FOR SMALL COMPANIES

There is a capital raising alternative for small to medium-sized companies. The Small Corporate Offering Registration (SCOR), has been gaining in popularity since it was first developed in the late 1980's. SCOR has been adopted formally or informally for state registration of corporate securities by most states.

Unlike private placements, SCOR offerings are not capped at a fixed number of purchasers, allow general solicitation of offerees and may be advertised using a "tombstone" advertising form.

SCOR was developed to aid those issuers using a federal exemption to raise proceeds (Rule 504 of Regulation D). SCOR is designed to simplify and reduce the costs of the registration process by use of a simplified "question and answer" form that can be prepared by business persons, lawyers or accountants who are not securities specialists. One objective of the standardized approach is to produce a more readable and understandable disclosure document. Form U-7, a uniform form, can be filed and processed simultaneously in multiple states.

Disclosure Requirements
The Massachusetts Uniform Securities Act provides for the registration of securities by qualification. An accompanying Massachusetts Securities Division regulation allows a corporate issue to register an offering of up to $1 million of its securities using the Form U-7. The question and answer format of Form U-7 seeks disclosure of material facts relating to a securities offering. Key areas of disclosure include:

Risk Factors
The first substantive disclosure required by Form U-7 is a detailed statement of the material risks of the offering. The risk factors should be listed in order of significance, with the most likely and substantial risks at the beginning. Typical risk factors might include: lack of prior operations by the company; lack of profitable operations; lack of a prototype of the company's product; unproven commercial potential of the company's product or service; anticipated need for future financing by the company; possible unavailability (or increased cost) of supplies needed to produce the company's product or service; competitive conditions with the company's field; and dependence on the company s management.

Business Plan
Form U-7 requires a detailed statement of what business the company intends to do, and how the company intends to carry out its business activities. Along with this disclosure Form U-7 calls for a detailed discussion of the competitive conditions faced by the company and the company's anticipated methods for coping with those conditions. Form U-7 also calls for the company to summarize material events in its development over five years. For any company that was not profitable in its last fiscal year, Form U-7 requires that the management list the business milestones that the company must reach to become profitable, and to show how the company will achieve those milestones.

Financial Statements
Required financial statements include a balance sheet; statements of income and cash flows; statement of changes in shareholders equity for the preceding fiscal year (or shorter period the company has been in business). Financial statements must be audited. Reviewed statements will be accepted if all of the following conditions are met:

• The company has not previously sold securities in an offering that involved public solicitation

• The company has not previously been required by securities laws to have audited financials

• All prior sales of company securities aggregate to $1 million or less (exclusive of indebtedness to commercial lenders) and

Pricing of Securities
Form U-7 requires an analysis of the factors relating to the offering price of the company's securities. Included in this section is a requirement to show what portion of the company investors will receive for their investment. Form U-7 also calls for the company to spell out the value that management is implicitly attributing to the company in its pricing of the offering (e.g.,if 20 percent of a company is being sold for $1 million, management is implicitly valuing the entire company at $5 million)

Additional Disclosures
Other areas of disclosure required in Form U-7 are: use of proceeds and anticipated cash requirements; company capitalization; a description of the securities being offered; the manner of distribution of the securities; biographies of the officers, directors and key personnel; information on the company's principal stockholders; management relationships: litigation and management's discussion and analysis of the company's performance up to the time of the offering.

Mechanics of Filing
A Form U-7 filing should include: a federal Form D; a Form U-1; consent to service of process on Form U-2 and U-2A; and a filing fee of 1/20 of one percent of the aggregate amount of the offering (minimum fee $300, with a maximum fee of $500 for an offering of $1 million worth of securities.) Form U-7 registrations become effective when they are declared effective by the division. The registration statement remains effective for up to one year.

Restrictions
Under applicable regulations, offerings on Form U-7 may not exceed $1 million in a 12 month period. The minimum price per share is $5, and the company must agree not to split its stock or issue stock dividends for two years unless the Division consents. Form U-7 may not be used by partnerships, blind pool offerings firm commitment offerings (best efforts offerings only), investment companies as defined by the Investment Company Act of 1940, or by companies that are reporting companies under the Securities Exchange Act of 1934. Form U-7 is not available to companies in the mining or oil and gas business. Form U-7 is not available to a registrant that is subject to the "bad boy" disqualification.

Advertising
All advertising must he filed with and cleared by the division of securities

Selling Agents
The company may engage a registered broker-dealer to sell its securities or the company may register its own issuer-agents. Selling agents have a due-diligence obligation as to the accuracy and completeness of the disclosure document.

Pre-Filing Conferences
The division conducts individualized pre-filing conferences. A typical conference involves a SCOR candidate company sending a representative(s) to meet with the corporate finance section attorneys to discuss its business plan and financing options and any specific questions the company might have about the SCOR form. Conferences are setup on an as-needed basis and last for about two hours.

The division provides these conferences to help business persons in the often difficult area of capital raising. However, as a regulatory agency, the securities division cannot represent any company, so any desired legal representatives must be obtained through private counsel.

SCOR filings that have been registered with the division are available to the public through a state Freedom of Information request. These filings may be a helpful guide to those contemplating a SCOR offering. Copies of previous SCOR registrations provided through FOI requests are not "approved" by the division and the division does not recommend any of the documents filed. Copies of blank Form U-7's and broker-dealer and agent registration forms may also be obtained from the division.

Regulation A
Since an offering on Form U-7 cannot exceed $1 million in any twelve-month period and the offering price of common stock sold cannot exceed five dollars per share, some companies opt to make offerings under the federal regulation A offerings. The SEC has raised the dollar limit under regulation A to $5 million, $1.5 million of which may be a secondary offering by existing security holders if the company is profitable. The SEC also adopted Form U-7 and allows this to be used as an alternative disclosure form under regulation A. Regulation A offerings are reviewed by both the SEC and state securities regulators so the level of disclosure may be more complex than Rule 504 SCOR offerings.

Testing the Waters
Another amendment to regulation A is the "testing the waters" procedure which allows a small business issuer to solicit indications of interest from potential investors in a proposed securities offering prior to the preparation and filing disclosure materials. NASAA has also developed a model state "testing the waters" procedure. Massachusetts is one of the states involved in this project. The "testing the waters" procedure allows a small business to informally inquire whether it is likely to find financing before it incurs the often considerable expense of registering an offering.

While compliance with the state "testing the waters" rule is intended to also result in compliance with the federal rule, there are some key differences between the two provisions.

• The state Solicitation of Interest Form includes more information than comparable federal filing on the company's products or services, on the use to proceeds and on key personnel.
• The state rule requires that the solicitation to interest materials be filed 10 business days prior to use (five business days for amendments). This allows the division sufficient time to request necessary revisions of solicitations of interest materials. The federal rule requires filing on or before the date of first use.
• The state rule requires delivery of the Solicitation of Interest Form to all potential investors with whom there are oral communications. The federal rule has no comparable requirement nor restriction on oral communications.
• The state rule requires delivery of a prospectus seven days prior to sale. Regulation A has no equivalent.
• The state rule prohibits private placements for six months after the last solicitation of interest. Regulation A has no equivalent.