Dropbox v. Box: Is a Private Placement Better than an IPO?

Dropbox and Box are two rival cloud-storage companies that are raising large amounts of capital lately, but they are doing it in different ways under the securities laws.  Dropbox.com is raising private capital through a private placement of securities while Box.com is raising public capital through an initial public offering.  Success and failure in an emerging industry is often determined by which competitor has more cash.  The big question is which company will emerge the strongest: the company that raised private capital or the one that raised public capital?

Dropbox filed a Form D with the SEC on February 24th, 2014, which indicated a private investment of approximately $325 million.  A Form D is filed when a company is selling securities that is exempt from the normal securities in a transaction registration process.

The sale is exempt because it is done through a private placement of securities.  Companies can raise capital privately and rely on the typical exemptions from registration because the registration is costly and time consuming.  Dropbox is using the rule 506(b) exemption under Regulation D. In order to be eligible for the rule 506(b) exemption, a company must:

  1. Not make general solicitations or advertisements.  Examples of prohibited advertisements would be television spots or magazine ads.
  2. Sell to accredited investors.
  3. Impose limitations on the resale of the security.  Since the securities are not being offered to the public, they cannot be resold to the public.

When companies like Dropbox raise capital through a private offering of securities, the companies are not constrained to the public stock price in their negotiations.

Box, on the other hand, is not using a private placement to raise its capital but going through the process of an IPO, or an Initial Public Offering.  Box is going to have to publicly disclose its financial information, register with the SEC and file quarterly and annual reports that are publicly available.  While companies traditionally can attract extensive capital when their stock is listed on a public market, it is costly and time consuming because companies must file quarterly and annual reports, must adopt additional corporate governance procedures and will incur higher professional fees (lawyers and accountants). Accountants estimate that the average cost of being public is more than $1.5 million annually. (If you want a link, use http://www.pwc.com/en_us/us/transaction-services/publications/assets/pwc-cost-of-ipo.pdf)

Which company is employing the better method of raising capital?  While the most obvious difference between the two methods is that one is private and the other is public, the IPO is probably the method that most people are familiar with.

For example, did you hear about Twitter’s recent emergence into the market last year through its IPO? You probably did. Did you hear about all of the funding that Twitter received before that point? You may have, but you probably did not. Since Box’s method of offering is to the public, Box will have to register the company and its shares with the SEC. The costs of doing this are enormous, and becoming a public company brings about added transparency and fiduciary obligations. So is there a clear advantage for an IPO verses a private placement under rule 506(b)? Here are some of the characteristics of each:

Private Placement under rule 506(b):

  • Amount of money that can be raised is not limited by law or regulation;
  • No federal or exchange registration fee (there are small fees in each state where a purchaser resides, which usually are less than $500, and one fee covers the security regardless of how many purchasers are in that state);
  • Limited transparency is required;
  • Equity holders’ rights generally are contractual and not determined by regulation or law;
  • Capital is not subject to the ebb and flow of the market;
  • In certain instances there is limited ability to advertise or solicit the public;
  • Maintains control of company.
  • Amount of money that can be raised is not limited by law or regulation;
  • Exchange listing fee can be hundreds of thousands of dollars a year (not to mention legal and outside accounting fees);
  • Ability to market to the public;
  • Virtue of being a listed public company is in itself a form of advertising;
  • Can receive additional capital at typically a much higher volume than private placements;
  • Extra reporting obligations can be costly;
  • Potential loss of control of the company.

Initial Public Offering:

Does the Private Placement through Regulation D exemptions benefit Dropbox more than the IPO benefits Box?  Dropbox has lower costs associated with its method but may find it harder to raise as much cash as Box’s IPO could potentially bring (not to mention the fact that there may be a few large onerous shareholders).  Box could have a mediocre offering though and may be bogged down by the extra costs and restrictions from being a public company. Both of these methods could be killer weapons, but we will have to wait for the dust to settle before we can see who wins this scuffle.