Businesses who seek funding for growth or expansion might consider a private placement over other types of funding, like venture capital or a public offering. Private placement is when a company sells securities directly to a small number of investors instead of making a public offering on open market.
A private placement program is often a better choice for businesses that aren’t ready for a public offering, but have passed the angel investor stage. A private placement allows the business to raise a significant amount of capital, but bypass many of the requirements that other security offerings must fill. Under SEC Regulation D, private placements don’t have to be registered with the SEC and the business can waive the need for a prospectus as long as the placement follows certain other rules. Private placements are easier to offer and allow the company to raise capital quickly. With a private placement, businesses can accomplish their funding goals and maintain their private status.
Venture capital investments are another way for businesses to raise capital. However, venture capitalists have more say in company decisions and more short-term repayment demands. Private placement investors, on the other hand, don’t have as much say-so in company operations and do not expect to see short-term returns on their investment.
A Few Rules
Businesses offering a private placement aren’t allowed to make general advertisements or solicitations. That means the private placement can’t be listed on the internet, advertised in the newspaper, or otherwise marketed to people you don’t know. Instead, they’re required to make the offering directly to investors. Companies should only offer the private placement to a small number of investors. The general public typically doesn’t find out about a private placement until it’s already happened.
Private Placement Memorandum
Companies offering a private placement issue a private placement memorandum, PPM, that details the company’s finances and business plan. Prospective investors can review this document to decide whether they should invest money in the private placement. While
it does provide information about what you’re investing in, it’s not as detailed as the prospectus you’d receive from other types of investments and it’s not regulated.
Investing in a Private Placement Program
Private placements are less liquid than public stock purchases. Also, investors may need to be accredited to qualify for these investments. That means the investor should have a net worth greater than $1 million and an annual income above $200,000 for the last two
years, $300,000 for joint investors. Accredited entities, e.g. companies, should have at least $5 million in assets. Investors should also be sophisticated and knowledgeable about securities before investing in private placements. It’s in the business’ best interest to deal with accredited investors since these individuals are more likely to understand the risk associated with a private placement. Other investors may become disgruntled later if they don’t receive the returns they expected. Private placement offerings have significant risks that should be evaluated and understood.
Investors can do a little bit of due diligence by checking with your state securities commission to make sure the broker or issuer is licensed to do business with your state. You can also use the office to find out if that person’s had any problems. FINRA’s BrokerChecker will give you the disciplinary record of registered brokers and firms. FINRA, the Financial Industry Regulatory Authority, requires brokers and firms to investigate the private placements that are sold and those who don’t uphold standards. Brokers and firms, often those seeking high commission fees, sometimes sell private placements to investors who don’t meet the qualifications.
Private placements can be extremely profitable, especially if the company eventually goes public. However, an investor shouldn’t make a decision based on the company’s promises to go public in the future. That’s a step that may not happen depending on the company’s performance.