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How Private Placement of Securities Works

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Here's how private placement of securities works.

A company can be more elective about who buys its shares if it sells them in a private placement. Shares sold in an initial public offering, or IPO, are offered to the general public and tend to attract more attention. However, private placement allows a company to raise money without going public and having to disclose financial information. A company can remain private while still gathering shareholder investments.

What Is a Private Placement?

A private placement is when company equity is bought and sold to a limited group of investors. That equity can be sold as stocks, bonds or other securities.

Private placement is also referred to as an unregistered offering. While an IPO requires a company to be registered with the Securities and Exchange Commission (SEC) before it sells securities, a private placement is exempt from that requirement.

A private placement might take place when a company needs to raise money from investors. Yet it is different from taking money from other private investors, like venture capitalists. It’s still regulated by the Securities and Exchange Commission (SEC), but under different rules, collectively known as Regulation D.

Reg D allows companies to issue securities based on the investors buying them. It distinguishes between accredited and non-accredited investors, as defined by the SEC.

Any number of accredited investors can take part in private placements. Though private placements can issue securities to non-accredited investors, only 35 such investors can be included.

If you’re looking to invest in a private placement as an accredited investor, you’ll need to meet some requirements, including:

  • A net worth of over $1 million (either independently or with a spouse).
  • Earned income more than $200,000 a year (or $300,000 with a spouse).
Private Placements: Pros and Cons

Here's how private placement of securities works.

Since private placements fall under different regulations compared to IPOs, they operate differently.

Pros
  • Faster turnaround time: The security underwriting process is faster, which means investors can get proceeds from the sale in less time.
  • Different assets: Since sellers aren’t registering with the SEC, even bonds can be sold more quickly. A company doesn’t have to get a credit rating from a bond agency and can sell to accredited investors who understand more complex bond offerings.
  • Privately owned status: A company can file a private placement and remain privately owned, avoiding the regulations and information disclosures of publicly owned companies.
Cons
  • Higher interest rates: Compared to bonds issued by publicly traded companies, private placement bonds earn a higher rate of interest. That leaves a company on the hook for larger payouts.
  • Increased collateral: Without a credit rating, a private placement bond offers little assurance to a buyer. A company may have to offer some form of collateral to entice buyers.
  • More ownership: An investor of a private placement company may want a larger percentage of ownership in the business or a guaranteed fixed dividend payment for each share of stock they own.
Restrictions of Private Placements

There are some limitations of private placements, especially when it comes to what types of investors are allowed to participate. A number of rules within the SEC’s regulation D cover those restrictions.

Rule 504: Issuers can offer and sell up to $1 million of securities a year to as many of any type of investor as you want. They aren’t subjected to disclosure requirements.

Rule 505: This rule says issuers can offer and sell up to $5 million of securities a year to unlimited accredited investors and 35 non-accredited investors. If you’re selling to a non-accredited investor, you’ll need to disclose financial documents and other information. With accredited investors, the issuer can choose whether or not to disclose information to investors. But if you provide that information to accredited investors, you must also share that information with their non-accredited ones.

Rule 506: An unlimited amount of money can be raised if the issuer doesn’t participate in solicitation or advertising. While an unlimited amount of accredited investors can be brought in, 35 non-accredited can take part if they meet specific criteria. They need to have enough financial knowledge or have a purchaser representative present to understand and evaluate the investment.

Bottom Line

Private placement can offer investors an exclusive opportunity that isn’t available to the public. It can also offer companies funding without requiring them to register with the SEC or disclose a lot of financial information.

However, all investments carry risk. Though still covered by antifraud portions of securities laws, private placements can withhold more information than investors than public offerings. Companies should know that non-accredited investors still require financial disclosures. Meanwhile, potential investors should consider gathering information beyond what’s offered before sinking their money into a private placement.

Investment Tips

Here's how private placement of securities works.

  • Investing in securities that don’t disclose their financial information can be confusing. A financial advisor can help investors get a clearer picture. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
  • Are you concerned about a particular investment and the risk it carries? Does a lack of financial disclosure concern you? The SmartAsset investing guide can help you determine your risk tolerance and find the investments that are right for you.

Photo credit: iStock.com/Sainam Poploy, iStock.com/golero, iStock.com/iamnoonmai

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