Private placements are securities offerings exempt from full SEC registration requirements. Placements are often made by the company issuing stock or by an underwriter. The offering may be debt or equity.
Private placements are not an asset class. They are a non-public capital-raising technique. With them, non-institutional private capital sources — mainly individuals — raise capital. You see private placements in private equity, venture capital, and some tangible assets.
A multitude of state and federal laws and regulations govern private placements, including:
There are placements of tens or hundreds of millions of dollars. But this article focuses on placement alternatives that can raise $5 million or less in a single year.
[Editors’ Note: As of January 2019, bipartisan support continues for the JOBS Act 3.0. The House of Representatives passed the act, but it failed in the Senate. The deregulatory act aimed to ease the way for small businesses to raise capital from ordinary investors. The legislation included private offering reforms, including redefining accredited investors. There has not been further progress.]
In a private placement, both federal and state securities law consider shares of stock or debt instruments to be securities. Transactions involving shares or debt must be registered or be exempt from registration.
The offeror is often an emerging growth company that has few capital alternatives. More mature companies tend to be more successful in this process. Securities laws generally require that offers are made mainly to accredited investors.
There are 2 types of private placement offerings:
Private placements are exempt from full SEC registration, but they must comply with federal and state regulations. The most important private placement rules fall under Regulation D.
Reg D is a series of six rules. Rules 501-506 establish 3 exemptions from the registration requirements of the 1933 Act. Rules 501-503 describe general definitions, terms, and conditions. Specific exemptions are set out in Rules 504-506.
Rule 504 is the most popular of the Reg D rules. Raising capital for a small business can be expensive and time consuming. Private placement under Rule 504 can minimize costs and delays while giving the issuer access to debt or equity capital.
In a Rule 504 offering, a business can raise a maximum of $1 million in any year. Rule 504 has
Offerings exempt under Rule 504 are simpler to prepare. Therefore, they can be undertaken by the offeror without substantial outside professional expenses. The JOBS Act of 2012 allows offerings to be made through general solicitation or advertising.
Rule 504 does not mandate the offeror to provide specified disclosure to purchasers. However, the offeror must provide enough information to meet the full disclosure obligations under the anti-fraud provisions of the securities laws.
A Rule 505 offering may not exceed $5 million in any given 12-month period. This exemption limits the number of non-accredited investors to 35 with no investor sophistication standards and no limit on accredited investors. The SEC adopted Rule 505 to give small businesses more flexibility in raising capital.
If only accredited investors are involved in the offering, there is no specific information the issuer must furnish. If the offering involves non-accredited persons, the issuer must furnish all purchasers with the information specified by Regulation D. As with a 504 offering prior to the JOBS Act of 2012, this offering could not be made by means of general solicitation or advertising.
For Rule 505 offerings over $2 million, financial statement conditions include the following:
Rule 506 provides an exemption for limited offers and sales. There is no ceiling on the amount of money which may be raised. The JOBS Act of 2012 permits general solicitation and advertising. There is no limit to the number of accredited investors, but the number of non-accredited investors may not exceed 35. However, the issuer must furnish information specified by Regulation D unless all investors are accredited.
Rule 506 requires detailed disclosure of information to potential investors; the extent of disclosure depends on the dollar size of the offering. For offerings over $2 million, the issuer must provide audited financial statements. Offerings under $2 million follow Reg A as a guide, with an additional requirement for a certified balance sheet.
The securities sold are restricted under the same stipulations in Rules 504 and 505. A company is required to file a notice of the offering on Form D at SEC headquarters within 15 days of the first sale in the offering. There is no requirement to file the offering memorandum with the SEC.
Here are some important compliance features of Regulation D:
Table 1: Summary of Private Placements Characteristics, Per Reg D
|Reg D Type||Offering Limit/Year||Non-accredited Investors||Accredited Investors||Financial Stmt Audit Required?|
|504||$1 million||No limit||No limit||No|
|505||$5 million||Up to 35||Yes|
|506||No ceiling||Up to 35||Yes|
The following documents are needed to raise private financing from investors.
Private Placement Memorandum
A private placement memorandum (PPM) provides critical details about the offering. Note that this differs from a business plan, which does not provide information about the technical structure of an offering. A PPM is used to raise capital from a number of investors instead of trying to find one with the entire amount of required capital.
The PPM outlines information such as:
Additional Private Placement Documents
An equity offering lists the securities authorized and offered by the issuer. Also, it describes the use of proceeds. Purchasers of these securities are almost always minority investors; this creates a liquidity risk and minority rights issues that should be strongly considered. Offerees should seek legal assistance before making such an investment.
A debt offering involves the sale of a promissory note to investors. The note sets forth terms and conditions of the loan arrangement between the company and the investor. It describes the interest rate, payment periods, and maturity date.
Notes are sold in fractional amounts providing investor flexibility. For example, in a debt offering, a company raises $1,000,000 which might involve the sale of 20 notes at $50,000 per note.
When private placements fail, it is usually because the offeror does not present the market with a security that promises enough return for the risk, or the investors cannot ascertain the risk of the investment.
Most of these offerors are small companies with unproven business models. It is reasonable for investors to expect 25% to 35% effective returns on their investments. Individual investors cannot measure the risk of most private placements. Blue-sky laws protect individual investors from themselves.
Here are some questions to ask offerors before you consider investing in a private placement:
Offerors should treat all investors at arm’s length, even if the offering is targeted mainly at family and friends. There should be no special deal offered to some investors that isn’t offered to all.
[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can listen to at your leisure and each includes a comprehensive customer PowerPoint about the topic):
This is an updated version of an article originally published in February 2013 and was previously updated on June 21, 2019. It has been updated by Maryan Pelland.]
©2022. DailyDACTM, LLC d/b/a/ Financial PoiseTM. This article is subject to the disclaimers found here.
Robert Slee is the Founder and Managing Director of Robertson & Foley. He is the author of Private Capital Markets, 2nd Ed, and several other books as well as over 300 articles. He is an advisor on billion-dollar transactions and the owner of 30+ private companies (including a unicorn). He is a public lecturer on…
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