Private Placements: Alternative Ways to Go Public

Companies that want to go public have opportunities to complete an initial public offering (IPO), in which they offer shares on the open market. They can also use direct listings to skip the underwriting process or go public by being acquired through a special purpose acquisition company (SPAC). However, there is a fourth option for companies that specifically want a small number of investors: a private placement.

A private placement is when a company sells shares to targeted investors or institutions. While it may still go through the valuation process, it will not offer stocks to the public.

Learn more about private placements and why companies choose them. Getting information from reliable, unbiased sources can help you learn about your investing options and better understand why companies go public in different ways.

How Private Placements Work

Companies go public to raise capital and expand their operations. Shareholders put money into the company by buying stocks, and the company uses the funds to grow. This growth should raise the valuation of the company, thus increasing the stock price and growing the wealth of shareholders.

Private placements occur when a company appeals to a targeted group of investors. Smaller companies, firms that don’t need to raise a large amount of capital, and organizations that don’t want to public scrutiny that comes with the IPO underwriting process may use the private placement method.

With private placements, companies do not need to file with the Securities and Exchange Commission (SEC) and do not need to market themselves widely. Instead, they can develop tailored pitch campaigns for specific investors.

Types of Private Placement

There are multiple types of private placements for you to invest in. Here are a few options to consider:

• Regulation D investments: These are investments that are exempt from SEC reporting restrictions. Regulation D will be covered in the restrictions section of this article.
• Private stocks and equity: This refers to investments in private companies that do not want to go public.
• Angel investing: This refers to supporting startups. Angel investors often invest in developing companies, enabling them to grow.

When discussing private placements, most people refer to investing enabled by Regulation D exemptions. However, there are plenty of ways to invest in private companies.

Key Features of Private Placements

If you’re considering investing in a private placement as opposed to buying into an IPO or direct listing, be aware of a few key features. Here’s how you can recognize a private placement:

• Limited or no SEC documentation:** **These companies do not need to report to the SEC because they are not publicly traded.
• A private placement memorandum: Companies will provide potential investors with relevant information through a memorandum instead.
• Limited investors: Companies will work with a limited number of sophisticated investors instead of appealing to the general public.
• Large minimum buy-ins: Companies want large contributions because of the small investor pool.

If a company is not going through standard SEC procedures to go public, the burden falls on investors to do their own research before deciding to buy into a private placement.

Pros

There are several benefits of choosing private placements. Here are a few reasons why a company might choose this option or investors might seek private agreements:

• Getting capital is easier because companies don’t have to go through the laborious, expensive, and time-consuming underwriting process.
• Companies do not have to register with the SEC.
• Companies do not need to make their finances and operations processes transparent to anyone other than investors.
• The company can set more complex investment terms.

After the round of funding is complete, the company remains private. It does not have to go public in exchange for funds.

Cons

Despite the benefits, there are drawbacks to moving forward with private placements. Here are a few reasons companies avoid this option:

• The SEC sets limits on how much money companies can raise with private placements.
• Companies need to appeal to a smaller group of investors. If these investors aren’t interested, they might not get funding.
• Private placements are considered riskier to investors and some might not want to move forward with this option.
• To overcome this risk, some investors might want higher rates of returns, making the capital more expensive.
• Fewer investors mean the entities that do invest have a larger share of ownership and a greater say in how the company is run.

Investors considering unregistered offerings also need to be aware of scams. Some fraudsters appear as reputable investment options when they just want your money.

Examples

The public usually doesn’t hear about private placements because they aren’t able to buy into these companies. However, you can still find examples in the news:

• BeMetals, a mining company, recently raised $4.8 million through a private placement.
• Argo Blockchain, a cryptocurrency mining firm, recently raised $9.9 million through private placement. These funds are meant to be used as working capital.
• Alpha Teknova, a medical research company, raised $15.4 million. The money will be used for general operating purposes.

As you can see, some companies have specific reasons for seeking private placements while others simply need more working capital.

Restrictions of Private Placements

Regulation D, which states every company that sells shares must either register with the SEC or meet the exemption criteria, makes private placements possible. Two key exemption criteria pave the way for private placements: Rule 506 and Rule 504.

• Rule 506: The company cannot use general solicitation to convince people to buy shares. It can sell shares to an unlimited number of accredited investors, but only 35 un-accredited ones. The SEC has detailed guidelines on what it means to be an accredited investor.
• Rule 504: The company can sell up to $10 million of securities within 12 months. This is a small amount in the world of investing.

Companies that need to raise less than $10 million or who are interested in working with a small pool of investors often use private placements. They can work around these restrictions comfortably.

Private Placement Memorandum

Instead of going on an IPO roadshow and creating a marketing campaign for potential shareholders, companies will create a private placement memorandum to help investors learn about their organization. You can see an example from Securitas EDGAR Filings to learn what these look like. The memorandum includes information about the shares, the financial health of the company, and the reasons why someone should invest.

The SEC highlights that this memorandum is not reviewed by any regulators and is not presented in a balanced light. The company is trying to persuade investors and it is up to those investors to do their own due diligence before moving forward.

Private Placement Programs

Private placement programs are exclusive groups that seek out investment opportunities. While some of these programs are legitimate, scams are common. The SEC highlights how investors should be careful when evaluating private placement groups, also known as high-yield investment programs. Organizations that directly seek you out to become an investor are more likely to be scams than if you seek out a private placement program on your own.

Private Placement Insurance

The Securities Investor Protection Corporation (SIPC) can provide coverage if you lose your investments. This insurance organization usually steps in if companies mishandle investor funds and cause them to lose their money. Investors are protected up to $500,000 in lost funds; however, the private entity has to be a SIPC member. Ask about SIPC before you invest.

Private placements offer opportunities for companies to raise capital without going public. However, there are limits to how much they can raise and which investors they can work with. Knowing about this investment option can help you allocate your money strategically while mitigating risk and avoiding fraud.