Definition of a Private Placement

By: Eric Powers Click author's name for more of his/her articles

A private placement is an offering of equity to institutions or individuals which meets federal requirements exempting the offering from registration with the SEC. The US government made this possible through Regulation D, part of the Securities Act of 1933 created in the aftermath of the stock market crash. Reg. D allows businesses to sell shares and equity instruments to informed investors without the extreme red tape of SEC registration if they meet certain requirements.

Private Aspect

To be exempt from SEC registration, the “private” aspect of the offering is a key element. This generally means that public solicitations (such as listing on an open market or advertising through a form of mass media) are forbidden. Instead, the potential investors must be previously known by the business owners or found through personal contacts and networking.

Restricted Shares

Under many of the exemptions within Regulation D, it is required that shares are purchased primarily as longer-term investments rather than for immediate resale on a secondary market. Some rules state that the shares purchased cannot be resold for two years. This requirement forces investors in private placements to be more diligent about what they are purchasing to be sure that it will be a profitable investment in the long run.

Accredited Investors

Also, most exemptions under Regulation D require that all or most investors in the private placement be what are called “accredited investors”. There is no formal “accreditation” with the government. These investors are generally institutions and individuals who are expected to be sophisticated when it comes to business investment deals. This includes, but is not limited to, institutions, like banks, business development companies, and registered investment companies, officers or partners of the company selling the shares, and individuals whose net worth is over $1 million or annual income is over $200,000.

Private Placement Memorandum

Whether or not the business is required to present disclaimers to investors (some Regulation D exemptions do not require this) it is in the best interest of the business creating the private placement to do so through a private placement memorandum. This document presents the potential risks of the investment along with its specific terms and a subscription agreement for interested investors to move forward. The document may contain aspects of a business plan or have a business plan as an appendix. The PPM can help the company defend against claims of fraud for not disclosing the investment’s risks

The Blue Sky Laws

Blue sky laws (state laws regulating the sale of securities), must be consulted for the state you are incorporated in as well as states you will be selling the securities in.

State Power

The fact that the federal securities regulator, the SEC (Securities and Exchange Commission), exists does not preclude the states from regulating securities as well. For the most part, states focus their security regulation on the power to investigate and prosecute businesses for securities fraud. To avoid actual fraud and the suspicion of fraud as much as possible, a private placement memorandum must carefully and clearly disclose all of the risks associated with the offering.

Complicating the Process

The offering must be clearly exempted from registration by the blue sky laws, which may be more restrictive than the federal exemptions. About forty states model their securities law on the Uniform Securities Act of 1956, but the interpretation of these laws can vary from state to state. Even if full registration is not required, there are generally state forms (like the federal Form D) which must be filed.

The upside of the type of disclosures which must be made under blue sky laws is that meeting them will make your offering more transparent, better protecting your business from security fraud claims and perhaps even reducing the time involved for investor’s due diligence.

Conclusion

The effect of the complicated combination of federal and state laws affecting private placements is that experienced legal counsel must be obtained by any business hoping to raise equity capital this way.

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About The Author: Eric Powers is associated with Growthink, the leading investment banking firm for emerging businesses. Growthink has provided Regulation D private placement memorandum services since 1999. To learn more about Growthink's private placement memorandum services, call 800-506-5728.