Private Placement Guide
As stated by Investopedia, a private placement is a capital raising event that involves the sale of securities to a relatively small number of select investors.
Investors in private placements include large financial entities including, banks, mutual funds, insurance companies and pension funds, as well venture capitalists, angle investors and other corporations. Most private placements are offered under the Rules known as Regulation D. While not requiring the formal process and paperwork of a typical public offering, private placement disclosure documentation must still be filed with the SEC.
Conversely, a public issue/offering is when securities are made available for sale on the open market to any type of investor.
Here are some real world examples of Private Placements:
1) You hear about friend's startup that just raised a relatively small amount, say $200,000 for a stake in their company. Chances are, that was a private placement to one or more high net-worth investors, known as angel investors.
2) You read about a high-tech company raising $10 million in what you hear is a “Series B” investment. That is also a private placement, probably to more than one venture capital funds.
3) A hedgefFund raises $10,000,000 for investment purposes from a couple institutions. Within 15 days of the sale, they file a Form D with the SEC as this is a third type of private placement.
To qualify as a private placement, an offering by an issuer must meet either the requirement of Sections 3(b) or 4(2) of the 1933 Act as developed through SEC interpretation and court decisions or must follow the conditions set out under Regulation D of the 1933 Act. Persons claiming the exemption from the 1933 Act carry the burden of proving that its activities came within that exemption.
Regulation D is a series of six rules, Rules 501-506, establishing three transactional exemptions from the registration requirements of the 1933 Act. In other words, if a company meets the requirements, they are exempt from having to register the securities they are looking to sell.
SEC Form D is a document filed with the SEC that most firms issuing private placements are required to file within 14 days form the first sales of securities. These filings are created by the issuer's attorney.
Outside of large institutions and funds, one group that participates in private placements are referred to as “accredited investors”. Especially, when a startup is looking for its first funding, they will often approach this group. So who are accredited investors?
“Accredited Investor” is defined in Rule 501(a). The principal categories of accredited investors are as follows:
1) Directors, executive officers, and general partners of the issuer, including general partners of general partners in two-tier syndicating. (The term “executive officers” is more fully defined in the Regulation.)
(2) Purchasers whose net worth either individually or jointly with their spouse equals or exceeds $1 million. It is important to note that while there is no definition of “net worth” in Regulation D, the value of the purchaser’s home is excluded in Section 501(a)(5)(i)(A)
(3) Natural person purchasers who have “income” in excess of $200,000 in each of the two most recent years and who reasonably expect an income in excess of $200,000 in current year (or $300,000, jointly with their spouse).
(4) A business entity will be treated as a single accredited investor unless it was organized for the specific purpose of acquiring the securities offered, in which case each beneficial owner of the security is counted separately.
To meet the requirement of Regulation D or the requirements of Section 4(2) of the 1933 Act (the private placement exemption), the issuer is almost always required to make extensive disclosures regarding the nature, character and risk factors relating to an offering. The disclosure document often is labeled “Offering Memorandum”. Offering Memorandums are created by an issuer’s attorney.