Of course, many new businesses incorporate, and private companies go public by raising capital through public offerings of equity shares in their corporations – usually of stock. However, while going public may be the right decision for many businesses, federal securities laws allow certain private and public companies to attract private investment that is exempt from the regulatory oversight of public offerings.
A business may choose a private placement – the term for offering investments exempt from registration requirements – as a vehicle to raise initial capital for a new business or to raise money later for ongoing or unexpected expenses, to reinvest into the business or for a particular project.
Publicly traded companies must carefully comply with complicated regulations when they offer, register and sell securities. For example, an initial public offering (IPO) must include document filings like a prospectus and registration statement. The business must then file ongoing detailed quarterly and annual reports with the U.S. Securities and Exchange Commission (SEC), among other things.
Positive aspects of nonpublic offerings
Potential advantages of a private placement may include:
- Keeping company information more private, especially in closely held or family businesses
- Offering more advantageous terms like fixed interest rates and longer maturity periods
- Paying fewer fees and expenses
- Getting through the offering process more quickly
- Generating higher returns
- Being subject to fewer regulatory requirements
- And others
Nuts and bolts
In the private placement process, an attorney or banker often prepares a private placement memorandum (PPM), sometimes called an offering memorandum or offering circular, for the company. A PPM contains details for potential private investors about the financial health of the business, operations, executive team, plans for use of the privately raised capital and future goals. The memorandum usually includes a subscription agreement containing the terms of the private offering like the number of shares and pricing.
These documents provide the kinds of information for interested private investors that the public would otherwise learn about in SEC filings in a public offering. A company issuing a private equity offering may not advertise the offer to the public, but rather must sell only to “accredited investors” who fall into categories that signal that they are likely sophisticated enough that they do not need the protections of disclosures accompanying public offerings.
Federal regulations define accredited investors that are usually qualified institutional buyers (QIBs, like pension funds, insurance companies or financial institutions), some trusts, brokers, investment advisors, high-net-worth individuals (HNWIs) and others. A company seeking private investors must be careful not to use any vehicle or engage in any activity that regulators could construe as a general, public solicitation that might run afoul of securities laws. However, in a private offering, a general solicitation narrowly focused only on accredited investors is allowable.
A business may also “test the waters,” which is a narrowly defined regulatory activity designed to generate feedback from potential investors before making the nonpublic offering. There are some limited provisions for sales to unaccredited purchasers.
To avoid penalties, fines and even criminal liability in serious cases, a company considering a private placement transaction should first undergo careful, comprehensive analysis to clarify its eligibility for an exemption from public registration of securities – usually a complicated question. Noncompliance with registration regulations can trigger federal or state investigation by the SEC or state authorities like the Securities Division of the Kentucky Department of Financial Institutions (DFI) or the Colorado Division of Securities.
In the right circumstances, choosing to go the private placement route can be a wise and lucrative decision.