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What is a private placement and should I use it for my business?

On Behalf of | Dec 5, 2022 | Private Placements |

When your company would like to raise money, selling corporate stock is one of the standard ways of going about it. If your company hasn’t sold stock before, you should be aware that the sale of corporate stock is regulated by both the Securities and Exchange Commission (SEC) and, to a lesser but also important extent, state securities regulators.

Once you’ve decided to sell stock, you have a choice to make. Should you make an initial public offering (IPO) or a private placement?

They are both ways to sell stock in your corporation. The essential differences are how they are regulated and who you can sell your stock to.

In an IPO, you’ll be selling stock publicly. First, you will need to ensure your books stand up to scrutiny and create a variety of documents required by securities laws. You may need to register your offering with both the SEC and your state. Once you have sold stock to the public, there is significant ongoing public disclosure and regular reporting to contend with.

Some companies will benefit from making a private placement offering instead. A private placement allows you to raise capital by selling stock, but it is exempt from certain federal legal requirements. In return, you may not publicly advertise your stock, which is a restricted security, and must sell primarily to accredited investors.

Who are accredited investors?

The SEC provides a long list of who counts as an accredited investor, but these are individuals and institutions of significant wealth and experience investing. Examples include:

  • Banks
  • Investment companies and SEC-registered broker dealers
  • Certain employee benefit plans with assets exceeding $5 million
  • Corporations, LLCs and charitable organizations with assets exceeding $5 million
  • Qualifying trusts with assets exceeding $5 million
  • Individuals with a net worth with qualifying assets of at least $1 million
  • Directors, executive officers, general partners and certain employees of the company selling stock

These are investors who know the lay of the land and can afford to take risks.

The stock you sell in a private placement is restricted from future trading to and by the public. That means your investors can only sell it to other accredited investors. To sell to the public, you must issue an IPO.

What is the main exemption for a private placement?

Private placements are exempt from Section 4(a)2 of the Securities Act. Companies offering private placements can still raise unlimited money and they can sell their stock to an unlimited number of accredited investors. Companies offering private placements are subject to these limitations, according to the SEC:

  • No general marketing or solicitation of the public as investors
  • You may sell the restricted securities to no more than 35 non-accredited investors
  • If any non-accredited investors are participating in the offering, the company must give them disclosures similar to those required for an initial public offering, along with any information the company provides to accredited investors
  • Any non-accredited investors must be given specific financial statement information
  • The company making the private placement should be available to answer questions from non-accredited investors

Note that although the Securities Act creates this exemption federally, states can still require notice filings and collect state-level fees.

A private placement is less costly and burdensome than an IPO and may allow you to maintain more control over your stock. An IPO has more legal requirements but allows you to sell your stock to the public.

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