Definition and Examples of Private Investment
Private investment is a method through which companies can sell securities via the private market instead of undergoing the traditional initial public offering (IPO) process.
Private investments are a relatively common practice. According to the Financial Industry Regulatory Authority (FINRA), nearly 23% of registered securities brokers reported revenue from private investments in the past five years. They are particularly common for startups and small companies that do not wish to conduct a traditional IPO.
Despite their common usage, some private investments attract more interest than traditional IPOs. In a famous example, Goldman Sachs announced in 2011 that it would sell private shares in Meta (formerly known as Facebook), which at that time was a private company. Goldman Sachs was set to sell private shares to local investors but instead decided to restrict sales to non-U.S. investors. These sales helped raise $1.5 billion for the company.
Alternate Name: Unregistered Offering
How Private Investment Works
Generally, companies that sell public shares are subject to specific requirements, including registration with the Securities and Exchange Commission and periodic financial reporting. However, the SEC regulations exempt unregistered offerings. These exceptions fall under the “safe harbor” rules covered in Regulation D of the Securities Act of 1933.
Companies offering securities under Regulation D are not required to meet all traditional SEC requirements. This makes it easier – and perhaps cheaper – for them to raise capital, but there are other requirements they must meet.
First, companies are limited in terms of the type of investors to whom they can sell securities. Depending on the type of private investment, it may be restricted to selling securities only to accredited investors or those classified as accredited investors. Accredited investors include:
- Financial institutions
- Private business development companies
- Executives or partners in the company
- Individuals with a net worth exceeding $1 million, excluding their primary residence
In cases where companies are allowed to sell securities to non-accredited investors, they must provide more information to those investors. Private investments also require companies to file Form D, which provides basic information about the company, its operations, the offering, and its top officers.
Note: Companies selling via private investment are subject to the “bad actor” rule from SEC Rule 506, which excludes companies from selling via private investment if they have a relevant criminal record or similar judgment in their record.
For example, let’s assume that a tech startup wants to raise capital to expand its business, but it is not ready to issue an IPO. The company can instead use private investment or an unregistered offering.
First, the company will issue a private placement memorandum or offering memorandum that presents the investment opportunity and shares additional information about the securities being offered for sale. However, there is no absolute need for such a memorandum, and the SEC warns that its absence from a private investment can be considered a red flag. The memorandum is also not reviewed by the regulatory body, so it may not provide a balanced view of the company or the offering.
In some types of private investments, companies may even be able to solicit investors directly. Then, once the company conducts its first sale, it must submit Form D to the SEC.
Types
Private Investment
Companies are allowed to sell shares and other securities due to the exceptions available in the Securities Act of 1933. These exceptions are found in Regulation D, but there are several different rules that outline regulations for different types of private investments.
Rule 504:
Under Rule 504, companies can sell unregistered securities to both accredited and non-accredited investors without disclosure requirements for non-accredited investors. The company may also solicit investors through advertising at
Source: https://www.thebalancemoney.com/private-placement-5182438
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