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July 12, 2017
Looking for a hot stock deal? Insider trading is a no-no, and getting first crack at an initial public offering is impossible unless you are super-rich and well-connected. Yet there is a way to get the jump on the general public when it comes to owning shares in the next big company: they’re called private placements.
A private placement is the issuance of restricted securities sold privately. These securities, usually in the form of shares, warrants or debt instruments, are exempt from registration with the Securities and Exchange Commission and cannot be issued on the open market. Issuers usually complete a Regulation A or Regulation D filing with the SEC to secure an exemption from registration.
Regulation A is an SEC regulation that provides a simplified exemption for companies with offerings of $1,500,000 or less. Regulation A exemptions work best for businesses that are legally registered to do business in the United States or Canada. Companies eligible for the exemption must also not be a developmental stage company. They should have a specific business plan with no plans to merge with unidentified businesses. An investment company is also ineligible for Regulation A exemptions.
Title IV of the Jumpstart Our Business Startups (JOBS) Act amended Regulation A (dubbed Regulation A+) that enables small companies to raise up to $20 million (Tier I offering) or $50 million (Tier II offering) from accredited and non-accredited investors.
Private placements can be made under Regulation D via three rules:
Generally, private securities are not subject to all the disclosures made in the prospectus of a publicly traded security. The JOBS Act permits Section 506 private-share issuers to market to the general public, but sales can only be made to accredited investors.
Banks, pensions, insurance companies, hedge funds and individual accredited investors are the primary buyers of private placements.
Privately placed securities are illiquid. Buyers can resell the securities either privately, or after a specified interval (normally, one year), via public sale. Both issuer and purchaser benefit from a private placement’s lower costs as compared to those engendered by an initial public offering (IPO). Best of all, it allows buyers to get in the “ground floor,” before a stock goes public.
Many, but not all, buyers of private securities are accredited investors. Individuals are accredited if:
A small number of non-accredited investors can purchase private placements under Rule 506 of Regulation D. These investors are sophisticated (i.e. understand the basic risk/return characteristics of an offering), wealthy (can absorb a complete loss of their investment) and informed (i.e. have access to the same kind of material information that would be included in the prospectus of a public offering).
Regulation D placements usually distribute, prior to the sale of securities, copies of a Private Placement Memorandum (PPM), which makes financial disclosures that are equivalent to those provided by a public-offering prospectus, including suitability standards, risk factors, use of proceeds, distribution plan, dilution effects, financial data, tax and legal matters, and principal shareholders. An issuer may choose not to release a PPM for placements limited to only accredited investors. The PPM must include an audited balance sheet dated within 120 days before the start date for the offering. In addition, when non-accredited investors are present, each investor has the right to ask questions and receive answers regarding the terms and conditions of the offering, as well as any other information that verifies the accuracy of information already presented
The JOBS Act created an easy means for non-accredited investors to buy private securities. It’s called crowdfunding, and it allows private startup companies to raise up to $1 million a year by issuing stock to the general public. This stock is restricted – you can resell it after holding it for one year. You can buy crowdfunded shares from a broker-dealer or via an online portal set up for this purpose. Individuals must observe annual limits on how much they can invest in crowdfunded securities:
You can buy shares of private companies in a self-directed IRA. The rules for accredited investors persist whether or not private placements are made to an IRA. A self-directed traditional IRA that uses a custodian willing to purchase and sell private securities provides tax benefits:
Unless you receive an exception, you’ll pay a 10 percent penalty if you withdraw from your traditional IRA before reaching age 59 ½. Also, you must begin taking distributions from your traditional IRA once you reach age 70 ½.
Naturally, you should research any investment before you buy it. When you combine the tax benefits of an IRA with the ability to buy the next hot stock before it goes public, you can see why many savvy investors use their self-directed IRAs to purchase private securities.
Authored by Tracy Stein – CEO & President of Prime Pinnacle