Private Placement Offerings versus Publicly Registered Securities

  • Under the US federal securities laws, all securities offered for sale to investors(both debt and equity) require registration with the Securities Exchange Commission (SEC) unless the securities qualify for one of the exemptions from registration which are specified in the Securities Act of 1933 (the “Act”).  The manner of offering a privately placed security falls under Section 4(2) of the Act.
  • Publically registered securities, which are issued by larger, more established companies, enable issuers to raise larger amounts of capital at a lower cost of funds, or in the case of equities, a typically higher company valuation.    
  • Public registration enables secondary market for the securities whereby investors can unilaterally sell the investment at their discretion following their initial purchase.  Public offerings of securities require sponsorship from a FINRA registered broker dealer that underwrites the initial offering and commits to make a secondary market in the security.
  • Private securities, on the other hand, are often issued by relatively small and much younger companies and in amounts and on terms providing the issuer the maximum flexibility.  Because there is no SEC approval required, offerings can be arranged relatively quickly.  
  • Private placements must be held to their maturity in the case of debt, or if equity securities, until the company is sold or publically registers its stock. Because of the “illiquidity”  (i.e. the investor’s inability to sell the investment to a third party until it has matured or has been otherwise been redeemed by the issuer), privately placed securities involve a cost premium versus publically registered securities.
  • Private offerings of securities can be conducted directly by the issuer or through an agented, “best efforts” process (i.e. non-underwritten) using a FINRA-registered broker dealer as a “placement agent”.  Under US law, only registered broker-dealers can conduct private placements as third-parties and receive compensation for such services. 
  • All publically registered securities are filed with the SEC, which has approved the breadth and manner of the information disclosed by the issuer.  Importantly, the SEC does not approve an issue on its investment merits, only to the degree that the disclosures meet the standards for public registration (audited financial statements, length of operating history, etc.).  
  • Private placements offered in conformance with Regulation D of the SEC must also file with the SEC, but the offering is not approved by the SEC, rather a history of the offering is kept on file.  Disclosure standards are not specified for private placements, but if they ultimately prove to be fraudulent or misleading it could lead to criminal prosecution for the parties involved with the offering.

Risk vs. Return Considerations

  • Evaluating the risk of a potential investment is arguably the most important aspect of any investing activity, whether as part of a private securities offering or for a publically registered investment.  No investment is riskless, and losses will inevitably happen within a portfolio.  Limiting losses and achieving the projected returns of performing investments is therefore critically important.
  • Private investment offers the opportunity for substantially higher returns than comparable publically registered securities, but investors must be committed to a deal by deal analysis process that thoroughly evaluates each opportunity both for its individual merits as well as its consistency with the investors overall investment goals and risk tolerance
  • Private investments, because of they have virtually no ability for secondary sales, are priced at a premium to comparable publically registered securities.  This offers the opportunity for incremental yield to private investors, but it severely limits the investor’s ability to actively manage their investment portfolio.
  • The key to consistently successful private investing is for the investor to build a diversified portfolio (no more than 10% exposure to a single transaction) where each investment has been subjected to comprehensive due diligence, which includes an independent testing of all of the basic issuer disclosures and the underlying elements of the business model driving the success of the company being financed.
  • As a general rule, an individual investors aggregate private investment should constitute a minority (say 5% to 30%) of their overall portfolio, with publically registered investments and money market funds comprising the balance.
  • Private investments should be made with an individual investor’s discretionary funds.  That is, cash resources which the investor can lose without impacting their important personal obligations such as mortgages, college tuition, retirement, etc.
  • There are two general categories of risk accompanying any investment…fundamental risk and market risk.  Fundamental risks are those relating to the business being financed, such as the cost of production, customer demand for its products, personnel performance, etc.  Market risk pertains to the ongoing volatility of the public financial markets and its impact on the potential liquidity or relative attractiveness of a private security. 

What is a private placement?

  • Private placements are offerings of securities which do not involve registration of the underlying security with the Securities Exchange Commission (SEC).  They are traditionally offered discreetly and sold to investors, historically, in a non-public manner (i.e. without public advertising).  (see Regulation D, Rule 506(b))
  • However, a recent SEC Rule authorizes general solicitations for some privately placed securities which are only purchased by Accredited Investors and Accredited Investors Questionnaire .  (see Regulation D, Rule 506(c)).
  • Regulation D is a regulation of the SEC, and it contains specific rules for the proper conduct of a private placement in the United States (“safe harbor” guidelines).  Following the Rules within Regulation D is strongly recommended.  All CFG private offerings follow Regulation D guidelines.
  • Registered securities broker-dealers may act as a “Placement Agent” to conduct an offering on behalf of the issuer or the issuer can offer securities directly to investors.  If a Placement Agent is used, the firm must be a registered broker-dealer with the Financial Industry Regulatory Authority (FINRA).
  • Private offerings can include any form of security, such as promissory notes or equity interests (eg. common stock, preferred stock or membership interest in a Limited Liability Company).
  • Investors in private placements include individuals, wealth managers, managed funds, insurance companies, etc.
  • Private placements are subject to all federal and state regulations regarding securities issuance, including those relating to misrepresentation and fraud.

Investment Considerations - Fundamentals

It is very important that Investors participating in private placements evaluate their own SUITABILITY for what are generally higher risk investments which have no opportunity for a secondary sale before the investment is scheduled to return the invested capital.

CFG is not a financial advisor or wealth manager.  However, as a FINRA registered broker dealer, it is our responsibility to explore the following with each prospective individual Investor before they make a private investment with our firm (See CFS Privacy Policy):

  • Overall personal financial profile
  • Size and nature of the overall investment portfolio 
  • Investment strategy relative to the Investor’s stage of life
  • Liquidity required of investments
  • Whether a given CFG private investment represents a prudent addition to the portfolio, based upon risk/return sensitivities.

Incorporating private placements, specifically, and so-called “alternative investments”, generally, into an overall investment portfolios is a complex and important issue, particularly because since Investor must take into account the investments characteristic of a given private investment in relation to their unique personal considerations.  Individual Investors are advised to consult with a financial planner or wealth manager as they consider alternative investments, such as private investments.

Some of the variables affecting personal investment choices include:

  • Personal income 
  • Liquidity (i.e. cash on hand) and any potential for the need to suddenly sell a security before it is scheduled to return the invested capital 
  • The investor’s age, employment status, state of health and dependents
  • Philanthropic goals and objectives
  • Tax considerations

Alternative investments include the following investment categories:

  • Privately placed debt of private companies
  • Privately placed equity of private companies (e.g. venture capital)
  • Hedge funds
  • Private equity funds
  • Mezzanine funds
  • Distressed debt funds
  • Natural resources (timberland, water, agriculture, oil, gas, minerals)
  • Real Estate
  • Commodity and financial futures funds

The characteristics of an alternative investment often include:

  • Illiquidity (very difficult to sell once invested)
  • Low correlation with traditional financial investments such as stocks and shares
  • Difficulty in determining the current market value of the asset
  • Costs of purchase and sale may be relatively high
  • Limited historical risk and return data
  • A high degree of personal investment analysis is required before investing in a specific offering
  • Limited disclosure regarding performance and status of investment when compared with publicly registered securities.

However, alternative investments and private placements may offer the Investor:

  • Higher returns, such as interest rate or capital gains, than that typically generated by traditional, publicly traded or offered investments such as stocks, bonds or mutual funds.
  • Lower volatility in price and performance  than traditional investments
  • Diversification of risk and performance from traditional investment