How can Individuals Invest in Private Placements

Private placements are offerings (sale of securities) made to a small number of selected investors as against offering shares to the public in the case of initial public offerings (IPO). However, as with IPOs, the idea behind a private placement is also to raise capital. The investors involved in such placements are usually the larger banks, mutual funds, insurance companies etc while the companies offering such placements are usually the small-scale businesses, which are not yet ready to go public in order to raise their working capital.

Thus, private placements are not straightforward individual investment opportunities as in the case of ‘open market’ investments. However, there are means and ways of participating in such investments in an indirect way. In order to understand this, it is best to learn why companies choose private placements and the rules applied for being an investor of such placements.

The reasons to prefer private placements

For emerging companies, private placements offer a high degree of flexibility and lower cost in relation to the amount of financing they wish to obtain. One reason for this is that private placements do not require financial brokerage or underwriting, which could eat into some of the money raised. At the same time, it takes less time than an initial public offering. In addition, it may be the only source of funding available for risky ventures or start-up firms. Furthermore, private placements allows the companies to hand pick the investors that they prefer and could gain from the expertise of the investors without having to negotiate with a ‘director board’ as in the case of going public. However, there are restrictions imposed on such private placements as well and some of these restrictions prevent individual investors from taking part in such transactions without fulfilling a pre-defined criterion.

The general rules governing investments in private placements

In order to make a private placement, an investor must be accredited by the Securities and Exchange Commission and should have a net worth of over $1 million, or an income in excess of $200,000 in the last two years. However, when the private offering belongs to a certain category as depicted by the rules 505 and 506, there is a possibility of non-accredited investor participation of up to 35 in number although all such investors need to have sufficient experience and knowledge regarding private placements in order to make informed decisions with regard to such high risk investments.

Individuals’ ability to deal with private placements

When considering the criteria set out for private placement investors, experts believe it is possible for many individual investors to qualify as ‘accredited investors’ based on their financial ability. However, individual investors lacking sufficient experience and knowledge in order to become ‘accredited investors’ should obtain the services of an investment brokerage or underwriters to fulfill their wishes. Forming investment clubs is another way to enter into the private placements market as it will allow several investors to pull their available resources together, as well as the expertise in being qualified for accreditation.