Qualifying for a Private Placement as an Accredited non Accredited or Sophisticated Investor

Private placements of securities, for the purpose of raising capital, are something most individual investors only hear about in a press release long after the shares or bonds in question have been fully allocated to the financial or investment organizations who have agreed to purchase them. The whole parcel may go to a single institutional investor, or it may be divided into a limited number of large portions to be shared out among the corporate clients of the broker or brokers underwriting the placement. So this kind of off-market activity is beyond the reach of the average individual investor, but it is still possible to participate in a private placement as an out-of-the-ordinary individual.

• Difference between public and private placement

A private placement can avoid many of the strict rules applicable to public offerings, such as the IPO (initial public offering) of a private company making its shares available to the public for the first time. In the United States, registration of a private placement with the Securities and Exchange Commission (under the federal Securities Act of 1933) is not required, nor is there any need to issue a prospectus. It therefore follows that a private placement can be inherently risky for individual investors unless they are fully appraised of all the details about the current and future business and financial situation of the company seeking to raise capital. These details are normally disclosed in a lengthy prospectus, whereas for private placements financial and business information is often provided in a less comprehensive private placement memorandum. Private placements are often chosen by seekers of capital because they are less costly to prepare and complete, and because they allow a company to offer smaller amounts of equity or debt than is usual in an IPO.

• Normal participants in a private placement

As a result of the large amounts involved and the need to be fully informed, private placement investors are normally investment banks and investment funds, pension funds and insurance companies. As well as having substantial financial resources at their disposal they also often have in-house investment analysts specializing in staying up-to-date with the activities of particular industries or even individual companies.

• Securities Act 1933 Regulation D

However, under certain circumstances, individual investors are able to participate in private placements. These conditions are detailed in a section of the Securities Act 1933 known as Regulation D, Rules 505 and 506. Rule 505 covers small placements of securities by a company (not more than $5 million in any twelve month period) where no general public solicitation or advertising is permitted. Up to 35 individuals who are ‘non-accredited investors’ plus any number of individual ‘accredited investors’ may participate. (See below for definitions of both accredited and non-accredited investors.) Rule 506 is similar, but there is no limit to the amount of capital that can be raised. In exchange for the removal of this limit, a restriction is placed on the 35 non-accredited investors, who must now be ‘sophisticated’ investors. This means that they must have enough financial and business knowledge or experience to enable them to evaluate both the advantages and risks of the investment they are proposing to undertake. Often they may be asked to provide a certificate to this effect or other documentation from a stockbroker, investment banker or other financial professional.

• Accredited investors

There are three ways to qualify as an accredited investor under rules 505 and 506 of Regulation D. The first way is to be a director, executive officer or general partner of the company issuing the securities for private placement. The remaining two ways are concerned with personal net worth and income. Effectively, because of the greater risks involved, the Securities and Exchange Commission (SEC) has to be satisfied that the investor could in fact afford to lose their entire investment, even though this may be unlikely. This means that an accredited investor must be able to demonstrate a high level of either ongoing income or net worth. Under Rule 501 of Regulation D of the 1933 Securities Act, as amended to meet the requirements of the Dodd-Frank Act of 2010, such individuals must have a net worth of more than $1 million, excluding the value of their primary place of residence. Alternatively, the proposed investor needs to have a personal income of more than $200,000 (or $300,000 joint income with a spouse) in each of the two years immediately preceding the private placement, together with a ‘reasonable expectation’ of the same level of income in the current year. This is explained in the SEC’s Accredited Investors page. Similar rules apply in Canada and in some European countries, with values expressed in local currencies.

• Non-accredited investors

Non-accredited investors are those individuals who fail to meet the conditions either as office-bearers of the issuer or through their own financial status. As previously explained, the number of these non-accredited investors is limited to 35 for all levels of private placement, with the extra requirement that they must each have demonstrable investment acumen where a company’s placements exceed $5 million over twelve months.

Individuals can therefore invest in private placements made by an organization of which they are a director, executive officer or general partner. Otherwise, they must be either an accredited investor or one of not more than 35 non-accredited investors in the placement. Where an organization has exceeded the limit of $5 million in private placements over twelve months, non-accredited investors must also demonstrate that they are sophisticated investors.