Private Placements are offerings of new securities by an issuer made privately without registration with a government authority. Such securities are typically subject to a resale holding period and are, therefore, not a liquid investment. Investing in Private Placements is speculative and highly risky and is only appropriate for certain investors. We do not provide tax, legal, or accounting advice and do not recommend the suitability of any investment or investment strategy. You assume full responsibility for determining whether any new issue is appropriate for you.

If your company is not publicly traded, and you are seeking equity capital as funding, then you need private equity investors. The owner and the principals of your company are free to invest your own money. Your family members and the family of principals are also generally exempt from any restriction on investing in a private equity placement. In addition to these exempt individuals, you may also have up to 35 non-qualified investors, who can be anyone without exception. You may also have up to an infinite number of qualified investors, who are generally those who meet the test of financial status you suggest.

A private placement memorandum may be organized by an investment banking company on behalf of a private company that is not registered with the SEC and is a non-reporting company. The investment bankers will look over the business plan, the results achieved, and the assets pledged. Often, investment bankers will want to do a good deal of investigation, known in the trade as "due diligence" which will include verifying numbers, audit-type activities, and may include various financial analyses. The investment bankers will then create a private placement memorandum, a document, which they will circulate among their contacts. These contacts may include large institutional investors, wealthy individuals, and anyone else they believe may be interested in an investment in the given company. Often, the investment banker will want the contact lists of the principals of the company to circulate copies of the memorandum to, so they can get the placement fully subscribed as quickly as possible.

It is possible to raise tens of millions of dollars through a series of private placement memoranda, and a number of companies have done just that. Generally, a small amount of money is raised first, often from the principals of the company and their personal contacts. That money is used to develop a refined business plan and get started on some of the essential aspects of the innovation being pursued. This stage of investment is often referred to as seed capital. Seed capital may consist of only a few tens to hundreds of thousands of dollars. It may produce such milestones as a finished business plan and a conceptual design of the products or services to be offered. Few investment bankers or venture capitalists will provide
seed capital.

After seed capital, depending on how the plan is organized, it may be possible to set up several phases of development, and match these to phases of investment. It is sometimes possible to obtain commitments for second round financing which include additional commitments for later rounds of financing in the event milestones are met.

In some instances, companies will decide to go to the public and sell stock through an initial public offering, or IPO. Such a public offering would be made by means of a registration statement and prospectus filed with and reviewed by the SEC , which is generally a lengthy and expensive undertaking.

More often, however, companies will want to conduct a stock offering not involving a public offering, and instead plan for a "private placement". Offers and sales not involving a public offering are exempt from registration under federal securities laws, and most states have comparable exemptions. Case law and rulings under federal securities laws provide some guidance as to what specific transactions may constitute private placements.

Generally, the simplest and safest way to ensure that a private placement offering and transaction is exempt from the registration requirement is to conduct it in a manner that complies with the safe harbor for private placements, Regulation D, [which is found at CFR 230.501-230.508].


Securities Laws

The United States Federal Securities Act of 1933 provides that it is unlawful for any person to make use of any means or instruments of transportation or communication in interstate commerce or the mails to offer or sell a security unless a registration statement is in effect with respect to the security [Securities Act, section 5.]

The Securities Act also provides that the foregoing restriction is not applicable to transactions by persons other than the issuer, underwriter, or dealer, nor to transactions by an issuer not involving a public offering [Securities Act, Sections 4(1) and 4(2).]

These laws have the effect generally of requiring a company to register it's stock or other securities with the SEC prior to offer of sale in interstate commerce unless transactions or securities themselves are exempt from the registration requirement. Most states have a similar requirement.

Securities laws also prohibit the offer and sale of securities without disclosing all material facts about the issuer. As a practical matter, prior to selling stock, every start-up company needs to prepare and deliver to investors an offering document (referred to as a "memorandum" or "prospectus") which describes the business and company's financial condition, all risks associated with the investment, and the products and services offered to which specific markets.


Exemptions From the Registration Requirement

Registration exemptions are a critical portion of the securities laws for smaller firms and start-up companies looking to raise investment funds.

Under federal law, there are three primary exemptions for the private placements of securities as defined in Section 4(2) of the Securities Act of 1933 and SEC Regulation D. These exemptions are set forth in SEC Rules 504, 505, and 506.


Rule 504: Offerings of $1 million or less

The amount of money a company needs to raise will affect the rule under Regulation D you cause the transaction to comply with. In general, Rule 504 may be used for offerings of $1 million or less [17CFR230.504(b)(2)].

Under SEC Rule 504, an issuer may within a twelve-month period issue up to $1,000,000 worth of securities to an unlimited number of unsophisticated investors who purchase the securities for their own account and not for resale. There are no required disclosures under Rule 504 except those that are necessary under the antifraud disclosure laws. (General solicitation is usually limited or prohibited by state law.) The securities are not "restricted securities," and so are free of some restrictions on resale. A Form D must be filed with the SEC within 15 days after the first sale. The date of the first sale is the date on which the first investment agreement is signed by an investor, not necessarily the date on which the money is transferred. The issuer must comply with the securities laws of each state in which a purchaser is a resident, and must usually file a notice with that state's commissioner of corporations or similar official. The persons who acquire the securities should sign an investment agreement as proof of their investment intent and other required representations.

Three major advantages to Rule 504, as contrasted with Rules 505 and 506, are that:

There are no requirements to furnish any specific information to investors investors in a memorandum, although general anti-fraud rules apply, [17CFR 230.502(b)(1)];

The securities obtained in a transaction complying with Rule 504 are not "restricted securities", [17CFR230.502(d),17CFR230.504(b)(1)];

There is no limit to the number of purchasers in the transaction.

Although Rule 504 may seem attractive because of the above three items, it's major drawback is that some states do not have a comparable rule. This means that although your transaction is exempt from federal regulations there may be no comparable exemption under the state laws. The other major drawback is that for most companies $1 Million is simply to little money to achieve the intended objectives.


Rule 505: Offerings of $5 million or less

Rule 505 is available for offerings of $5 million or less [17CFR230.505(b)(2)(i)] and is restricted to 35 purchasers other than "accredited investors" [17CFR230.505(b)(2)(ii), 17CFR230.506(b)(2)(i), 17CFR230.501(e)(1)(iv)].

Under SEC Rule 505, an issuer may a within twelve-month period issue up to $5,000,000 worth of securities to thirty-five unsophisticated investors plus any number of "accredited investors." There are a number of required disclosures, which are described below, if the sale of securities includes investors who are not accredited investors. Advertising and a general solicitation are prohibited. The securities are "restricted securities" and may not be readily resold. A Form D must be filed with the SEC within 15 days after the first sale. The Issuer must comply with the securities laws of each state in which a person who buys the security is a resident, and must usually file a notice with that state's commissioner of corporations or similar official. The persons who acquire the securities should sign an appropriate investment agreement.


Rule 506: Offerings of no limit

Under SEC Rule 506, an issuer may issue an unlimited amount of securities, with no dollar limit, to 35 sophisticated investors plus any number of "accredited investors." There are required disclosures, described below, if a sale of securities includes purchasers who are not accredited investors. Advertising and a general solicitation are prohibited. The securities are "restricted securities" which may not be readily resold. There is a singular and great advantage to Rule 506, and this is that it supersedes and preempts the securities laws of all the states. This save a lot of time, effort, and expense if the issuer is obtaining money from investors in several states. Form D must be filed with the SEC within 15 days after the first sale of securities and also with the commissioner of corporations of each state in which a purchaser is a resident. The persons who acquire the securities should sign an appropriate investment agreement.


Accredited Investors

Both Rules 505 and 506 require that certain specified information must be supplied by the company to "unaccredited investors" [17CRF230.505(b)(1), 17CRF230.506(b)(1), 17CRF230.502(b)]. The term "accredited investor" has a lengthy definition which includes among other things:

A person whose net worth, or joint net worth with his or her spouse exceeds $1,000,000;

A person who has made over $200K in each of the past two years and reasonably expects to do so in the current year;

A person who, with his or her spouse, has made over $300K in the past two years and reasonably expects to do so in the current year.

A financial institution such as bank, broker-dealer, insurance company or business development company.

Any director, officer or general partner of the issuer, or a trust or business partnership with assets in excess of $5 million that was not formed for the purpose of acquiring the unregistered securities.

Any entity wholly owned by accredited investors. [17CFR230.501(a)]

The rules *advise* that if a company supplies information to unaccredited investors, it should consider supplying the same information to accredited ones [17CRF230.502(b)(note)]

In practice a company will usually have it's counsel prepare a private placement memorandum which contains all the information required to be disclosed to unaccredited investors, and the memorandum will be distributed to all prospective investors, whether accredited or not.

Note that investments in Private Placement Offerings are not covered by SIPC insurance. Only registered securities (such as Initial Public Offerings) are included under the SIPC coverage.