Private Placement Services
Raising capital through the public marketplace can be a milestone
for certain companies and a necessity for other companies. A successful
company that is growing rapidly can access the public marketplace
to raise capital to create liquidity for expansion purposes. A company
that is having operational problems may also need to access the public
marketplace to raise capital for liquidity purposes. Most of us view
raising capital as a function for companies that are only traded
in the public marketplace. While this may generally be true, private
companies may also have an opportunity to raise capital in the private
marketplace. This article is an introduction to certain methods that
privately held companies have available at their disposal to raise
capital in the private marketplace.
Private companies can raise growth capital through internally generated
funds, bank loans and the private placement of their securities.
Many companies can generate the capital they need through traditional
bank financing methods. However, bank financing is often not enough
to achieve the necessary capital needed for the task at hand. Private
placement transactions are usually needed to generate the additional
amount of capital in excess of bank financing needed by a company
to facilitate the task.
A private placement is the sale of the securities of a private
company to private individuals or other entities to raise capital.
Private placements are typically used by companies in conjunction
with bank financing to fund certain projects and initiatives, and
to create liquidity for operations. The sale of any security is regulated
to some degree. Raising capital through public markets is regulated
by the Securities and Exchange Acts of 1933 and 1934 (the Act). Most
private placement transactions are exempt from the Act under Regulation
D but may require a federal and state review of the prospectus that
will be used by a company to raise private funds. The following rules
outline the most common private placement transactions.
RULE 504 - Offerings Up to $1 Million
Rule 504 of Regulation
D provides an exemption from the registration requirements of federal
securities law for some companies when they
offer and sell up to $1 million of
their securities in any 12-month period. The exemption generally
does not allow companies to solicit
or advertise their securities to the
public, and purchasers receive "restricted
securities," meaning they may not sell the securities without
registration or an applicable exemption.
Rule 504 of Regulation D allows some companies to make a public
offering of freely tradable securities if one of the following circumstances
is met:
1) The company registers the offering exclusively in one or more
states that require a publicly filed registration statement and delivery
of a substantive disclosure document to investors;
The company registers
and sells the offering in a state that requires registration and
disclosure delivery; and also sells in a state without
those requirements, so long as the
company delivers the disclosure documents required by the state
where the company registered the
offering to all purchasers (including
those in the state that has no such requirements); or3) The company
sells exclusively according
to state law exemptions that permit
general solicitation and advertising, so long as the company sells
only to "accredited investors.”
RULE 505 - Offerings Up to $5 Million
Rule 505 of Regulation D provides an exemption from federal securities
law if the following circumstances are met:
1) The company can offer and sell up to $5 million of its securities
in any 12-month period.
2) The company may sell
to an unlimited number of "accredited
investors" and up to 35 other persons who do not need to satisfy
the sophistication or wealth standards
associated with other exemptions;
3) The company must
inform purchasers that they are receiving "restricted
securities," meaning that the securities cannot be sold for
at least a year without registering
them;
4) The company may not use general solicitation or advertising to
sell the securities.
5) Financial statements need to be certified by a certified public
accountant.
RULE 506 - Offerings Unlimited
Rule 506 of Regulation D provides an exemption from federal securities
law if all of the following circumstances are met:
1) The company may raise an unlimited amount of money.
2) The company may sell
its securities to an unlimited number of "accredited
investors" and up to 35 other purchasers. The non-accredited
investors must be sophisticated and
have sufficient knowledge and experience in business and financial
matters making them capable
of the merits and risks of the prospective
investment.
3) The company must
inform purchasers that they are receiving "restricted
securities," meaning that the securities cannot be sold for
at least a year without registering
them.
4) The company must provide
non-accredited investors a disclosure document and provide any
information that has been provided to "accredited
investors."
6) Financial statements need to be certified by a certified public
accountant.
7) The company may not use general solicitation or advertising to
sell the securities.
8) The company must be available to answer questions by prospective
purchasers.
Deal
Structure - Private placement transactions can take up to 12
months to complete. The following illustrates the typical activity
by month.
Month 1 - Evaluation of the deal, review financials, business plans,
preliminary valuation and preliminary structure of the deal are developed.
Month 2 – Finalization
of the deal structure, and preparation of documents and filings.
Months 3 through 12 - Begin to market or move the deal.
Disclosures: - A private placement transaction requires the issuer
of the security to disclose information about the transaction in
an offering memorandum. The following list of disclosure items are
usually found in an offering memorandum:
1) Description of the Offering
2) Disclosures of Risk and Restriction
3) Description of the Issuer
4) Offering Period
5) Offering Price
6) Description of the Issuer
7) Executive Summary
8) Historical Financial Information
9) Prospective Financial Information
10) Use of Proceeds
11) Dilution
12) Management
13) Professional Advisors
14) Shareholder Liquidity
15) Business Plan
16) Suitability Questionnaire
Accredited
Investors: - An accredited investor is one who has a
net worth of $1.5 million or more, has had an annual income of $200,000
or more in each of the two most recent years ($300,000 jointly with
a spouse), and who has a reasonable expectation of reaching the same
income level in the current year. Assets under management of $750,000
must be in place at the time of set-up or shortly thereafter. Accredited
investors are required to complete a questionnaire to determine the
knowledge, suitability and experience of the investor in evaluating
the risks of the prospective investment.
Liquidity: - A private placement can be sold through a registered
broker-dealer or directly by the issuer. A private placement investor
must sign a letter stating that he intends to hold the stock for
investment purposes only. The stock certificates bear a legend indicating
that the shares are restricted usually for a period of at least one
year. Because of these restrictions, the shares are considered illiquid.
Raising capital in the public marketplace is very expensive and
is not an option for most privately held companies. Raising capital
in the private marketplace will usually cost the company 10 percent
to 15 percent of the total proceeds raised in a typical transaction.
Generally speaking, it is very difficult to raise capital through
the private marketplace. There is a tremendous amount of knowledge
necessary in the areas of business valuation, financing structure,
the marketplace and legal considerations. The company can perform
these types of transactions internally however; it is the author's
recommendation that a company interested in private placement transactions
engage a seasoned professional to quarterback the process.
In summary, the private placement transaction offers a supplemental
form of financing through the self-underwriting of a company's own
securities. In some cases, the private placement transaction is the
only available method for a company to raise funds.