Accredited Investors and Private Placements
Raising funds to finance a business
There are many sources of financing business expansion or ‘capitalization’, and each of course has its pros and cons. Some banks offer loans to finance the growth of a small business, for example, but most commercial lenders won’t offer any money if the business hasn’t been established long enough. One potentially attractive alternative is a creative business financing mechanism known as “private placement”. Small businesses that are ready to expand are ideal candidates for private placements. The requirements are: a sound business plan, a private placement memorandum (PPM), and a lawyer who has experience in private placement dealings.
What is Private Placement?
Private placement, or private investment capital, is defined as a way for businesses to raise capital without making public stock offerings. These include Direct Public Offerings (DPO) in the form of a Reg A; Small Corporate Offering Registration (SCOR) or Form U-7; Limited Liability Partnership Offering (LLPO) or Private Placement Memorandums (PPM). In each of these methods, money is invested in the business by private (as opposed to institutional) accredited investors, usually in the form of stocks and/or bonds. Compared to taking a company public, private placements are usually less expensive and easier to accomplish.
Private placements are obtained by finding accredited investors. An accredited investor is defined by Rule 501 of Regulation D of the Securities Act of 1933, and must abide by the registration requirements of the U.S. Securities and Exchange Commission (SEC). These investors must meet certain criteria. For example, they must meet one of the following requirements:
- Earn an individual income of more than $200,000 per year, or a joint income of $300,000, in each of the last 2 years and expect to reasonably maintain the same level of income
- Have a net worth exceeding $1 million, either individually or joint with their spouse
- Be a general partner, executive officer, director, or a related combination for the issuer of the security being offered.
These investors are considered to be fully functional without all the restrictions of the SEC.
Benefits of Private Placements
Some of the chief benefits of using private placement to finance a business include the flexibility of financing amounts, a lower cost for this financing, and a shorter timeframe to complete the financial documentation and fund raising cycle compared to other venture capital markets. Two major benefits of offering private stock. The business owner doesn’t have to worry about loan payments as there are none, and there is no risk to personal assets, such as a home or car, etc.
Raising Small Business Capital: Some Definitions
Direct Public Offerings (DPO)
DPOs are the direct sale of shares in a
company to individual investors. After the shares are sold by the company, investors may or may not trade on a stock market or exchange.
Small Corporate Offering Registration (SCOR)
A process by which small businesses can go public without the costs or regulatory requirements of a typical initial public offering.
Limited Liability Partnership Offerings (LLPO)
Fortunately, smaller Limited Liability Companies or Partnerships (LLC, LLP), even those that plan to sell memberships to passive investors, usually qualify for securities law exemptions. For example, SEC rules exempt the private sale of securities if all owners reside in one state and all sales are made within the state; this is called the “intrastate offering” exemption. Another federal exemption covers “private offerings.” A private offering is an unadvertised sale that is limited to a small number of people (35 or fewer) or to those who, because of their net worth or income earning capacity, can reasonably be expected to be able to take care of themselves in the investment process. Most states have enacted their own versions of these popular federal exemptions. (Source: Nolo Law for All)
Private Placement Memorandum, or Regulation D Offering (PPM)
A PPM is the document that discloses all information the investor needs to know to make an informed investment decision: the offering structure, the share structure of the company, SEC disclosures about the shares being purchased, information on the company and its operations, risks involved with the investment, management information, use of proceeds, information on transactions that could affect the investor, and investor suitability data. The PPM includes the subscription agreement which is the actual “sales contract” for the shares of stock. The accredited investor will sign and send this document with their investment funds.
Many companies will attach their business plans to the PPM as supporting documentation. This is an acceptable practice as long as two conditions are met: the information in the business plan must correspond exactly to the information in the PPM, and the investors must be made aware that the business plan alone does not constitute an offer to sell securities.
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