Businesses’ have a multitude of financing options available to them, from commercial bank loans to venture capital to asset-based financing.  However, few options provide high-growth companies the flexibility and control that private placements, otherwise known as private investment capital, can offer.

What is “private placement”?

Private placement is the investment of capital – usually in the form of stock but can involve other types of securities – by private investors, sometimes referred to as “angel” investors or accredited investors.  Unlike public stock offerings, private placements are exempt from the rigorous, and costly, registration requirements imposed by the Securities and Exchange Commission for securities offerings.

Nevertheless, private placements are not totally free from legal obstacles.  And securities offered or sold improperly, or with incorrect documentation, can incur serious consequences for the issuer and other involved parties.  To issue private placements, most companies rely on the exemptions provided in Regulation D promulgated under the federal Securities Act, and the limited offering exemptions provided under state law.

Why private placement?

First, private placement investors tend to be more patient and less demanding than venture capitalists, who often demand terms and control that can be burdensome to a new business venture.  Secondly, private placements are relatively easy, less costly, and less time-consuming than approaching venture capitalists or undertaking an initial public offering (IPO).

Finally, Regulation D allows for an unlimited amount of fundraising, depending on the specific exemption relied on, without the need for registration.  Although the legal requirements become more complex under Regulation D as the amount of money raised increases, these requirements are nevertheless often less burdensome than the alternatives.

When should a company consider private placement?

Almost any company is a candidate for private placement, whether a start-up or a mid-level company looking to take the leap to the next level. Ideal candidates for private placement should have a solid business plan, and enough product development and market analysis to offer an attractive investment.

However, the exemptions available under Regulation D are not available if any interested party has been subject to certain state administrative actions, court orders, judgments, decrees, or convictions principally concerning wrongful acts involving the sale of securities, such as fraud.

What is required for private placement?

Although Regulation D exempts an issuer from registration, it does not exempt it from the anti-fraud or civil liability provisions of federal securities laws.  It also does not exempt an issuer from complying with state laws, which might, depending on the jurisdiction, require the issuer to file a notice of sale with the state or even apply for a state exemption prior to the sale.  So, to undertake a private placement offering, the issuer is required to comply with both federal and state requirements. The contemplated sale, therefore, can become more complicated if multiple investors hail from multiple jurisdictions.

To meet the requirement of Regulation D, and other federal and state law, the issuer is almost always required to make extensive disclosures regarding the nature, character and risk factors relating to the offering.  The disclosure document is often referred to as an “Offering Memorandum” or “Private Placement Memorandum” and in the normal course is drafted by the issuer’s counsel.  Because the offering is not exempt, as mentioned above, from anti-fraud provisions of federal securities law, the completeness and accuracy of this Memorandum is crucial, and one of the most important documents provided in the offering.

Other documents common to a private placement offering include a stock or membership interest purchase agreement, investor rights agreement, right of first refusal and co-sale agreement, and restated articles of the issuing entity.  Whether any of these documents might be employed, and the sophistication of each, is dependent on the terms of the offering.

No matter the sophistication of the offering, however, a private placement should never be undertaken before consulting with an attorney who can provide the advice and documentation the specific circumstances demand.  If your company is considering a private placement or a public offering, the attorneys of Safford & Baker can provide you with the documentation you will need for your fundraising program.

–Matt