Private Placement from the Issuer’s Perspective- Part 1 The Basics

By Vivek Krisnaswamy, for Legal Corner LLP. Vivek is a final year student of NALSAR University of Law and will be graduating in 2021. 

The views expressed here are not to be considered as legal opinion. You may not rely on this article as legal advice. You should reach out to me ( if you need advice and assistance with private offerings in the US so as to get legal advice that is specific to your business needs. 

What is Private Placement?

Private placement refers to the offering and selling of stock and bonds to a small group of pre-selected, “accredited investors”, rather than in the public market. It is an alternative to an initial public offering for a company seeking to raise capital for expansion. These investors could be banks, pension funds, mutual funds, insurance companies, or extremely wealthy individuals. As expert investors, “sophisticated investors” usually have more bargaining power and can easily acquire financial information from issuing companies before making a deal. Seeing as these investors can conduct due diligence themselves, the Securities & Exchange Commission does not provide them with the same level of protection awarded to the average investor, giving companies more freedom to choose what to disclose to potential investors.

How is it Regulated?

Investors receive sufficient disclosures and other protections from the rules and regulations laid out in the Securities Act of 1933, “the Act.” All securities in the United States have to register with the SEC or qualify for an exemption. Section 4(a)(2) of the Act exempts registration of transactions that do not involve a public offering. To be eligible for this exemption, the purchaser of the security must (1) have the required expertise in finance and business to be able to evaluate and bear the investment’s economic risk, (2) have the ability to acquire the information that is usually presented in a prospectus for a registered securities offering, (3) not resell securities to the public. If a company offers securities to even one person who does not satisfy these conditions, then said company would be in violation of the Act. For a better understanding of the requirements of all exemptions, one can refer to Rule 504, 506(b), 506(c), of Regulation D; Regulation S; or Rule 144A. It’s imperative to look through the act and decide under which category you would like to offer private securities with the help of a lawyer, to ensure that your company doesn’t accidentally violate the Act or any anti-fraud provisions.

Who is an Accredited Investor?

The definition of an Accredited Investor (AI) can be found under Rule 501 – any natural person with a net worth of at least $1 Million (excluding primary residence); OR has an income of at least $200,000 each year for the last two years ($300,000 combined income if married) and have the expectation to make the same amount this year. AIs are expected to be well informed, able to fend for themselves in the world of finance and business, and protect their interests. The definition did not consider the actual financial sophistication of the investor, and tests were based on the income of the potential investor.

On August 26, 2020, the SEC made several changes to this definition, that make it more inclusive by broadening its scope and including a new principle for determining who is worthy of the AI title. While there are many technical additions to the definition, the one that could be the most important change would be – “Add a new category to the definition that permits natural persons to qualify as accredited investors based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the Commission may designate from time to time by order.” – because it shows that the SEC has accepted the general principle that “sophistication” can and should be one of the methods of determining who can become an AI.

When & Why is Private Placement Preferred?

Stock is usually offered privately by Companies looking for smaller amounts of capital from a limited number of investors. Start-ups, particularly those that are in the risky internet and fin-tech sectors, benefit from this set-up. Suppose a company chose to issue shares under Reg. D, then it would be exempt from many reporting requirements – saving the company time and money. By keeping the investor pool small and sophisticated, the company can afford to sell more complex securities, maintain private ownership, and control its annual disclosures with the SEC.

Considering the high risk, lower liquidity, and higher complexity of the securities being offered, it may not be easy to market private stock. These factors would also result in more demanding buyers. Higher rates of interest, collateral, or even for a higher percentage of ownership in the company are just a few things companies that offer private stock are willing to trade for a quicker issuing process, that allows them to remain private entities, and helps avoid the full glare of the public’s and SEC’s scrutiny.

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