Private Placements . . .
are sales of company securities that do not involve a
public offering and that are not required to be registered with the
federal and state securities commissions. "Private Placement"
refers to offerings that comply with the requirements of an exemption
to the registration requirements of the securities laws. In most
cases, the exemption calls for the preparation of an offering
memorandum that describes the company and the risks associated with
investing in it. Sometimes the exemption permits a sale of a limited
number or securities to certain qualified investors without a formal
Failure to register the sale of securities or to
comply with the requirements for an exemption from registration can
impose serious liabilities on a company and its management.
Experienced counsel should be consulted before any offering of company
securities is made, including an offer to a professional venture
Whether an offering is a private placement depends
upon a number of factors, including requirements and limitations
relating to the
Number of offerees (not purchasers).
Experience and knowledge of the offerees in making
Ability of the offerees to bear the economic risk
of the investment.
Number of securities offered.
Size (in dollars) of the offering.
Manner in which the offering is conducted.
The company issuing securities also bears the burden
of establishing that each offeree in a private placement has had
appropriate access to sufficient information about the company and is
capable of fending for himself in analyzing such information to reach
an investment decision. To fulfill this burden the issuing company
must document the identity of each offeree, the characteristics that
make him an appropriate purchaser, and the nature of his access to
This requirement can be hard to meet with any
certainty. This is because it requires the issuing company to make
judgments about the nature of the offerees. While this may be
relatively easy to do with institutional investors (such as
established venture capital funds), which are clearly sophisticated
and able to fend for themselves (based on the fact that they have made
many other investments), judging the qualifications of individual
investors is more difficult. As a general rule, individuals who are
officers of the issuer or who have made similar investments before and
are familiar with the issuerís operations will be easier to qualify
than individuals who are not involved in the companyís ongoing
operations or who have not made investments in similar ventures.
Companies must also be sure that the purchasers of
their securities are acquiring shares for investment and not for the
purpose of redistributing them. If those purchasers, in turn, transfer
the securities to others, the company may be deemed to have engaged in
a public offering from the outset and to have violated the
In order to prevent such transfers, companies should
require each purchaser in a private placement to state in writing that
he is purchasing the securities for his own account and without a view
to their subsequent distribution. In addition, the company should
place a restrictive legend on the share certificate that is delivered
to the purchaser. The legend should state that the securities
represented by the certificate cannot be transferred unless pursuant
to an effective registration statement or an exemption from the
registration requirements, which is satisfactory to the companyís
counsel. The company should also instruct its transfer agent not to
transfer any of the securities (containing the legend or not) without
counselís written approval.
It is not difficult to see that the general exemption
for private placements (Section 4(2) of the 33 Act and corresponding
state laws) contains subjective requirements that can be difficult for
a company to fulfill with any certainty. Because of this, the
Securities and Exchange Commission (SEC) and the state securities
commissions have identified a number of more clearly delineated
"safe harbor" exemptions that companies can use to avoid the
registration requirements of the securities laws. These safe harbors
set out very specific objective requirements that must be followed in
order for them to apply. Because of this specificity, companies find
them easier and safer to use than the general 4(2) exemption.
The federal safe harbor exemptions include the Rule
504, 505, and 506 exemptions of Regulation D (discussed in detail in
the Reg D entry), the federal intrastate exemption, and the
Regulation A exemption. In general, these exemptions provide for three
types of offerings with different requirements for disclosure,
investor sophistication and maximum number of investors. One exemption
permits offerings of up to $1 million, another allows offerings of up to
$7.5 million, while the third contains no dollar limitation but
imposes sophistication requirements on "unaccredited"
The federal intrastate safe harbor provides a
registration exemption for local offerings by local companies that are
conducted entirely in one state. It provides objective standards
companies can follow to be sure of obtaining the more general
intrastate exemption contained in Section 3(a)(11) of the 33 Act. The
standards are contained in Rule 147. In general, they permit sales
only in the state of residence of the issuing company and only to
residents of that state. They require that the issuing company derive
a substantial percentage of its revenues from the state and limit resales
of securities purchased in the offering. Under the rule, resales may
be made only to residents of the state for a period of time after the offering. If any resales are made outside the state during
the period, the exemption for the entire offering can be disqualified.
Because of this resale requirement and the restriction of the
exemption to local companies, other exemptions are more commonly used
than the intrastate exemption.
The SECís Regulation A permits offerings of up to $5
million of securities under specified conditions. To meet this
exemptionís requirements, a company must prepare an offering
circular (unless the offering is for less than $100,000) that includes
two years of financial statements. The offering circular is reviewed
by the SEC, much like a public offering circular. Also, as in
registered public offerings, there is no limitation on the number of
persons the shares may be offered or sold to and no special investor
qualification requirements. Nonetheless, the Reg A exemption has been
used infrequently compared to other exemption because of the
restrictions on the amount of money that can be raised and the expense generated by preparing the offering
circular and completing the SEC review. See:
Stock, Public Offerings,
D, Restricted Securities,
SEC (Securities and Exchange Commission),