When a company sells shares of its stock (or limited liability company membership interests or partnership interests) to third party investors, an offer and sale of securities has occurred. The general rule both under US federal law and state securities laws is that all securities must be registered unless the offer and sale qualifies for an exemption from the US federal and state securities laws registration requirements. Registration is a costly process that requires extensive interaction with the SEC and generally is a task undertaken by companies with larger capitalizations. Legal fees alone can range into the hundreds of thousands of dollars. An example of such a company would be any company whose securities are freely tradable on a public stock exchange, such as NASDAQ or NYSE.
A securities offering exempt from registration with the SEC is sometimes referred to as a private placement or an unregistered offering. Generally speaking, private placements are not subject to some of the laws and regulations that are designed to protect investors, such as the comprehensive disclosure requirements that apply to registered offerings. Private and public companies engage in private placements to raise funds from investors. Hedge funds and other private investment funds also engage in private placements. The transaction costs (i.e., legal fees) for a private placement almost always will be substantially lower than with a publicly registered offering.
As an individual investor, you may be offered an opportunity to invest in an unregistered offering. You may be told that you are being given an exclusive opportunity. The opportunity may come from a broker, acquaintance, friend or relative. You may have seen an advertisement regarding the opportunity. Keep in mind that private placements can be very risky and any investment may be difficult, if not virtually impossible to sell. On the buy side, while you are buying a bona fide interest in the company, you may not know all of the implications associated with the investment, and that is why it is so crucial to engage an attorney to represent your interests.
If you are a company that is interested in selling its securities to raise capital, it is very important to understand what your specific obligations are to your investors so that you can avoid the risk of liability for securities fraud. Selling securities in a private placement can be a great tool to raise capital for your company, but it is a substantial undertaking and should not be attempted without the advice of an experienced securities attorney.
Written by: Roland Wiederaenders, Attorney