Private placements are a critical piece of the investment landscape, especially as companies stay private longer. While not without risk, they offer accredited investors unique investment opportunities to invest in companies before they go public. Through private placements, more investors can now access investments that were once typically available only to institutions like venture capitalists. Companies can also raise funds without the complex and costly process of a public offering through these placements.
Accredited investors should know the differences between 506(b) and 506(c) private placements to make smart investment choices. In this blog post, we’ll dive into the specifics of these two types of private placements and what investors should know.
What is a Private Placement?
A private placement involves the sale of securities to a select group of investors without a public offering. This allows companies to sell equity or debt securities to select investors, such as institutional investors or accredited investors. In doing so, private placements allow companies to raise funds more quickly and efficiently while avoiding the extensive regulatory requirements required of public companies and offerings.
For accredited investors, private placements provide access to unique investment opportunities with potential for high returns, like pre-IPO stock. Popular alternative investments such as venture capital, hedge funds, and private equity are often available through private placements.
Regulation D: The Framework for Private Placements
Regulation D provides exemptions from the Securities and Exchange Commission (SEC) registration, simplifying the process for companies or investment managers to raise capital. Within Regulation D, Rules 506(b) and 506(c) are the most commonly used exemptions, each with unique characteristics and requirements.
Rule 506(b) Private Placements
Rule 506(b) is the traditional and widely used private placement exemption. This is the structure used by EquityZen to offer pre-IPO stock via our funds. Here are the key features:
- Investor Limits: Under 506(b), a company can raise unlimited amounts of money. They can do this from both accredited investors and up to 35 non-accredited investors. Accredited investors include individuals with a net worth exceeding $1 million (excluding their primary residence) or with an income of over $200,000 in each of the last two years (or $300,000 combined income with a spouse or spousal equivalent), among other criteria. Any non-accredited investors must be knowledgeable in finance and business to assess the benefits and risks of an investment.
- No General Solicitation: One major restriction of 506(b) is that companies cannot widely solicit the public or advertise to sell investments. This means they cannot advertise an offering through public media such as newspapers, the internet, or television.
- Disclosure Requirements: If non-accredited investors invest, the company must provide disclosure documents, similar to those used in registered offerings. However, if only accredited investors participate, the disclosure requirements are less stringent.
Interested in browsing the private company investment opportunities available on EquityZen's marketplace?
Rule 506(c) Private Placements
In 2012, the JOBS Act created Rule 506(c) to allow general advertising with more rigorous verification requirements for investors. Here are the key aspects:
- General Solicitation Permitted: Rule 506(c) lets companies advertise their offering, unlike 506(b) which does not allow this. This broader reach can help companies attract a larger pool of potential investors.
- Accredited Investors Only: 506(c) offerings are only available to accredited investors. The company must take steps to verify each investors’ accreditation status. This can include reviewing documentation like tax returns, bank statements, or obtaining written confirmation from a third party (like as a broker-dealer, attorney, or accountant).
- No Non-Accredited Investors: Unlike 506(b), 506(c) does not allow non-accredited investors to participate, regardless of their sophistication.
- Disclosure Flexibility: Since only accredited investors can participate, there are no mandatory disclosure requirements. However, issuers typically still provide detailed information to satisfy investor due diligence.
Benefits of 506(b) and 506(c) for Accredited Investors
506(b) Opportunities:
- Access to Exclusive Deals: Many 506(b) offerings are shared within established networks, like EquityZen’s marketplace, providing access to exclusive investment opportunities.
- Relationship Building: These offerings may facilitate direct relationships with company founders and management or investment managers, enhancing insights or access.
- Confidentiality: 506(b) offerings do not publicly advertise, so investments typically remains more discreet.
506(c) Opportunities:
- Broader Access: Given the option for general solicitation, investors may discover a wider range of investments through social media or other channels.
- Transparency and Verification: The verification process for 506(c) offerings ensures that all investors meet the accredited status, potentially reducing risk.
- Market Reach: Companies or investment managers using 506(c) offerings may attract more capital quickly.
Private placements through Rules 506(b) and 506(c) allow accredited investors to invest in growing private companies. Understanding the nuances of these regulations is important. When looking at private investments, it's crucial to know the specific structure and details of your investment. By doing so, private placements can become a valuable component of a diversified investment portfolio.
Risks of 506(b) and 506(c) for Accredited Investors
Private placements also come with risks. Some of these risks include
- Lack of Liquidity: Private placements are typically long-term investments that investors should expect to hold for several years. Liquidity is not readily available like in the public markets. This means investors should only invest capital that they are comfortable locking up for an elongated period of time. This is one of the trade offs of the illiquidity premium.
- Higher Uncertainty: Private investments are not typically required to disclose the same level of information about their financials, growth and performance publicly, which can pose a due diligence hurdle for private market investors. It is important that investors conduct thorough due diligence and invest with experienced investment managers to help mitigate this risk.
Private placements can open up exciting new investment opportunities for accredited and institutional investors. By understanding the nuances between different offerings, investors can make smart decisions that align with their investment objectives.
Disclaimer: Private placements of securities are not publicly traded, are subject to holding period requirements, and are intended for investors who do not need a liquid investment. Investing in private placements may be considered highly speculative and involves a high degree of risk, including the risk of substantial loss of investment. Diversification does not assure a profit or protect against market loss.
Interested in browsing the private company investment opportunities available on EquityZen's marketplace?
