There is an increase in the use of private placements as a means for raising equity funds according to an article at Inc.com. "According to Capital Hunter, a California-based research firm, there were nearly 2,000 more Reg D filings in 2004 than the year before - accounting for a 14% increase."
Certainly the chill that Sarbanes-Oxley has put on the path of "venture capital money leads to an IPO" that many entrepreneurs in high capital start-ups is partly behind this trend. Also, the ever growing expectations for high returns among VCs have caused many entrepreneurs to look to other options such as angels, angel networks and private placements.
Private placements are highly regulated and require careful attention to the rules. Investors must be "accredited", which means they must be one of the following:
-Any national bank
-Any corporation or business trust with assets in excess of $5 million.
-Any insider of the issuing company (officer, director, or owner).
-Any individual with income over $200,000 or couple with income over $300,000 (must have two years with income at these levels and reasonable expectations on continuation of this level of income).
-Any individual with net worth in excess of $1 million.
The SEC has specific rules (504, 505, and 506) that dictate how much money can be raised in a private placement, but most stay under the $1 million threshold to keep it simple and to keep costs to a minimum.
Advertising and formal promotion of a private placement is prohibited, so potential investors are typically found through personal networking. It can be a very time consuming process. Attorney fees can add up as the information supplied must comply with all formal requirements.
Managing a business that has raised funds this way can create complexity for the entrepreneur. Since transfer of stock is usually restricted, any shareholder problems will be long-term. Also, management of the Board becomes much more formal, complex, and even become quite a political process.
Inc.com makes private placements sound simple. They are not, but they can be a good option for some new ventures.
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