Private or closed companies may keep a low profile, but they play a pivotal role in the United States economy. Consequently, investors consider private companies when identifying businesses in which they want to invest.
As with any investment, a rational investor will conduct some due diligence on multiple targets in terms of their current financial and operational status as well as their likely future success. In short, an investor must know a company's value and have an idea of what moves the company might make to make it even more valuable.
Once you've completed your due diligence and identified a private company in which you want to invest, you can use one of three options to purchase the private company's stock.
Private Corporations and Restricted Shares
A private company is prohibited from selling unregistered shares in the company to the public and, in this way, the shares are said to be "restricted." In most cases, to sell its unregistered shares, federal regulations require the private company to acquire a registration exemption. But regardless of this stipulation, in some cases, it is possible to purchase private common stock whether you are a wealthy investor or an investor of average income.
Closely Held Common Stock
A corporation that has yet to issue stock through an IPO, or initial public offering, is a private corporation. In this case, one or a small number of the company's founders hold the majority of the corporation's common stock, hence the term closely held stock. The mix of owners may also include venture capitalists or private equity firms that hold shares of common stock, preferred stock or debt in the private corporation.
Each of these private stock arrangements is allowed by the Securities and Exchange Commission regulations that also exempt that stock from public registration under certain circumstances. For instance, a person which the SEC terms a "sophisticated investor" can negotiate with the private corporation to purchase shares directly from the company. In this case, the stock purchase contract is referred to as a private placement memorandum.
In many cases, to qualify for the purchase of restricted shares of a private company's common stock, the potential investor must be an accredited investor. This means that the investor must have received an annual income of $200,000 or more in each of the two years preceding the purchase. Alternatively, the investor must have a net wealth of $1 million or more, an amount that excludes the person's primary residence.
In the case of an accredited investor, an existing private company shareholder can sell shares to that investor, but that investor can't make them available for public resale. In some cases, a registered broker-dealer acts as a go-between by identifying an owner of restricted shares of a private company who's willing to sell the shares to an interested buyer.
Read More: Types of Investments
In some cases, federal regulators issue a corporation a registration exemption by which the company can sell a limited number of private common shares to non-accredited investors. This option may be possible for restricted shares that comply with SEC Rule 144.
Rule 144 states that restricted shares may qualify for public resale in as little as six months to one year following the shares' issue. Consequently, following that holding period, an owner might sell the private shares publicly. Often, a broker facilitates this transaction.
Read More: How to Sell Privately Held Stocks
Crowdfunding Private Shares
Alternatively, non-accredited investors might purchase private common stock through a crowdfunding website. As stipulated by the Jumpstart Our Business Startups Act of 2012, an average investor can buy private common shares using an equity crowdfunding approach. In this case, a private corporation sells its stock via a crowdfunding portal to non-accredited investors. According to the 2012 Act, a private company can raise as much as $2 million using this process.
Crowdfunding sites require all purchasers to register with the portal and read the private corporation's financial disclosures before placing a purchase order. Then, the participant's order dollar value is limited on the basis of the potential investor's income.
While a private company may keep a low profile, it may play an essential role in the United States economy. Consequently, some investors choose to acquire shares in these companies. While federal regulations place limits on the sale of closely held stock to both accredited and non-accredited buyers, a buyer can acquire shares in a private company using one of three options: make the stock purchase as an accredited investor, make the stock purchase as a non-accredited investor per Rule 144 or complete the purchase via a crowdsourcing platform per Jumpstart Our Business Startups Act of 2012.
- SEC.gov: Small Business
- StartEngine.com: What Is Equity Crowdfunding
- Investor.gov: Accredited Investors
- SEC.gov: Rule 144: Selling Restricted and Control Securities
- SEC.gov: Investor Bulletin: Private Placements Under Regulation D
- SEC.gov: Spotlight on Crowdfunding
- SEC.gov: Net Worth Standard for Accredited Investors
- SEC.gov: SEC Adopts Rules to Permit Crowdfunding
- An accredited investor is an individual who has a net worth of $1 million or more, or has reliable annual income of $200,000 or $300,000 if investing as a couple. The SEC sets these requirements in an attempt to assure that people who are investing in private placements are sophisticated enough to understand the risks or wealthy enough to afford the potential losses.
- Not every private company goes public at a premium price, and not every private company goes public. Some want to go public and will tell you that is their intention, but either don't have the money to spend on audits, attorneys and investment bankers, or they have some internal problem that must be solved before they can qualify to go public.
Billie Nordmeyer is an IT consultant of 25 years standing. As a senior technical consultant for SAP America and Deloitte Touche DRT Systems, a business analyst, senior staff, and independent consultant, Billie has worked across the retail, oil and gas, pharmaceutical, aeronautics and banking industries. Billie holds a BSBA accounting, MBA finance, MA international management as well as the Business Analyst and Software Project Management certificates from the Cockrell School of Engineering at the University of Texas at Austin.