Conventional wisdom constantly beseeches investors to balance and diversify. That same wisdom advises portfolios loaded up with stocks and bonds indexed to a wide variety of indices. But in this landscape of volatility and interest rate yields that don’t even keep pace with inflation, conventional wisdom can burn. That’s why savvy, high net worth investors hedge against these downsides with a broad range of alternative classes that include commodities, real estate, notes, and private placements.
Private placements are investments in private enterprises such as restaurants, oil and gas development, real estate ventures, bowling alleys, agriculture projects and farmland, water purification projects, and a variety of alternative energy ventures. And while risky, private placements offer investors an array of dynamic opportunities for portfolio diversification with a low correlation to public markets.
Private Stock Deals
Private placement class investments also include private stock issues, or private offerings. While generally offered primarily to institutional investors such as large banks, mutual funds, insurance companies, and pension funds, these investments are also offered to qualified high net worth individuals. They offer investors the opportunity to get in on the ground floor of an enterprise with the potential for phenomenal returns.
For example, in 2011 the investment bank Goldman Sachs offered private shares in Facebook, the social networking site, at its Initial Public Offering. The private placement was offered with a $2 million minimum and a 4 percent placement fee along with 5 percent of gains. That contrasts to the standard private placement fee of 1 to 2 percent.
Facebook’s underwriters settled at an IPO price of $38 per share, for a market valuation of $104 billion, the largest valuation ever of an American firm at the time. Today Facebook sells for roughly $78 per share for a market valuation of $203 billion. That private placement turned out to be a hugely lucrative play for those select few investors, even with the steep fees.
For companies, private placements can also be a high-value strategy. They offer firms an infusion of capital far more quickly and much less expensively than public offerings, which are subject to costly public disclosure obligations.
These investments come with a number of stipulations and they carry a high degree of risk for a number of reasons. First, private placements are often investments in the early stages of enterprise development—firms that haven’t been fully tested in the open market. Second, private placements often come with holding periods. Investors in these “restricted” securities cannot sell their shares for at least a year.
Third, because private placements are not publicly traded, they have far less liquidity. With common stock investors can sell on the open market when signs of operational struggles and/or stock price declines emerge. Private placements may lock investors into a sinking ship with no means of escape.
There are also restrictions on who can invest. Investment entities must have assets of at least $5 million. Individuals must have a net worth of over $1 million or gross income for each of the last two years of more than $200,000 ($300,000 with a spouse) and the expectation of the same income level in the current year.
Are Private Placements Right for You?
In 2013 the volume of private placement issues hit $49.17 billion, off 9.5 percent from 2012’s record levels. Yet this was still the second highest posting of private placement issuance volume in history. It’s clear: in the current market environment, private placements are attracting savvy high net worth investors seeking diversification with a range of alternatives only marginally correlated to public markets.
Private placements create robust opportunities for companies to generate capital and expand their enterprises without going public. They offer investors early access to a wide range of promising companies and projects, with the potential for steep returns in a lackluster investment landscape.