You’re considering investing in your first private placement. What can you expect?

​​Expect the unexpected. Investing in a private fund is very different from investing in stocks. You can’t just download a Robinhood app and start investing within minutes. That’s just the beginning of the differences between investing in private placements and public equities. There are many others.

Here is what you need to know about private placements:

  • The Market

Where do you find private placements? As the name implies, private placements are private. You can’t find them on the public markets. Although advertising is permitted in certain limited circumstances, most private placements are discovered through personal connections. You won’t find them splashed across CNBC. You won’t hear a peep about them from your financial planner either.

​​Private placements are out there, though. You just have to put in a little effort to find them. Get out in your physical and online communities. Join investment clubs. Develop professional connections. Those are a few starting points.

  • Qualification

Unlike stocks where anyone with money can invest, private placements impose certain qualification requirements based on financial sophistication, net worth, and income requirements. At a minimum, investors in private placements are required to possess a certain degree of financial sophistication and experience where they understand the risks they’re undertaking and are willing to accept the risk of potentially losing their entire investment.

In addition to possessing financial sophistication, most private placements require potential investors to be Accredited Investors, investors meeting certain net worth ($1M not including a residence) and income ($200k per year or $300k per year with a spouse for the last two years with the expectation of the same for the current year) requirements according to SEC regulations.

To qualify to invest in a private placement, most companies will require you to fill out an Investor Questionnaire stating your personal, income, and net worth information to verify your accredited status.

​​In the alternative, Accredited Investor status can be verified by a third-party CPA, lawyer, broker, or other professional familiar with your assets and financial status.

  • The Process

Once you overcome the hurdle of qualifying to invest in a private placement, next comes the offering documents. With public companies, investors are provided access to the company’s prospectus with information on the company, the securities offered, risks, and financial projections.

​​With private placements, this information is provided in a private placement memorandum (PPM). Accompanying the PPM will be supporting documents, including a Subscription Agreement where you declare your intention to subscribe to the securities being offered, including the amount you wish to subscribe to. Within the Subscription Agreement will be instructions for paying for the securities – typically through a wire transfer.

  • Real Companies

Most companies raising capital through private placements are real companies with real products or services to offer. These aren’t pie-in-the-sky enterprises like ICO’s (Initial Coin Offerings) or abstract venture capital pitches. These are tangible companies with tangible products, concrete business plans, and solid underlying economic fundamentals.

  • Investing with a Team

The masterminds behind the private companies raising capital typically have knowledge, experience, and expertise in the industry in which they’re attempting to raise capital. Because they’ve already been behind the block in a particular industry, they’ll also have the infrastructure and personnel already in place for carrying out their business plan.

With private placements, you will be investing in a team, and unlike public offerings where you’re investing in faceless companies, private companies are more transparent. Management makes themselves readily available to answer questions and interface with potential investors.

  • The Financials

Unlike stocks where your return is unpredictable and will be wholly dependent on any price increase of the stock from the time of acquisition until the time of sale, your return on investment from a private placement is calculable and typically based on projections.

​​Management can project potential returns on investment with reasonable confidence because you’re dealing with a tangible business with measurable underlying economic data and fundamentals.

​​For example, suppose there is data available to show the performance of a certain class of asset in a certain market over a certain period of time. In that case, reasonable projections can be made based on an extrapolation of that data, considering all contingencies and variables.

  • Distributions and Exit

Most private companies will make their first distributions after a reasonable ramp-up period. If the business plan involves acquiring a real asset, distributions will typically commence after completion of renovations, if any, and after a few months of operations. Distributions can be made on a quarterly, semi-annual, or annual basis depending on the company.

Most private companies will have a defined exit plan – typically after so many years of operations. The exit plan can involve a sale or refinance of the company’s assets to return investor capital.

  • On-Going Communication

Once you take the plunge and invest in a private company, management will have procedures for updating you on company progress and business developments. Many will even provide an online investor portal where the investor can receive updates, communications, documents, and tax forms from the company – including periodic financial statements and reports, and K-1s.

Investing in private placements can be rewarding, but you’ll be better prepared to make the right investment decisions if you know what to expect.