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|EDUCATION: MBA, MS Finance from NYU, DePaul||BLOG: Eric Bank, Freelance Writer|
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Private Equity Sales for Small Businesses
A private company has the right to sell stock even though it hasn't registered the shares for public trading. To do so, it must take advantage of certain Securities and Exchange Commission “safe harbor” rules that allow you to privately place unregistered stock. This is handy, because the alternative, an initial public offering, is hugely expensive and not really appropriate for a small business.
The SEC’s Regulation D Rule 506 allows you to sell an unlimited amount of unregistered stock. First, you have to complete and submit Form D to the SEC, detailing some facts about your business. After the SEC approves your submission, you can sell stock to no more than 35 “accredited” investors.
An accredited investor has $1 million in wealth, not counting a principal residence. Another way to achieve this designation is to gross $200,000 in income for each of the two past years. If you’re married, make that $300,000. An institution can also be accredited -- venture capital firms, private equity banks, hedge funds, etc. In the past, you couldn’t simply advertise your desire to sell private stock, but that changed on Sept. 23, 2013.
From that date forward, you could publicly market your private shares. That means you can hawk them on your website, in the public media and elsewhere. The only thing that you must remember is that you can only sell your shares to accredited investors. The SEC puts the onus on you to check out your potential investor before closing the deal. The rules allow you to hire someone to do the checking, and indeed a cottage industry is springing up just for this purpose.
The SEC’s move might free up capital for projects and investments. However, the big story that is still waiting in the wings is equity crowdfunding. The 2012 JOBS Act created this new way for small businesses to raise money from modest investors -- no need to find accredited investors. Under equity crowdfunding, you can raise up to $1 million a year by selling private stock shares through websites, called crowdfunding portals, to the public. There are income-related caps on how much each investor can buy. But the real rub is that the whole enterprise is on hold until late 2014 at the earliest, as the SEC continues to work out the details.
Of course, crowdfunding isn’t for everyone. If you are a tiny business, selling shares to the public can create a bunch of “partners” with “input” you don’t need or appreciate. However, there are ways to work around intrusive shareholders.
In the meantime, if you are considering a Section 506 private placement, know that after six months, the share buyer can sell the stock publicly. This means that eventually, your private shares might be floating around in the public market. We don’t think that this will be a major concern, just something you should be aware of. The prospect of a fresh capital injection has many small businesses very excited.