The SEC has strict rules about how offerings of stock in a private company can be made and who may purchase the shares. Private stock is not registered with the SEC, and the companies are not required to report financials and key company developments. These disclosure requirements apply only to companies with stock issued through registered public offerings. Resale of private stock is also prohibited unless the transaction meets certain requirements.
Private stock is issued under Regulation D of the Securities Act of 1933, which requires all offerings of stock to be registered with the SEC or be offered in compliance with Regulation D requirements. Reg D has three exemption levels known as Rules 504, 505 and 506. They primarily apply to the amount of the offering. Most private offerings are made under Rule 506. If you are approached to buy private stock, Reg D requires that you receive a private placement memorandum disclosing the company business and potential negatives associated with the company and the value of the investment. Also required is a subscription agreement and an accredited investor questionnaire.
Private stock can only be sold to accredited investors, unless the investors meet specific requirements as non-accredited investors. An accredited investor is an individual who has a net worth higher than $1 million, excluding the value of her primary residence. Or, she may qualify if she has annual income in the previous two years higher than $200,000 or, if married, $300,000 in combined spousal income, and expects to maintain that level for the following year. A director, executive officer or general partner of the company issuing the securities is also considered an accredited investor.
Non-accredited investors able to buy stock in a private offering include relatives and spouses of accredited investors, providing they live at the same address. Trusts, estates and corporations owned by an accredited investor also qualify. A company may only sell stock to 35 non-accredited investors. These restrictions are imposed to protect inexperienced investors or those whose lifestyle would be severely affected by losing the money they invest in private stock.
Restrictions governing who may buy a private placement of stock also seek to protect investors who might need to sell their securities for financial reasons. It is extremely difficult to sell private stock. Such stock is “restricted” by the SEC so, unless you obtain an attorney's letter stating your stock is exempt from registration with the SEC, you can't sell your stock. Such exemptions are common, but there is no market for most private stocks. There are a few alternative exchanges that try to trade some of the more popular issues, but the market is still extremely illiquid. If you need to sell your private stock, contact the investor relations manager at the issuing company and ask for an attorney's exemption letter. You can sell your stock to another private individual or company if you know someone who wants to buy it, but first inform the issuing company and obtain the attorney's letter.
- Mondaq: United States: Market Practice Evolves Under The Jumpstart Our Business Startups Act
- Hinshaw & Culbertson, LLP: Securities Rules for Private Equity Financings
- U.S. Securities and Exchange Commission: VI. Are There Legal Ways To Offer and Sell Securities Without Registering With the SEC?
- U.S. Securities and Exchange Commission: Risky Business: "Pre-IPO" Investing
- U.S. Securities and Exchange Commission: Regulation D Offerings
Victoria Duff specializes in entrepreneurial subjects, drawing on her experience as an acclaimed start-up facilitator, venture catalyst and investor relations manager. Since 1995 she has written many articles for e-zines and was a regular columnist for "Digital Coast Reporter" and "Developments Magazine." She holds a Bachelor of Arts in public administration from the University of California at Berkeley.