Should You Invest in Private Companies?

Should you invest in non-public companies? A lot of people are doing that, via privately issued equities and debt instruments; hedge funds, venture capital funds and limited partnerships are also popular non-public companies.

This trend includes a broad swath of industries, just not tech companies. Banking is the largest in dollar terms. An advisor presentation on private investing, as part of National Financial Advisor Week, noted that this arena is an increasingly popular and profitable one.

“The new issue private capital market is actually substantially larger than [newly issued companies in the] U.S. public markets and has historically outperformed the U.S. public markets,” said Peter Williams, chief executive of Ace Portal, a private securities broker. The new issue private security market is now about $1.6 billion, or about three times the total of newly public companies, which is shrinking by a percent or two, he said.

Although tracking the performance of the asset class is difficult, the private placements markets out-performed the public markets by 18 percent from 1984 to 2010, according to an Ohio State study.

The panel, on “How to Safely Invest in Private Companies,” was held recently as part of National Financial Advisor Week in New York’s Times Square. This event, which attracted hundreds of onlookers, featured financial advisors giving tips on personal finance, ranging from retirement saving to college funding. The panels also focused on how people can get the most out of advisors. At the event, Jennifer Rufener of Dover, Ohio, won a sweepstakes for a free college education.

The number of new private offerings is growing at a 15 percent rate and increasingly becoming an important asset class in individuals’ portfolios, Williams said. Credit a number of regulatory changes for the surge in popularity. The Securities and Exchange Commission loosened its rules to allow private securities sponsors (banks, insurance companies, registered investment advisories and their ilk) to market them to a wider audience.

In the past, the SEC restricted sale of private securities to institutions and individuals in which the securities’ sponsors had a “substantive pre-existing relationship.” That of course hindered the sale of these securities. Now, sponsors can market the securities to any accredited investor, whether the sponsors know them or not.

In addition, the SEC used to prohibit any advertising and limited the number of investors allowed to participate, in some case to as few as 50.

Oh, and technology – technology has put the offerings in the 21st century, allowing private security sponsors to reach a wider audience. In the not-to-distant past, the securities were sold “by a couple of guys on the phone,” Williams said. And because the SEC rules were so stringent on the asset class, “The list of investors was literally the same 50 investors every time,” Williams said.

The growth is also largely due to the U.S. JOBS Act (Jumpstart Our Business Startups), which Williams said, made “sweeping” changes to the market and gives greater access to individuals and may increase liquidity. The 2012 law allows crowdfunding for small companies and social media to enlist investors. The securities must be registered with the Securities and Exchange Commission in most cases.

Of course, to invest in the private securities, such as hedge funds and debt securities, an investor has to be an accredited investor, defined as a person with income of at least $200,000 for the two previous years or joint income for a couple of at least $300,000.

Some institutions that are now allowed to buy private securities include employee benefit plans, so long as the plan has at least $5 million in assets.

“Participants need to be cautious. No matter what private securities will always be less liquid than the public market,” he said. And the risk of being swindled is higher than in the public markets. “For an investor this is something you will want to talk to your advisor about,” he said. And advisors “will need “to keep up to speed” about what’s happening in the private capital market space.

Follow AdviceIQ on Twitter at @adviceiq

AdviceIQ delivers quality personal finance articles by both financial advisors and AdviceIQ editors. It ranks advisors in your area by specialty, including small businesses, doctors and clients of modest means, for example. Those with the biggest number of clients in a given specialty rank the highest. AdviceIQ also vets ranked advisors so only those with pristine regulatory histories can participate. AdviceIQ was launched Jan. 9, 2012, by veteran Wall Street executives, editors and technologists. Right now, investors may see many advisor rankings, although in some areas only a few are ranked. Check back often as thousands of advisors are undergoing AdviceIQ screening. New advisors appear in rankings daily.