Problem with Private Securities Offerings

The average person believes that they are legally allowed to make any investment that a rich person can. However, this is not true in America, and this is certainly not true in many parts of the developed world. The reality is that the average American population is only legally allowed to purchase securities which are offered by public companies. On the other hand, wealthy Americans known as accredited investors can purchase securities being sold in the private market as well! In order to become an accredited investor, a person must have at least $1 million in net worth or must earn at least $200,000 per annum. It is said that some of the best investment opportunities are denied to the average American investor since they cannot buy private securities offerings.

In this article, we will have a closer look at the way private securities offerings work.

What are Private Securities Offerings?

Speaking from a common sense point of view, the difference between private securities and public securities is that public securities are registered, whereas private securities aren’t. The reality is that the registration process can be extremely onerous and time-consuming. This is the reason why many companies decide to forego the process. This is because they are still in their nascent stage and hence cannot afford to bear the expenses. In order to allow such companies to raise capital, American securities law allows the sale of unregistered offerings as long as the securities are not being sold to the general public.

Over a period of time, private offerings have definitely come of age. Today, most start-up companies raise capital from angel investors and venture capital firms. Private securities are the investment vehicle which is used in the majority of these cases.

Why do Companies Prefer Private Securities Offerings?

There are several reasons which make a company choose a private securities offering over a public one. Some of these reasons have been listed below:

• Venture capitalists and angel investors are fond of these investments. This is because they do not have to disclose much information and can avoid public glare. Preventing the leakage of information is extremely important for companies in the nascent stage. If they fail to do so, they might end up attracting unnecessary competition
• Issuing public securities is expensive. It usually requires a team of lawyers, accountants, and other personnel. The services of these personnel have to be employed because a wide variety of documents need to be prepared in the exact manner as specified by the Securities and Exchange Commission. The cost of this exercise can run into at least a million dollars. If the company just wants to raise a few million dollars, then the entire exercise seems futile.

The Problem with Private Offerings as of Now

• At the present moment, government laws do not restrict the amount of money that can be raised via private security offerings. Hence, it is not surprising that companies sometimes raise billions of dollars using this route. The government must ensure that private securities offerings do not remain a way to raise huge sums of money without providing any information. As a result, the amount of money that can be raised via such offerings must be capped.
• The problem with private security offerings is that they lock out the common investor. As a result, American investors only have mediocre options available to invest in. All the good options are taken up by the accredited investors in the private securities market. The empirical data record is very clear in this regard. The average rate of return provided by the securities issued in the private market is much higher than the ones issued in the public market.
• The government laws surrounding private offerings automatically assume that rich people are smarter and have more access to information. The law also inherently assumes that rich people know which information is important for making an investment, and when should one ask for it. It is assumed that the poor and the middle class are not as information savvy. Hence, the government needs to get involved to ensure that mandatory disclosure are made.

The reality is that in the connected world that we live in today, obtaining information is not really a tough task. Also, in many cases, people inherit their wealth. As a result, they do have the money to be called an accredited investor. However, they do not have any knowledge or experience. The current law assumes that since they are rich, they will be able to bear any losses that arise from these investments.

The reality is that it is not really the government’s job to regulate the safety of investments in the securities market. The government does not need to handhold investors. Instead, they must be provided with the freedom required to make their own decisions and also face the consequences (rewards and/or losses). It is strange that the government allows poor people to buy dangerous products like negative amortization mortgages and payday loans. However, they cannot buy private securities.

The market for private securities was ideally thought of as being a small peripheral market to the larger public securities markets. However, over time, it has started to dwarf the open market in size as well as scope. It would be better if the government relaxed the laws around the public listing of securities. This would solve many of the problems which are currently present in the private securities market.

Authorship/Referencing - About the Author(s)

The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.