What is a private placement?
A privately placed security is one that does not get offered to the public when first issued. Private issues of stocks and bonds are usually offered to a limited number of large investors such as mutual funds and rich individuals.
Unlike public offerings of securities, private placements do not require the generation of a prospectus or registration with the SEC. Often these deals are disclosed after the transactions have taken place.
If you work for a private company and receive shares as compensation, wonderful. If you believe your firm has great promise and you are presented with the opportunity to buy a verifiable stake, it is something to consider. Ditto regarding firms for which you have intimate, substantiated information indicating great prospects. Otherwise, without intimate access to material corporate information and a high probability of positive outcome, it is prudent to stay away from private securities.
Why you should avoid private placements
Limited liquidity
When you own a private security, your choices for selling it are very limited. There is no obligation for anyone to buy it back from you. There are no exchanges for you to find a buyer, or even a price. Effectively, your sale would represent a private placement of its own. The odds that you will get a fair price are quite small. Even if bought back by the issuer or the investment banker who did the deal, they will factor in the costs of remarketing your stake in coming up with a price for you.
Lack of information
One reason deals are done privately is to avoid the bureaucratic process of filing with the SEC. Many of these filings provide information needed to analyze the value of a stock or credit worthiness of a bond. Without such, you are reliant on brochures from an investment banking salesperson or the firm wanting your money. Neither should be taken at their word.
Fraud likely, not just possible
Given the lack of filing requirements, private placements are a common vehicle for defrauding investors. SEC rules were established to protect the public. Many purveyors of private placements seek to evade these protections, not the bureaucracy. Information provided need not be audited or confirmed by an independent third party. Put another way, the person coming privately to you for money was either rejected by, or did not even approach, bankers, venture capitalists and other professional financiers. Sound suspicious?
What you should do instead
Aside from firms for which you have intimate and substantiated information, stay away from private securities. If you receive a call or email regarding an opportunity to own a stake in an oil field, or a chance to be involved with film production, or a new medicine, or real estate, or any private investment whatsoever, ask to be put on their “do not call” list. Then hang up.