What Are The Opportunities In The “Private” Capital Markets?

There’s a good chance you’ve recently heard something about the private capital markets, given the hype around trading in Facebook shares while the company was still private, ahead of its initial public offering (IPO). It’s likely you will hear a lot more about the private capital markets going forward as the Securities and Exchange Commission (SEC) implements the JOBs Act in an effort to help small- and medium-sized companies raise capital more easily.

Before getting into the myriad investment opportunities in the private market, we must first address the most basic question: What is a private company?

Not surprisingly, a private company is any company that is not a public company. A public company is required to regularly disclose financial information to the SEC, which is then made available to the general public. Shares, representing fractional ownership in these companies, trade on an exchange such as the NYSE or Nasdaq, and all investors are qualified to own these shares. Typically, the shares of public companies are more liquid, meaning that an investor can easily buy and sell shares of the company. As an example, General Electric trades almost 40 million shares a day.

Investors in a public company have equal access to financial and operational information about the company, and in general this leads to market-efficient pricing. The rise of derivatives (financial instruments whose values are derived from one or more underlying assets, such as the shares of a public company) and other technologies such as high-speed trading has resulted in the public markets being viewed more and more as a playground for “traders” rather than a home for longer-term “investors.”

By contrast, a private company is any company that has less than 2,000 shareholders and is not publicly listed or traded on an exchange. It could be anything from the restaurant on your street to Bloomberg or Koch Industries. It does not need to be a start-up, though those companies tend to get most of the buzz. Given that the securities of these companies are not traded on an exchange, there is generally less liquidity available to security holders, making it more difficult to buy or sell shares.

Private companies do not have the same disclosure requirements as public companies. This lack of transparency and liquidity often provides opportunities to make outsized returns relative to public companies, which enjoy more market-efficient pricing, though private opportunities often are also associated with higher risk. Given the incremental risks and reduced disclosure requirements, investing in private companies has been limited to qualified investors, either institutions or accredited investors; these rules are designed to ensure that investors in private companies have a certain level of financial sophistication and/or capital reserves to participate in this market. The lack of derivatives and liquidity also generally means that owners of private company securities tend to be fundamental investors and not traders. The SEC has estimated the annual size of the U.S. private placement market to be $1.2 trillion.

When discussing a sale of securities by a public company, the transaction is referred to as a Public Offering, and sale of securities by a private company is referred to as a Private Placement.

With a basic understanding of the private placement market, we will discuss more specific opportunities in these markets in greater detail in additional posts.

-- ACE Group manages the online marketplace for new issuances of private securities. ACE connects Qualified Institutional Buyers and other Accredited Investors with private investment opportunities marketed by investment banks and other private placement agents. ACE is a partner of AD:60, parent of MyBankTracker.