Edge-ucation / Market Commentary

Private Placements 101

  • Edge Editorial Team

    At Edge Investments, we make investing in small cap stocks enjoyable and edge-ucational. We are here to teach you about investing, keep you up to date on news, and help connect you with companies that you may have a desire to invest in.

    View all posts

You may, or may not, have heard this term before, depending on where you are in your equity investment journey. “Private placements” are an investment opportunity typically reserved for the mega-wealthy, though they are becoming more accessible as retail investors learn (and earn) more in the market.

You may hear your friend raving about the returns they’ve made on these types of financings. 

You may hear another friend who invested in one of these a year ago and has no clue what’s going on with their investment. 

If this is your experience and you get pitched on one, you may find yourself torn; one of your friends made a great return, and the other one is still waiting for the company to list (with no clear plan in sight). 

At this point, you have a few choices: 

A) Spend ample amounts of your time researching and learning what pre-IPO financing is all about, 

B) Realize you have a full-time job (and a life outside of that), and do not have time to look into this, so you pass,  

C) Blindly cut the cheque and hope for the best, or

D) Subscribe to Edge Investments so we can conveniently lay it all out for you.

Which one will you pick? 

Now that the shameless self-promotion is out of the way, let’s dive into an overview of what private placements entail. 

Venture Capital 

When a budding company hits a certain inflection point in their journey, there often comes a capital induced roadblock. The company has bootstrapped as far as they can, but they’ll have a hard time getting to where they want to go without a capital injection. 

Investors don’t just cut seed financing cheques for any company. The company must have a defined path to growth and profitability. They must have the strategy, human resources, and infrastructure to grow the company to where it needs to be. They essentially need to have every possible thing imaginable to get going, except for the money. 

Going public is a strategy used for several reasons and it’s a challenging (but often rewarding) process, having its ups and downs, just like any other major decision.

Pros of listing on an exchange: 

  • Equity Financing – Money raised by selling equity (shares) does not need to be paid back. The investors can sell their shares on the open market once the company lands on an exchange. 
  • Liquidity – Companies listed on an exchange can attain steady and sizable volumes of shares traded daily, allow for easy buying and selling of assets. Liquidity is important for many investors. 
  • Capital – Raising money for a debut on the public markets provides an adequate amount of capital for the company to scale and create value for shareholders. 

Cons of listing on an exchange: 

  • Disclosure – Public companies are required to provide continuous disclosure on all aspects of their business. Finances, operations, updates etc. This is a timely process. Typically filed on SEDAR and disclosed via press releases, these disclosures must be strategic, with carefully chosen legal wording. 
  • Expenses – Audits, legal fees, marketing, communications – these are a few of the many expenses that can rack up a hefty tab for a public company.  
  • Market Indifference – The stock market is the stock market. Regardless of how strong, profitable, and fundamentally sound your company is, the share price can often be unpredictable. Market sentiment flows from the top down, so any kind of volatile moves in the major indexes or generalized sectors can affect you’re a company’s share price due to widespread market fear/greed. Your investors need to be able to withstand volatility within the markets, especially at an early stage.

Primary VS Secondary Market 

Investing in a company privately is what is called the primary market. This is when investors (like yourself) purchase shares directly from the company (or through a brokerage), and receive a certificate of share ownership in exchange for the money invested. That money goes straight to the company. 

Once the company hits the market and shares are available for sale on a stock exchange, the investment opportunity becomes one on the secondary market. The shares of that company are now being passed from investor to investor, who hope to either hold them long term to capture a piece of the company’s growth, or simply sell them to the next person for a small gain. These shares will continue to be traded amongst independent investors and the company will not see ownership of them again (unless there is a share buyback, in which the company will buy shares from investors in the open market).

Did you know? 

Companies often do subsequent financings after they initially hit the market. The company issues more shares from their treasury and sells them to investors in the primary market. Once these newly issues shares are tradable, they enter the secondary market. These financings are usually done to meet further capital requirements as a company grows and targets bigger goals. They are typically priced somewhere around the average share price in the most recent 20 trading days and often come with warrants. 

Every company will have long-term investors and short-term traders. Such is the diverse world of the secondary market. Due to the rather unpredictable nature of the stock market (I.e., market indifference), companies often engage market makers to ensure there is a liquid market for anyone who needs to trade their shares, help regulate prices, and prevent any “whale” shareholders from manipulating the stock. 

While you do get an edge investing in the primary market, there are some inherent risks. 

You’ll notice when you are signing subscription documents for a private placement, the risk acknowledgement section can be quite startling. 

You’ll see statements like: 

  • Risk of loss – You could lose your entire investment. 
  • Liquidity Risk – You may not be able to sell your investment quickly, or at all. 
  • Lack of information – You may receive little or no information about your investment. 

You might be thinking that getting into a company before they list, at a lower price, with warrants built into your investment seems like a sweet deal. Why are these considered risky? 

The answer is, even though your position is most likely at an advantage to the secondary market, investing into a company before it is public is by nature, risky. If the company takes years, or even fails to go public for any reason, there is no guarantee you will be able to access or withdraw your money. 

This is why you must assess a variety of aspects of a company before making a decision to invest, including their ability to successfully list. This aspect of any opportunity can be vetted by looking at the capital markets team behind the company and examining their track record. 

Now that you know what a private placement is, what the risks and rewards are, and how it passes through from the primary to the secondary market… you’re ready to get started. 

Follow us on Instagram to see when we release the second part of this series, “How to Evaluate a Private Investment Opportunity”, and join our Discord server to learn more and speak directly with the Edge team & teachers! 

  • Edge Editorial Team

    At Edge Investments, we make investing in small cap stocks enjoyable and edge-ucational. We are here to teach you about investing, keep you up to date on news, and help connect you with companies that you may have a desire to invest in.

    View all posts

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