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Part
One
By Harlington L. Hanna
Jr.
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As a lawyer in the intellectual Property and
International Trade arena I often get questions from
clients about investment opportunities in private
offerings. Private offerings come in all shapes and
sizes. How often do you hear of a good investment deal,
or a friend or family member needing investment in some
business idea? Private offerings may often be far more
sophisticated with carefully drawn prospectuses offering
securities to so called "sophisticated investors".
Obviously each investment must rest on its own merit
however there are some general guidelines which investors
in privately offered securities should consider.
Opportunity Cost
The first consideration is where else could the money
be invested to bring in a similar or better return within
the same period of time. Generally this is the
"Opportunity Cost " principle which economists use to
determine the alternate opportunities for utilizing the
resources in some other way. In other words what are you
giving up by using the money in this investment? In order
to effectively figure out the opportunity cost of a
private offering investment you must first consider other
private offerings, but even more important you must
consider the numerous opportunities to effectively use
the money present in today's ever burgeoning publicly
traded securities markets. Today even where there is a
golden opportunity to invest privately most of the
advantages go to the public investor.
Asset Allocation
No one individual has sufficient money to invest in
all the opportunities available. Therefore effective
asset allocation whether it be in private or public
securities is paramount. Public traded investments
generally provide a much more effective and easy way to
allocate your assets across a broad or highly selective
range of securities. Proper Asset allocation provides not
only safety but enhanced productivity for the investment
dollar. Public trading allows the purchase of varying
amounts of a security, from a very small amount to
enormous amounts. Private offerings are usually limited
by requirements of purchasing the security in blocks many
times requiring the commitment of a significant amount of
an investors investable funds and thus unduly restricting
his ability to asses allocate. In deciding whether to
invest in a private offering you are effectively deciding
to place an excessive limitation on the allocation of
your money since there may significant restraints on the
transferability of the funds once invested.
Liquidity
A major problem with private investments is the lack
of liquidity of the investment. Trading and investments
in the public markets allow the participant to easily
retrieve her investment almost instantaneously, and in
the case of brokerage accounts which afford check writing
privileges allows immediate use and transferability of
the money. The ability to retrieve your investment almost
at will is perhaps the most important aspect of modern
public securities trading and investments. It provides a
safety factor and a trading factor which is unparalleled
in any private investment opportunity. This is even a
more important factor especially for the trader or those
who operate the stock trading and investment as a
business and who generally need to transfer assets
between investments at will. Private securities may be
extremely difficult to sell. Many times such securities
cannot be sold and even when sold may do so only at a
deep discount.
Immediacy of Profits
A major benefit of public investment is the immediacy
of profits. Profits can be quickly made ascertained and
recovered through the mechanisms available in the
securities markets. Private investors may have to wait
for several levels of administrative and bureaucratic
reviews, approvals, and other activity before their
profits can be realized and actually received. Generally
profits in private placement come from true fundamental
and productive performance of the company. Profits in
public companies may come from this source or may come
from other factors working in the public markets which
drive stock price growth other than fundamentals of the
company, vis a vis the recent price accumulations of
Internet related stocks.
Trading Opportunities
Trading in the private market is significantly
ineffective as compared to the public markets. Investors
in private securities are significantly limited in the
ability to transfer the invested funds. This effectively
eliminates trading as it is performed in the public
markets.
Safety
The liquidity of publicly invested monies coupled with
a close watch of the trading of the invested stock allows
a public trader or investor to quickly cut losses in
investments. In fact today computerized trading allows
investors to place stop loss restrictions on their
accounts which automatically triggers a sale of the asset
when a certain degree of loss occurs. These safety
features are generally not available to investors in
private companies.
Perhaps an even more important difference in private
versus public investments is the degree of scrutiny
public companies must undergo and the amount of reporting
and news which is available on such companies. Major
stock exchanges and the securities and exchange
commissions of various countries require public companies
to undergo and maintain strenuous reporting and
operational practices all designed to protect the public
investor. These requirements are generally not placed
upon private offerings. The amount of news on private
companies is not as available. The very nature of a
public company on a major exchange provides some
certainty of an acceptable level and quality of company
operations, management and overall efficacy.
Derivative Investments
Trading and investments in public markets allows
investors to participate in derivative issues such as
options, mutual funds and other controlled investment
opportunities derived from the presence of basic stock
issues. This is very important to the most sophisticated
traders and investors, and almost non-existent in the
private investment marketplace. These opportunities have
become even more important in the modern investment
marketplace.
Arbitrary Value…..Book Price V. Market
Price
Public securities have a built in proven and
accountable mechanism to determine true market value and
to determine and afford appreciation in the value of
securities. This is an important element in ensuring your
investment is acquired and sold at a true market value.
In other words public securities ensure you get what the
market thinks they are worth at any point in time. Their
value is determined by true supply and demand at any
particular point in time. The value of privately offered
securities however has no such mechanism or avenue to
provide such assurance. Investors therefore purchase and
sell private securities at an arbitrarily contrived price
which may or may not relate to the true market value of
the security.
One advantage a private investor should have is the
ability to invest in a company at a discount.
Theoretically a private or pre IPO investment should be
available at a discount to the same company on a public
market. However because of the arbitrary manner in which
most private offerings are valued this is not necessarily
the case in actual practice. The private investor must do
whatever he can to ensure that the cost of his investment
is significantly below what the
Ease of Negotiation & Contracting
A significant element in the success of trading and
investing is the ease with which the investment can be
negotiated and acquired. In the private arena this may
require specialized and professional help, specially
drawn contracts and a significant amount of time and
resources expended. Many times the reason the investment
is not made is because of the difficulty and the
logistics required to close the deal. Fortunately this
process is highly standardized and facilitated in the
public markets. This is one of the great advantages of
trading on the public markets. Many if not most
unsophisticated investors do not realize how important
this factor is. However as the level of investment
sophistication rises and as the volume of trading
increases this factor becomes more and more important.
One benefit in this area to the private investor is the
ability to tailor the transaction to his needs or
desires. Of course this increases the amount of
negotiation required, but if successful it may mean
greater success. The public market transaction usually
does not have this flexibility.
