Private vs. Public Investments - one man's view

Part One
By Harlington L. Hanna Jr.

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.

 

 Part Two

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