A company that wants to raise capital by selling stock can do so through an initial public offering, better known as an IPO, or with a "private placement." With an IPO, the company can sell stock to anyone, but it is subject to tight regulatory scrutiny. With a private placement, the scrutiny isn't as intense, but the pool of investors to whom the company can sell stock is much more limited.
A company planning an IPO must register its stock with the Securities and Exchange Commission. To register, the company files documents describing its assets and operations. The filing must include details about the stock it plans to issue – the number of shares, classes of stock and so forth. The company must also provide the SEC with audited financial statements. Once registered, the company must file quarterly and annual financial statements, as well as separate disclosures about events of importance to investors. A company seeking private placement of its stock, on the other hand, does not have to register with the SEC and does not have to file financial statements so long as it meets the requirements for a registration exemption as spelled out in an SEC rule known as Regulation D.
Who Can Buy
A company that registers with the SEC can sell its stock to the general public; anyone who can afford the shares can buy them. With private placement, on the other hand, the company can sell only to "sophisticated" investors, meaning those who are able to understand the risks involved. Whether or not an investor qualifies as sophisticated can be subjective, so Regulation D lists rules that, if followed, guarantee an exemption from the registration requirement. Under those rules, a company can sell its stock to an unlimited number of "accredited investors." Accredited investors are people and entities that, because of their wealth, occupation or position, are assumed to be sophisticated investors. These include banks, insurance companies and pension funds; directors and officers of the company itself; certain trusts and charities; and individuals with at least $1 million in net worth (excluding the value of their home) or $200,000 in annual income. Regulation D also allows sales to up to 35 "unaccredited" investors, people who don't meet the listed criteria, but it says the company may be asked to demonstrate that those investors, too, are sophisticated.
To stage an IPO, a company typically hires an investment bank, which researches both the company and the market to determine the level of demand for the stock, which influences the initial share price. The company and the bank then work to drum up interest, promoting the stock and sending company officers around the country to meet with potential buyers. Although the stock sale is called an initial "public" offering, in reality the public usually doesn't get first crack at the shares. IPO shares typically go to big institutional investors and wealthy individuals, who then turn around and sell them to the public. With a private placement sale, the company hires an agent, such as a bank, a lawyer or some other individual, to contact potential investors, usually people and institutions with whom the company or the agent already has a relationship. Under Regulation D, the company is not allowed to advertise the stock or engage in any general solicitation. There are no cold calls or mass mailings – only direct contacts with familiar faces. The SEC offers a stern warning on this point: if the stock is offered to even one unsophisticated investor, the offering may lose its exemption.
Once shares of an SEC-registered stock hit the open market after an IPO, shareholders can sell them to anyone, often at a higher price than the amount originally paid. Trades are handled through whichever exchange has listed the stock. Privately placed stock, by contrast, is restricted. Investors can't resell their shares as long as the shares remain unregistered with the SEC.
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