Categories: Investment Strategies
Topics: Private Placements

Investing in Startups via Private Placements

I have made millions of dollars investing in startup companies via private placements over the last decade. 

I say this not to impress you, but so you know off the bat that I’m not some amateur stock jockey wasting your time.

I have invested in dozens of companies through over 100 deals of various structures — crowdfunding, Regulations A & D, reverse takeovers, direct listings, etc.

These deals were in multiple sectors, including mining, technology, biotech, cannabis, psychedelics, real estate, crypto and more. 

Drawing on this broad experience and success, here is some of what I learned about investing in private placements… what to look out for and what to avoid… and some questions that seem to pop up over and over. 

What Is a Private Placement? 

When a company needs to raise money, it can do so in the private market as opposed to the public market.

Traditionally, one reason companies raised money via private placements was to avoid the costly process of filing a prospectus and/or registering the securities with the Securities and Exchange Commission (SEC). This way, companies can get the capital from investors' hands into their coffers at a much faster pace and with less red tape than they would if the capital were to be raised publicly. 

When companies sell unregistered securities directly to investors in a private placement, they must meet an exemption from the registration requirements. There are several ways to meet this exemption requirement, including by using Regulation D, Regulation A, or Regulation Crowdfunding (CF).

In a traditional private placement (Regulation D), you are funding the company directly so they issue the securities to you. In that case, they are the issuer. And because you (the investor) are buying unregistered securities from an issuer, the government says you must be an accredited investor, meaning you have a net worth over $1 million or have annual income north of $200,000. 

Private placements can be lucrative because in many cases, you (the investor) are taking on more risk and so there needs to be incentives for you to provide the company with capital. In some cases, that can be a discount to market, where you're issued the shares at a discounted price to what they're trading publicly. In other cases it can be a warrant to sweeten the pot. You may either get a half warrant or a full warrant that allows you to buy more shares at a future date at a specified price. Warrants give you leveraged upside with no risk because you do not have to exercise them if the stock goes down, but can buy more at a lower price if it goes up.

Because private placements can be so lucrative and have such a high barrier to entry, some people view them as a main tool the rich use to get richer. 

As such, there have been trends and government actions over the past several years to lower the barrier to entry for private investments. 

Crowdfunding offers perhaps the lowest barrier. This is where a crowd pools capital, often for some common goal or to launch a new product. This is done through sites you’ve likely come across like GoFundMe, Kickstarter, and Indiegogo. These are often projects meant to engage the user or customer, but that aren’t necessarily great investments, or investments at all. Crowdfunding tenth-grade Johnny’s trip to fix up a village in Guatemala is a feel-good noble cause, but no one is getting rich by funding it. Same with helping a local band produce their first demo tape. You may get some warm-and-fuzzies or some rad merch, but you likely aren’t going to retire from a crowdfunding deal. Securities sold under Regulation Crowdfunding (CF) are limited to raising $5 million in a 12-month period and not used by most serious and/or high net worth individuals for private placement investing. 

Private investments done under the exemption of Regulation A are a bit more serious in my experience, but still don’t offer the liquidity or upside of traditional private placements. Regulation A was overhauled as part of the JOBS Act in 2015 to allow non-accredited investors to participate in unregistered securities offerings with two tiers. Non-accredited investors can participate in Tier 1 Regulation A offerings, but the company can only raise $20 million in a 12-month period. Non-accredited investors can also participate in Tier 2 Regulation A offerings in which companies can raise up to $75 million in a 12-month period, but those non-accredited investors can invest no more than 10% of their annual income or net worth.
 

I have participated in both crowdfunding and Regulation A deals. They are great for achieving communal goals. But they are not so great as investments. In my experience, companies funded this way chose to do so because they were unable to raise proper capital in traditional private placement markets (Regulation D of the Securities Act). As such, they are typically less serious or less experienced management teams. These investments have a higher chance of staying private, which means a higher chance of there being no exit event to get your capital back. 

The private placements I do most often and have had the most success with are traditional private placements in already public companies done under Regulation D of the Securities Act. There is no limit on the amount of capital that can be raised. The company is already public or going public so no exit plan is needed and your money can’t stay locked up privately forever. 

Why Can Private Placements Be Lucrative Investments?

As mentioned earlier, private placements can be lucrative investments. 

One reason is because these early stage companies need to “sweeten the pot” to attract investment capital. 

And one way companies can do that is by selling shares that are priced below what they’re trading for in the market, giving private placement investors an immediate “head start.”

Another way is by offering warrants that come with your investment. You may either get a half warrant or a full warrant for every share that you buy that allows you to buy more shares at a future date at a specified price. Warrants give you leveraged upside with no additional risk because you do not have to exercise them if the stock goes down, but can buy more shares at a lower price if it goes up.

But these sweeteners aren’t the only reason private placements can be so lucrative. Another reason is that you are often getting in near the ground floor of a new idea, company, trend, or industry. 

Here’s a concrete example that can drive these points home. 

Back in 2017, I financed a small uranium company called URZ Energy that has since been acquired by enCore Energy (NASDAQ: EU)(TSX: EU). We bought shares in a private placement at today’s equivalent of C$0.60 apiece. Each of those shares came with a half warrant to buy more shares at C$1.60 anytime in the next 18 months. So if you bought 50,000 shares, you got 25,000 warrants.  

Here’s how that paid off. 

URZ was taken out by Azarga Uranium in an all-share deal. And then Azarga was taken out by enCore. Today, enCore Energy trades near C$6.50. The 50,000 shares you bought at C$0.60 for an initial investment of C$30,000 are now worth C$325,000. A true tenbagger.

The 25,000 warrants that you exercised at C$1.60 for C$40,000 are now worth C$162,500. 

They don’t all work out like this to be sure. But the goal with this type of investing — and what has been my experience so far — is that these large winners far outweigh the large individual losses that are inevitable in high-risk startup investing.

If you don’t understand this or can’t afford to invest similar amounts of capital, private placements may not be for you. 

How to Find and Participate in Private Placements

It’s often said that the rich get richer. 

And I just outlined how you need to be an accredited investor to participate in true private placement deals, which means you are likely already financially successful. 

But one of the problems, even for the financially well off, is how to get access to these deals. 

That’s where I come in. 

Many of the clients I help with accessing private placements are business owners or professionals like engineers and doctors. They’ve done well in their field, but they don’t know much about investing with private placements. 

I’ve been building my startup investment network for over 15 years now. And my partner, Gerardo Del Real, has been doing it just as long. We get pitched new deals every week. And we have a deep network of executives, geologists, and professional investors that we use to source and vet deals. 

So we have good dealflow. We see new slide decks every month. We’re always looking at and doing due diligence on new ideas. 

When we find one we think has merit, we participate in it personally and/or we pass it along to members of Private Placement Intel, which is a service we provide for investors looking for private placement opportunities. 

Otherwise, you’re on your own to find these deals and conduct due diligence on them. And then, you’re on your own to contact the company and hope that they let you in. 

There is a lot more to it than I covered in this brief introductory article. Things like the actual structure of a private placement deal, how to get your unregistered shares deposited and sold, if you need a full service broker, if there’s a minimum to invest, and what questions should you ask when vetting a company. And that’s just for starters. 

So if you’re interested in seriously pursuing private placements and have a meaningful amount of capital to invest, here’s what I suggest you do. 

Check out this free video I made about investing with private placements. It goes over many of the questions I just outlined and more. 

If you want to participate in deals that we vet for you, then become a member of Private Placement Intel. 

And if you have questions that aren’t addressed in this article or at those links, then give our knowledgeable customer engagement manager a call at 844-334-4700. If we can’t get you an answer right there on the phone then I’ll get back to you with one shortly. 

Best of luck with your quest for private placements.

Call it like you see it,

Nick Hodge
Publisher, Daily Profit Cycle