Some investment opportunities are offered to a group of investors. An investment described as private placement is one that qualifies to be exempt from registering with the SEC. It does not have to provide prospectuses or other detailed offering information to investors in most cases or file regular financial reports.
The exemption is usually based on the amount of money the sponsors will raise, the financial standing of the investors who will be offered the opportunity to participate, or both.
While private placements are exempt from federal regulatory oversight, they must comply with the federal anti-fraud provisions of the Exchange Act of 1934.
Getting private placement organized
Many private investments are organized as limited partnerships under the laws of the State where they are based. While these partnerships are exempt from SEC registration, they may be regulated as securities by their home states.
In a limited partnership, there is always a general partner — or partners — and one or more limited partners. The general partner actively operates the business and is personally responsible for its actions and debts. Limited partners, on the other hand, are passive participants whose only job is providing the capital that the partnership needs to run its business. The most they can lose is the amount they invest.
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Private energy investments
Private energy programs, like all private placements, are exempt from SEC registration, though the SEC may require that potential investors be accredited. In some cases, however, up to 35 non-accredited investors may participate. For these investors, the program sponsor must provide a prospectus, financial statements, and other information comparable to what’s required in a registered public program.
Some energy partnerships, private as well as registered, offer an interest conversion feature that allows investors who join the partnership as general partners for tax reasons to switch to limited partnership status after the drilling phase of the program ends. This arrangement exists because general partners are entitled to use intangible drilling costs (IDCs) incurred during drilling to offset active income, including wages and other earnings. Limited partners can use deductions to reduce only passive income.
However, investors should realize that while acting as a general partner, even for a limited time, they have unlimited liability for partnership debts and other obligations.
Real estate limited partnerships (RELPs)
Real estate limited partnerships (RELPs) are organized to develop and manage commercial real estate projects. While some are public, about half are privately placed. As with other limited partnerships, there is a general partner and a number of limited partners.
RELPs own and manage income-producing properties or, less frequently, own mortgages on properties. Generally, the specific properties haven’t been identified at the time the sponsor sells partnership interests, which makes it difficult to assess what the quality of the RELP portfolio will be and whether the acquisition costs turn out to be reasonable.
Other factors that influence whether or not a RELP is a good investment are how much debt the program takes on, the upfront and ongoing fees, and the experience and skill of the managers.
Limited partners may or may not receive distributions of project income, at the discretion of the general partner. But returns are often substantial. In addition, partners can deduct depreciation allowance; and other expenses against the income they receive, and they may be eligible for tax credits if the project rehabilitates properties that it owns. The general partner can also pass through losses, which can be used to offset gains. But claiming these benefits can be complex and requires the advice of a tax expert.
The total return is determined only when all the properties have been liquidated. As is the case with other alternative investments, there are upfront
fees and commissions. With RELPs they may be as high as 20% to 25% of the amount invested plus ongoing costs during the term. In addition, there is no organized secondary market so RELPs are illiquid.
Two regulations of the Securities Act of 1933, Reg A and Reg D, account for the vast majority of exempt investments. Reg D exemptions are more common, and most of them are granted under Rule 506 of the regulation.
Rule 506 allows issuers to raise an unlimited amount of capital. Section (c) of the rule allows issuers to advertise, but sales may be made only to accredited investors, and audited financial statements or balance sheets are required. Reg A exemptions apply small offerings, whose issuers will raise no more than $5 million in a 12-month period. Issuers must file an offering statement and provide an offering circular. Investors don’t have to accredited and audited financial statements aren’t required.
Private equity is an umbrella term for firms that raise capital to invest in business ventures. These pooled investment funds are typically organized as limited partnerships, with the owners of the firm as general partners and the investors as limited partners. Some firms specialize in venture capital, or investing in new or small companies they will be successful and yield a significant profit. Others are buyout firms. They focus on buying existing public or private companies, restructuring them, and cither selling them to other private investors or taking them public.
To participate in a private equity offering, investors must be accredited. Minimum investments are substantial, typically much higher than other alternative investments with the exception of hedge funds. Fees average 1 % to 2% of assets as an annual management fee plus a percentage of profits, often 20% or more.
As other alternatives, private equity investments are illiquid. Passive partners typically receive no payouts until the investment term ends, often eight to ten years after inception. But while there’s no guarantee, eventual returns can be significant, especially with firms that have established a strong reputation for success.
Common Alternative Investments Funds and Examples by Inna Rosputnia
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