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An Inside Look at the Private Placement Industry

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  |  By Christopher Orr, SDIP

At PENSCO, we want our clients to have all the resources necessary to become confident self-directed IRA investors. To that end, we’re always looking to provide both the knowledge to make informed investment decisions and the tools to implement them as efficiently as possible.  That’s why I recently caught up with Mat Dellorso, Chief Executive Officer at WealthForge, to learn more about the private placement industry and how technology is evolving to make investing easier.

CO: Why is it important for investors to understand the different types of private placements?

MD: The private placement market is estimated to be a $1.3 trillion industry. To date, much of the attention towards this large yet misunderstood industry has been about equity crowdfunding, especially since the passage of the JOBS Act. There’s a natural appeal to investing your hard-earned money in a business or project that you believe in, now with the added bonus of being able to receive equity in exchange if you are an accredited investor.

However, crowdfunding represents just a tiny fraction of the overall private placement industry, which includes any investment opportunity that is not offered to the general public. To understand the size of the industry and its potential to disrupt the financial ecosystem, it’s important to be familiar with the different types of private placements now available to institutional investors and—eventually—retail investors.

CO: So if crowdfunding is just a small piece of the private placement market, what makes up the majority? 

MD: Hedge funds, private equity and venture capital funds represent the lion’s share of the private placement industry. 

Hedge funds are investment vehicles designed to deliver alpha – returns in excess of an investment benchmark – by employing any number of different strategies such as long/short, event-driven, arbitrage, distressed or global macro. They get the majority of their assets from institutional investors, which include endowments, pension funds, sovereign wealth funds and other foundations.

Private equity and venture capital funds pool capital from a number of large institutional investors to invest in privately held companies across various sectors. These funds play a pivotal role in helping emerging businesses either reorganize or achieve economies of scale, creating economic value in the process.

CO: Just how big are the hedge fund, private equity and venture capital industries?

MD: Hedge fund assets have ballooned to more than $2 trillion and continue to grow at an accelerated clip.

Private equity fundraising reached an all-time high in 2013 with 873 funds raising an aggregate of $454 billion, according to industry data provider Preqin. It was a similarly big year for venture capital with 185 funds raising nearly $17 billion, according to the National Venture Capital Association.

CO: We often think about stocks and bonds as public investments only.  Is this right?

MD: Certain classes of stocks and bonds are also available to private investors, often right before those securities are made available to the general public. For example, companies filing for an initial public offering (IPO) will invite institutional investors such as pension funds to participate in a non-public offering of shares. The same thing occurs with companies that want to raise debt by issuing bonds. These early investors get preferred access to private investments, allowing them to purchase stocks or bonds at a reduced cost or giving them more flexibility in terms of what they can do with their investments.

CO: How easy is it to make an investment in a private placement?

MD: The current process for transferring money from an institutional investor to a hedge fund is slow and onerous, requiring a small mountain of legal and tax paperwork. Similarly, the fundraising process for private equity and venture capital funds is outdated and overly complex. As this process is streamlined, including by allowing investors to fill out most paperwork online, these funds will be able to raise assets and deploy capital faster than ever. 

In general, the financial industry is overloaded with intermediaries that help investors access public securities, but there are relatively few companies that can do the same thing for the private placement market. At WealthForge we are on the front lines of helping this industry move online by making it easier for private entities to connect with investors, both big and small.