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5 Things You Need to Know Now About Private Investments

03/09/2015 04:19 pm ET | Updated May 09, 2015

If you've been paying attention to what's new in investing, you've probably heard of crowdfinance, debt and equity crowdfunding, peer-to-peer lending, and maybe even community investments. You may also know about private placements, trading pre-IPO shares, hedge funds, private equity and venture capital. What they all have in common is that they're just a few of the names people give to investments you can make in securities that are not publicly traded on exchanges like the NYSE and NASDAQ. Investing in private companies and funds is becoming more accessible, with smaller investment amounts, helpful regulatory changes and the availability of streamlined processing. Opportunities to participate are growing by leaps and bounds. Of course, private investments are not for everyone. But before you decide they're not for you, you need to understand the watershed changes taking place in the private securities sector, and how those changes can affect you.

Until recently, private investment opportunities were either inaccessible or impractical for most investors. Securities and Exchange Commission (SEC) regulations have limited most of these opportunities to accredited investors, which for individuals, generally means people of substantial income or net worth. But even among investors who meet accreditation standards, many have found private investing too expensive, exclusive, time-consuming and opaque to participate.

But all that's changing. Regulations that were originally crafted in the 1930s have begun to be amended to reflect the current economy. Technological advances have started streamlining the investment process. And online private investment offerings are becoming numerous as a result.

Here's what you need to know:

  1. Not all private investments are the same. They can involve equity (e.g., shares of the company), debt (e.g., bonds) and other types of securities. They can be in companies that are just starting out, with the potential for growth (and maybe even an IPO) ahead of them. Or they can be in established companies seeking capital to expand their business. They can also involve private funds that may invest in many different types of assets, including private companies. Such funds can offer professional management and diversification, for a fee. Hedge funds are one type of private fund that was traditionally expected to "hedge" against risk across a spectrum of investments. The point here is that to judge whether an investment could be a valuable component of your diversified portfolio, you need to consider it on its own merits, and how it fits with the goals and risk tolerance of your asset allocation strategy, and not only by whether it is public or private.
  2. You don't have to be rich to participate. One reason why private investing has previously been limited to the wealthy is that to be eligible, one needed to be an "accredited investor." This requires that an individual investor have a net worth over $1 million, excluding primary residence, or an individual income exceeding $200,000 in each of the two most recent years (or a joint income of $300,000), and the expectation that such income will continue at this level in the coming year. These regulations are intended to limit non-public investments to those with the sophistication to protect themselves from taking on an inappropriate level of risk. And indeed, certain types of private investing still require accreditation. But under Title III and Title IV of the Jumpstart Our Business Startups (JOBS) Act of 2012, non-accredited investors will be able, once the appropriate regulations have been adopted, to invest in startups and small businesses when certain conditions are met. This will open up brand new opportunities for all investors, including the opportunity to invest in local businesses that benefit an investor's own community.
  3. You don't have to be well connected to participate. Until recently, most investors in private securities needed to be not only well heeled, but also well connected. Without having an inside track to the right deal, investors had no way of knowing what investment opportunities were out there or how to initiate a transaction. Title II of the JOBS Act expanded the ways in which investors and issuers are allowed to seek each other out, and the technology to facilitate these rendezvous has matured as well. Websites that serve as marketplaces for private investments have begun to proliferate, and more are on the way.
  4. The technology already exists to make private investing easy and transparent. When online brokerage technology became the norm in public securities trading, individual investing changed fundamentally. Look for the same changes to take place in private securities investing. Online brokerages will bring access, transparency and efficiency to an arena that has lacked these qualities.

Several online brokerages specializing in private securities have developed online destinations for investors to browse and sort private placement deals, subscribe to deals, and establish accreditation if needed. And a few such brokerages are beginning to enable users to open and fund accounts, including IRAs, in which they can invest in multiple public and private securities using the same account. Using an online brokerage rather than other avenues for private investing will automate the entire process, and could enable even secondary transactions to occur online. Online firms may also be able to provide investors with customer service, tax and performance reporting, statements, confirmations, and automatic alerts when action is needed -- and they may be able to consolidate their private and public securities into one account. They may even have a simple way to invest qualified retirement funds in private investments if they so choose.

  1. Private investments have the potential to improve the overall health of your portfolio. Because private equity and debt securities are not bought and sold on the stock market as public securities are, they are far less liquid, and as such are inherently riskier. But there is a reason why these investments are often used by institutional investors, endowments and the rich: the power of diversification. Because private investments represent whole new classes of securities for most investors, they represent assets that can be much less correlated than other assets in their portfolio. That means their value may not move in the same direction, at the same time, or in the same amount as your portfolio or the public stock markets. For that reason, it may be possible to actually decrease the overall volatility of your portfolio, and increase its expected return, by including private investments as part of a well-diversified mix of holdings.

Private investing is in rapid flux, so keep an eye out for new developments. As private investment marketplaces become more transparent, streamlined and accessible, investor confidence and participation will grow. The increased liquidity in these investments and the development of the secondary markets that sell them could further decrease risk. This in turn could lead to lower investment minimums and the ability to diversify much more -- even creating an avenue for investors to create the equivalent of their own private equity funds.

All of this has the potential to promote and sustain greater levels of investing in small and medium sized companies, thus growing jobs. None of these developments are guaranteed. But change is already rapidly occurring, and private investment opportunities are headed your way.

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