Have you ever asked yourself the following question: Do the wealthy invest in the same things everyone else does? The answer is, of course, absolutely not! Let’s find out why and what they are below.
Most people have their long-term investments in a mix of stocks and bonds, but top invjestors almost always have a significant portion of their investments within private investments.
These “private placements” can include a variety of offering types – from investments attached to friends and family (such as a new retail store) to angel investments in a social enterprise. It can also include venture capital investments in a company that has been consistently growing. Any kind of security can be offered as a private investment, which can include the following:
- Stocks (common or preferred).
- Revenue share securities.
- Convertible notes.
- Security Agreements for Future Equity (SAFE’s).
The properties (such as the rates of return, exit options, and valuation) can vary from each one.
What is a Private Investment?
Private investments are privately issued equity or debt securities that are offered by businesses, which can include anything from startups to late-stage companies. And they can be in a variety of industries (such as oil and gas, real estate, and technology). These investments are offered through a “private offering” provided by a Private Placement Memorandum (PPM).
Private offering exemptions give businesses, fund managers, and direct investment firms an alternative option for raising capital without having to file an IPO. But they’re subject to certain restrictions, which can include:
- Investor qualification requirements.
- Offering limits.
- Limitations on resale and advertising restrictions.
With one exception, the securities offering of a private investment may not be advertised. And the issuer may not actively solicit investors, which is why they’re called “private” offerings. Investors must also be “accredited,” so they must have a net worth of at least $1 million (excluding their home, cars, and furniture) or earn at least $200,000 a year (or $300,000 with a spouse).
The level of disclosure for the issuing company can vary (depending on the types of investors, the regulatory pathways that have been chosen, as well as their risk tolerance). At a minimum, they must provide a term sheet and an investor agreement that describes the final terms. Sometimes, it’s wise to provide an offering memorandum with a list of risk disclosures. If the offering includes investors who are not accredited, a more thorough set of disclosures are typically required.
Because private placement securities aren’t registered, they’re considered “restricted” securities. So, they can’t be resold without registration or an exemption from the registration process (which can make them harder to liquidate).
Why You May Not Have Heard of Private Investments
Private investments have been offered behind closed doors for many decades, because the Securities and Exchange Commission (SEC) wouldn’t allow companies to advertise or openly seek investors. Only people with the right connections would have access to these opportunities.
A variety of local projects (such as residential developments, manufacturing centers, or industrial facilities) will often have “key players” who invested in exchange for a “passive return.” The dealmakers would often have connections through an attorney, CPA, country club, private venue, or mutual passion (such as boating or golf) so they can build relationships with potential investors.
The SEC had specific regulations that reserved participation in many of these private investments for the wealthy investor (also referred to as an “accredited investor”), which is why the options available to the middle class were limited. That’s why many investors have never heard of private placements, real estate syndications, private investment funds, or other terms associated with private offerings.
New legislation that went into effect when the JOBS Act was passed allowed advertising (in limited circumstances) to qualified investors. As long as companies only take on accredited investors who can verify their status, they can make general solicitations. The SEC wants to give qualified investors more access to these opportunities. The potential for stronger returns and diversification benefits are what has attracted the wealthy to these investments for many decades.
Some of the advantages of private investments can include but may not be limited to:
- A shield from the volatility of Wall Street.
- A hedge against inflation.
- Access to significant tax benefits.
Private investments are no longer only available to well-connected wealthy individuals who have been using these assets for decades.
Why Private Investments are Attractive to the Wealthy
If they’re the right assets and are in the right hands, private investments can give you something that public investments can’t offer. And that is consistency and perhaps more importantly an element of control. Wealthy investors aren’t like day traders or speculators. They invest with their minds instead of their guts. If an investment makes financial sense after they have checked all the metrics, they will invest and stick it out.
Once the wealthy invest, they take a step back and let management do its job because they don’t have a choice. Private investments will have long lockup periods that are usually at least five years. Smart investors know that these companies need time to grow, which is why they get out of management’s way. They got into private investments because they didn’t want to do any heavy lifting, so they have no reason to start now.
Having a long-term investment strategy eliminates all the headaches and worry with regard to the broader economy because they know that in the long run, their private investments will give them a consistent and reliable return from both cash flow and appreciation (with significant downside protection from your typical stock market volatility). These are advantages that can’t be offered by public investments.
Wealthy individuals will explore every single angle, so they can get the most out of their investments. And they’re not just motivated by the rate of return. They also want to take advantage of tax benefits, offset inflation, and have a hedge against downturns.
Smart investors think of the financial independence that comes from wealth as a machine that needs to be fed, nurtured, and protected. The more they save in taxes, the more they can add to this wealth machine. And the more passive income that they’re able to generate, the more can be reinvested. Of course, none of it would mean anything if something were to come along and wipe out everything that keeps the machine rolling. That’s why it needs to be protected from inflation and recessions. Private investments are perfect for achieving this goal, which is why the successful investors love them.
Private investments used to be only for exclusive people who were part of “the club.” Now, investors who were once on the outside looking in have the opportunity to invest in the same private opportunities that the wealthy have been taking advantage of for decades. They can give you above-market returns that are shielded from the volatility of Wall Street and economic downturns, so they’re the perfect assets for people who want to generate income that’s independent of what people are willing to pay for.
Private investment are the preferred assets of the wealthy, which is why every investor should think about adding them to their portfolios. If you want to know more about how you can invest your money in a way that will generate positive growth, be sure to get in touch with Trevor Shakiba at Shakiba Capital.