Risks in a Private Offering

What Are the Risks in a Private Offering?

Raising capital through a private offering, rather than an Initial Public Offering (IPO), offers certain advantages, including lower visibility and reduced regulatory burdens. However, private offerings are still subject to strict legal requirements and carry meaningful risks.

Failure to comply with all applicable restrictions can result in the loss of the private offering exemption, exposing the issuer to significant regulatory and liability consequences.

Regulatory Framework for Private Offerings

The primary exemption from the IPO registration requirement is governed by Regulation D under the Securities Act of 1933. To maintain this exemption, issuers must strictly comply with the following requirements.

Key Requirements Under Regulation D

• Securities may be offered only to accredited investors
• Up to 35 non-accredited but sophisticated investors may participate, provided enhanced disclosures are made
• The issuer must take reasonable steps to verify accredited investor status
• All information provided to investors must be truthful, complete, and not misleading; federal anti-fraud rules apply
• A private placement memorandum (PPM) is typically used instead of a prospectus
• Securities are generally subject to transfer restrictions, often lasting six to twelve months

Common Risks Associated With Private Offerings

Despite their advantages, private offerings involve several risks that issuers must carefully manage.

Risk of Losing the Exemption

• Failure to comply with any Regulation D requirement—including general solicitation rules, investor qualification standards, or disclosure obligations—can invalidate the exemption
• Loss of the exemption may require rescission of the offering and repayment to investors

Investor Rights and Liability Exposure

• Investors may gain the right to demand their investment back if disclosures were misleading or omitted material information
• Both federal and state regulators may limit or prohibit future capital-raising efforts
• Private investors are often more willing than public shareholders to pursue direct legal action

Governance and Control Risks

• Investors with veto rights can exert substantial influence over company operations
• Sophisticated investors frequently demand enhanced protections and oversight
• Board seats and preferred rights are commonly required as a condition of investment

Risks Posed by Sophisticated and Accredited Investors

Accredited investors, particularly when dealing with inexperienced issuers, may leverage their position to secure favorable terms.

Common issues include:

• Company undervaluation or acceptance of unfavorable deal terms
• Early credit or liquidation preferences that deter future investors
• Expectations of ongoing financial reporting beyond legal requirements
• Reputational damage from a poorly structured or unsuccessful offering
• Demands for preferred equity, control provisions, or board representation

The Importance of Professional Guidance

Choosing between a private offering and an IPO requires a comprehensive understanding of the regulatory requirements, costs, risks, and long-term operational consequences of each approach.

The attorneys at Corporate Securities Legal, LLP have extensive experience advising business owners and companies seeking to raise capital and ultimately go public. Our team helps clients:

• Evaluate private offering versus IPO strategies
• Structure offerings to maintain regulatory exemptions
• Minimize liability exposure
• Protect long-term control over company operations

Careful planning and experienced legal guidance can help ensure that a private offering delivers the intended benefits without jeopardizing the company’s future. We invite you to contact our attorneys to discuss your goals and develop a strategy tailored to your business.