Private Placement Funding

 The search for Private Placement Funding is a very important and usually constant activity for most hedge funds and development stage companies. Hedge Funds raise capital through a Private Placement transaction so they can make additional investments, although some hedge funds would be wise not to raise more capital that they would have trouble investing, since that would hurt fund performance and the return to their existing investors.

There are of course large amounts of capital funded to private companies, but those transactions involve larger private companies that are funded by private equity firms. Those private equity firms usually make a return on their investment in 3 to 5 years through merger or buyout from an even larger company. Occasionally, the exit strategy may even be an IPO.

Hedge Funds have become very good sources of capital financing through equity lines which are done through a Standby Equity Purchase Agreement. Some companies have raised substantial sums through equity lines over the years. I have drafted many documents for hedge fund clients over the years for these types of funding structures. Small and large companies, as well as non-US companies have raised capital through this funding structure.

Private placement funding for public microcap companies is done mostly with a certain type of hedge fund, also known as a PIPE Fund. Hedge funds, such as a pipe fund, are typically not long term investors like their counterparts the private equity funds. PIPE Funds are usually only in an investment for about a year, or less, and that is why they invest mainly in public companies. There are also some “Special Situation” strategy funds, like Leaddog Capital L.P. That Fund’s strategy is what is referred to as ‘‘special situations’’ investing because it is designed to capture capital appreciation generated by a significant proposed corporate event such as a merger, acquisition, product launch, corporate restructuring or reorganization.

Although the number of transactions for raising capital are with microcap companies (market capitalization under $300 million), the majority of Private Placement Funding dollars goes to larger companies. This statistic is likely to be on the rise, and not change anytime soon, until the current credit crises and bank lending improves.

Examples of some large funding transactions include the investment Berkshire Hathaway made into Goldman Sachs. If you examine the federal government bailout that will take place in late 2008 into 2009 you would probably be correct in characterizing those bailout investments as Private Placement Funding, and there will be many large institutional investors make these types of investments as well as bank financing becomes harder and harder to obtain.

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Placement Agents are typically used by companies to help find hedge funds or even private investors that invest in microcap companies. I have worked with and represented a number of Placement Agents over the years. Sometimes the funding is done in stages or tranches and typically an escrow agent such as a bank or transfer agent is used to disburse funds.

Generally, the U.S. Securities Act of 1933, the Financial Regulatory Authority (“FINRA” formerly the National Association of Securities Dealers or “NASD”) and most state securities regulations require these placement agents to be registered representatives of a broker-dealer. These regulatory bodies do not like unregistered persons raising money for companies. If these placement agents are not registered, then there is no oversight and no agency to see how they are conducting business and what written materials they may be sending out to investors in an effort to raise money for a company that may be in serious financial trouble.

FINRA regulations require that a broker-dealer acting as a Placement Agent use an escrow agent to disburse funds from an escrow account. Sometimes the securities offering is done as a Mini-Maxi, which is short for Minimum-Maximum. For example, is the offering of the companies securities is conducted by the broker-dealer on a Mini-Maxi basis of $1,000,000 and $5,000,000 that means that the escrow agent will not break escrow until at least the $1,000,000 minimum has been raised. The minimum usually means gross proceeds of $1,000,000 not counting reductions for placement agent fees, attorney fees and escrow fees for the Escrow Agent.