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Investors and Private Placement

Investors and Private Placement

Author: James Howard

This lesson examines alternate forms of financing.

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Hello and welcome to this tutorial on investors and private placement. Now as always with these tutorials, please feel free to fast forward, pause, or rewind as many times as you need in order to get the most out of the time you are going to spend here. So let me ask you a question. What are some other ways that a company can get money for long term needs?

We talked about bonds and equity and stocks and short term financing, but what are some of the other things if none of these are available to me as a company? Well, what we're going to be looking at in this tutorial is alternative financing. We're also be looking at venture capitalist, private placement, and risk return relationship. Now the key terms for this lesson are going to be "angel investors," "venture capital," "private placement," and the "risk return relationship."

So let's go ahead and get started with alternative financing. Now, alternative financing can take the form of something called an angel investor. Angel investors are an individual who provides funding from their personal finances to a business, typically receiving ownership equity or a type of bond in exchange. Angel investors can also be a means of raising money for a business that appears to have a very high earnings potential, but it also has quite a bit of risk associated with it, so some of the more traditional means of financing wouldn't necessarily be available to them.

Now an angel investor, for example, Jeff Bezos, he would make several investments, an angel investor. Jeff Bezos is the person who owns a company called Zappos, and he uses his own money to invest in an area of Las Vegas where he set up his company. And he does this in order to help reinvigorate the community around where his business is placed.

So for the individuals and for the companies who are trying to build a business in this area, Mr. Bezos will be what's called an angel investor, because he's taking something that is not necessarily proven and kind of high risk area and he's investing his own money with the expectation that there'll be a pretty high potential to get that money back and a little bit more. And like I said before, generally angel investors will expect to have a share of ownership for the funds. So they're not just going to pay the money back. The angel investor will now be part owner in the business that they invest in.

Now the thing about angel investors compared with venture capitalists, for instance, well for one thing, angel investing is a lot more risky than venture capital. It also can help provide initial funding. Right out of the gate, the business is starting up and I'm going to need that money right now.

More likely it's going to be with passion projects. For instance of Mr. Bezos, what he wants to do is reinvigorate this particular area of Las Vegas, and that's his passion. And angel investors are typically individuals. They're one person investing their own money.

So what's a venture capitalist? Well, a venture capitalists has or uses venture capital. Venture capital is funding during the beginning stages of a new company or venture to get the business started in exchange for owner's equity. And this is provided to start up companies that appear to have a pretty high potential by a group of investors. But again, they're going to be a little bit risky, or too risky for banks to loan them money. The bank doesn't want to take on that risk.

And that's how venture capital can work. So a group of investors will look at potential moneymakers that have a lot of potential but a lot of risk, and they'll start investing their money to get the business started and off the ground. Now typically with these venture capitalists, they're going to assess that risk a lot more thoroughly. And investors and firms that offer venture capital are considered to be limited partners. They don't necessarily have a say in ownership of the business, but they do have owner equity in the business.

It's important to point out here that venture capital funds are typically going to be for no longer than 10 years. Management fees and interest are charged for loaning the start up business that funding. So in addition to taking a much better look at the risk to make sure they're not going to lose their money, venture capitalist will provide growth funding for a business to help it get off the ground and moving. Because if the business doesn't get moving, then there's no chance for the venture capitalists to make that money back and make use of that owner equity in the business. And typically, these are going to be groups, not individuals like angel investors.

Now the next thing we're going to look at is private placement. Now private placement is the selling of any tradable asset by a firm to a closed set of investors. And these are not offered to the public. It's a non-public offering of stock, for instance, to a group of closely held investors in a particular company.

Now private placement folks are not registered with the SEC. Because it's not a publicly traded stock it's not governed by the Securities and Exchange Commission. Now it can also be common stock, bonds, or promissory notes that are issued. And typically, smaller businesses are going to be the best candidates for private placement. Also banks or funds are going to purchase these offerings of stocks or bonds and they're going to have a lower cost than stocks, and they can be fairly quick as far as getting the funding, because I don't have to go through all the regulation of putting an IPO out and having it regulated by the SEC.

So the last thing we want to look at is risk return relationship. Now risk return relationship is the concept that the higher a risk is, the higher potential return is as well. Safer investments will typically have lower returns than risky investments. Risky investments will typically tend to have higher returns.

Now, if you invest in something with a very low risk, then you have what's called a conservative investment. Now when a conservative invests, investments are generally considered very safe, but they don't return very much money, for example, a certificate of deposit or a corporate bond, especially one that is backed by mortgage assets. Also a government bond is considered to be very, very safe. It's a very safe type of investment, but as a result, the return you're going to get on that is going to be very, very low.

Now with aggressive investments, these are investments that are typically very risky, but the potential for return is also very, very high. Examples of this type of investment will be things like angel investing. You're investing in companies that are unknown, they're just starting off and they have absolutely no history. There's a lot of risk in there. But if the company does well then there's a potential for a very high return on your money, and this would be a type of aggressive investment.

Also, things like low quality stocks or penny stocks, junk bonds, bonds that don't have a very good financial rating, and unproven stock, just starting off, just issuing their IPOs. These are all types of aggressive investments. And the idea here is you're getting in very, very low, very near the beginning of the business' operation. So any time that business grows you're getting the entire growth of the whole business. And that's what makes them attractive to investors or aggressive investors, because of that high return. The thing we have to keep in mind here is there's a very high risk that you'll lose that money and you won't have anything to show for it.

So what have we talked about today? Well, we talked about alternative financing. We also talked about venture capitalist and private placement. The last thing we looked at was that concept of the risk return relationship. The more the risk, the more the return on that investment.

Now as always, I want to thank you for spending some time with me today. And you folks have a great day.

Terms to Know
Angel Investors

An individual who provides funding from their personal finances to a business; typically receiving ownership equity or a type of bond in exchange.

Private Placement

The selling of any tradable asset by a firm to a closed set of investors.

Risk Return Relationship

The concept that the higher a risk is, the higher potential return is as well.

Venture capital

Funding during the beginning stages of a new company or venture to get the business started; in exchange for owner’s equity.