If you are looking for alternative investment options, consider privately held stock. While public organizations offer stock traded on exchanges or over-the-counter, privately held stock is purchased/traded directly and is not issued via an initial public offering. Before we delve into how to transfer privately held stock, it is important to gain a clear understanding of the differences between public and private stock as well as the types of business ownership seen in the private market.
Public vs. Private Stock
A public company by definition trades shares of its stock on one of many U.S. stock exchanges. Public companies are required to file earnings reports and a variety of paperwork with their respective exchanges and are monitored by the Securities and Exchange Commission. As private companies do not trade public stock, they are not required to follow these same standards. For this reason, privately held stock is often considered riskier than publicly traded stock, although it is important to note that both forms carry inherent risks.
Types of Privately Owned Businesses
While many consider privately owned businesses to be the ‘mom and pop’ owned organizations we drive by or see every day, many of the most successful business enterprises in existence today are privately owned. For example, the empire known as Facebook has remained privately owned since its inception. While the brand may choose to issue shares via an initial public offering in the future, it has been open to private investment capital over the past several years.
There are several different business structures that investors may run across in the private sector, including sole proprietorship, partnerships and corporations.
Sole proprietorship describes a business owned by a single investor, and as such, is not commonly seen in the investment marketplace. Partnerships describe businesses owned by two or more investors and can be formed as general partnerships, limited liability partnerships or limited partnerships. In any of these business formations, the underlying owners carry the majority, if not all of the financial risk. Corporations describe for-profit enterprises that carry a separate legal personality from their members. Corporations are owned by underlying shareholders, holding either private or public stock shares.
Investing in Privately Held Companies
Individual investors can invest in privately held companies directly, or through organized groups of investors such as venture capitalists. Privately held stock is generally transferred directly or via a third party such as a venture capital firm. Alternatively, some privately held stock is held in mutual fund like investments, allowing individual investors to hold a portion of the underlying investments with a smaller initial investment of their personal capital.
When transferring shares of a privately held company directly with the other shareholders, this is often performed under the guidance of a buy-sell agreement, and is handled manually. When working via a venture capital firm or via a mutual fund, it is important to note that in order to transfer shares, there must be either a willing buyer on the other side, or a buy-back provision in your investment contract. It is also important to note that many private investment opportunities carry stock restrictions, meaning that only a portion of one’s initial investment may be sold in year 1, year 2, etc. It is critical that prior to investing in any private placement investment opportunity that you read such restrictions, so you are fully aware of when, if at all, you will have the right to recapture your initial investment capital. Should you have satisfied the holding restrictions, transactions are often carried out in a brokerage account, on both the buy and sale side of the trade.