Why you should avoid private placements – at all cost!
Read this before you dive into any private placement
If you just subscribed to The Private Placement Club, I dearly hope this article is your first read! Why?
Because I will explain you now, how I define private placements and why those investments are most probably not for you. If you disagree with me and remain an interested subscriber, you at least know, what world you are getting into.
What is a private placement?
Technically speaking, private placements are non-prospectus offerings of companies already public or at least with the goal – in most cases – of going public. Naturally, in the US, Reg-A financings as well as PIPE (Private Investment into a Public Entity) investments fall into that category. In Canada, another large market for private placements, all non-prospectus offerings would fall into the same bucket.
However, I don’t draw my line that narrow: I generally include all capital raises for public (or soon to be public) companies that are available for retail investors. This is probably still not clear enough, so I will skin the cat from the opposite side.
Everyone of you will remember IPOs such as Facebook (now Meta), Tesla or BioNTech. Have these companies ever invited you to participate in any private rounds before the IPO? If so, lucky you. We should definitely talk. I wasn’t invited.
Those companies, such as all the other giant companies, never bothered with retail money.
When they required private capital, they phoned up the venture capitalists. When they went public, banks raised them institutional money.
Now that they are public, you and I can buy and sell shares on the open market. That’s the first time, 99.8% of could ever invest into those companies.
That’s quite frustrating. Because it feels like we are left out on the low hanging fruits (and we are).
But instead of sad story ending, here comes the surprising twist: Not all companies are so big and famous, before they go public. And even after the IPO, only a limited amount of investors may know them. Usually, those companies are smaller and so are their capital requirements.
The big venture capitalists are usually not interested in those types of deals. Same goes for institutional money, when going public. Those companies don’t raise 50 or 100m USD on the IPO. They are rather looking at 5, 10 or 15m USD. And this is a number, where our retail contribution, let it be small, can become significant.
Welcome in the world of capital raises with high net worth and retail capital. Everything in this category, I call a private placement.
Welcome to the Wild West for Retail Investors
In terms of the amount of IPOs and capital raises, the small cap/retail placement world is probably several nuances bigger than the Wall Street world. There are 100s of private placements and IPOs each year.
Needless to say, a lot of it is highly speculative garbage, which will never yield any positive returns. But how come, so many of those companies still become financed?
Don’t be insulted but in the capital markets retail money is often called “dumb money”.
Unfortunately, that assessment is not entirely wrong. Retail investors tend to do less research and due diligence. Not a shocking fact to reveal – they are not investment professionals and might have other (time consuming) commitments after all. So retail investors are too often and too easily hooked on – what I call – a “good story”.
If the story provides an exciting blue sky scenario for a financial homerun, all bets are off. Retail investors starting to count their future profits, instead of fact checking the story. A high level review or a “hot tip” from a broker is good enough to cut a cheque.
I have seen this across all sectors: I have been pitched the discovery of the world’s biggest gold mine, as well at the first cancer vaccine. As long as the big picture is strong and convincing enough, it doesn’t matter.
And its not easy to resist. After years of costly mistakes even today I make mistakes, I could have easily avoided. Because there is an entire industry build around making money on retail capital.
At the same time, independent information is scarce:
Will you receive a research report touting a fair value 3 times higher than the current valuation? You bet.
Does the revenue slide in the pitch deck show minimal revenue for the current year, but a hockey stick like growth path after? Of course.
Will you receive a comprehensive and honest risk analysis on the investment case? Dream on.
(Well actually sometimes you do…just not in a place you would know as a beginner)
The odds for success are horribly stacked against you…
So if you are entering this minefield of investments as a beginner, better turn around while you can. There is a famous book on the once notorious Vancouver Stock Exchange, an exchange for small cap investments. Its reputation got so bad that the exchange was eventually shut down. Anyhow, the book title is “Fleecing the Lamb” – and that’s exactly what awaits you.
If you don’t know the game, you will be the last one buying at the highest price. Not a good start to make money, right?
Of course, regulators have recognized the need to protect inexperienced retail investors from greedy brokers and shady businessmen. One measure was to introduce certain requirements for investors, to participate in private placements. You will have to fulfill the criteria of being an accredited investor, which comes with certain income thresholds to be met and so on.
The entire idea is that you invest only capital you can afford to lose.
Do I need to tell you that investors find ways around, to participate in the private placement circus? Of course, they do. I did too. Nobody ever checked my claims, if I would just sign them.
(Did I mention that my first 15k placement immediately went south and I exited the position for proceeds of 3k?)
…but I still made most of my money on private placements
If you are still with me reading this – what else do you need to know to avoid the lustrious dungeon of private placements? Although by now, I do appreciate your ambition and courage.
I think, you deserve to hear how my personal story unfolded. Fast forward from the initial placement, I have lost 7 figures with those investments until today. But at the same time, I also made a considerably bigger amount with private placements.
My so far personal record was an oil stock, I bought pre-IPO at 20 Cent. In the next two years after going public, the stock ran to a peak of 15 Dollars (of course I sold earlier, but still significantly higher). Plus, I had warrants at 50 cents strike price, I made money on too.
If I’d have to draw a conclusion, I would break down my findings as follows:
In the world of private placements, you will pick a good number of losers. It doesn’t matter how experienced and well connected you are. But eventually you will hit a real home run, which will compensate you for all the losers and generate you healthy profits on top.
How is that possible? In my opinion, the small cap markets are highly inefficient in comparison to larger markets. The major players don’t reside at the Wall Street, but rather at a house like yours or mine. The largest players are somewhat professional, but nothing compared to the hyaenas on Wall Street.
Famous investor Stanley Druckenmiller, mentored by George Soros, once said:
“It doesn’t matter, how often you are right or wrong. It matters how much you make, when you are right and how much you lose, when wrong.”
I didn’t know how to summarize the only successful strategy for private placement investing in one sentence, but good old Stan did it for me.
This is, what it boils down to:
Reduce your risk upfront as much as possible.
Recognize when wrong, as early as possible.
Ride the train of success as long as possible.
Today I am confident, I can follow this strategy without becoming emotional despite a very volatile investment experience. I know, who are the few good people to follow and I also know how to discover red flags from a mile away.
But getting there, was a grind. If you are made for this type of investments, you will only learn over time. However, if you don’t fully commit yourself to it, you might as well stop now. The odds are stacked against you and you will still have to commit significant time to become a successful private placement investor.
If that sounds appealing to you – welcome to The Private Placement Club!