I recently sat in on a board meeting where the leaders of a $800M revenue company discussed how they could “go public,” and do it in less than 2 years. After some chat, the terms “Private Placement” (PP) and “Direct Public Offering” (DPO) came up. The consensus was that both are cheaper and quicker than IPO, but nobody in the room could explain their differences. I left feeling determined.
Since that meeting, I’ve scoured through countless examples of companies that have completed DPOs and PP and analyzed the SEC’s rulings and filings to compile the data in this article so that you don’t have to look anywhere else to understand the difference between them, and which is better for you.
The key difference between Direct Public Offerings and Private Placements is that DPOs can be sold to an unlimited number of public investors as long as the total capital raised does not exceed $20M within a 12-month period (Reg A), whereas private placements can be sold to an unlimited number of accredited investors (think banks and individuals worth >$1M) and have no restrictions on the total capital raised (Reg D).
For many years, the private placement was simply considered an alternative to include a large number of investors in the share capital of a private company — which is otherwise limited to 2,000 shareholders.
Direct public offerings, on the other hand, were seen as either a way for companies to sell stock to its customers as a way to thank them, support the local state (FL, TX, NY) that launched them, or quickly exit a few shareholders in a highly-valued company without paying hefty underwriting fees in IPO.
But since they both occur privately, what exactly is the difference? Aren’t they just two uses of the same capital raising tool?
The reason we struggle to differentiate PPs and DPOs is that these titles are not overt classifications defined by the law. Instead, specific rules in Regulation D, Regulation A, and Intrastate Offering Exception of the Securities Act of 1933, outline specific exceptions to registering shares with the SEC, which leaves two IPO alternatives for raising money without registering. Investors then call these 2 options private placements and direct public offerings.
This article investigates the details of how private placements and direct public offerings differ based on SEC regulations. Let’s quickly define DPO and PP before exploring the specifics.
Definition: what is a direct public offering (DPO)?
A direct public offering is a transaction in which a company sells shares to the public without the participation of an underwriter.
Definition: what is a private placement (PP)?
A private placement is a financial transaction in which a company sells shares to a limited number of accredited and sophisticated investors without the participation of an underwriter.
Table Differences Between Direct Public Offerings, Private Placements, and IPOs
In general, you can think of differences in terms of 14 criteria: lockup period, maximum capital allowed, limits on affiliate’s share transferability, types of investors allowed, time restrictions to earn the defined capital, accounting standards required, prospectus writing (or equivalent), “restricted” status of shares, capital raising (yes or no), and presence of issued shares (versus the sale of existing shares), limitation to one state, and responsibility towards antifraud protections.
| Item | DPO (Tier 1 of Reg A) | DPO (Rule 504 of Reg D) | Private Placement (Tier 2 of Reg A) | Private Placement (Rule 506 of Reg D) | DPO Intrastate Offering Exception (All) | IPO |
|---|---|---|---|---|---|---|
| Lockup period | None | None | None | None | 6 months | 90 – 180 days |
| Maximum capital allowed (M) | $20M | $5M | $50M | None | None | Unlimited |
| Limit on insider (Affiliate) transferable amounts (M) | $6M | None | $15M | None | In-state for first 6 months | None |
| Type of investors allowed | All | All | Accredited (or any if listed) | Accredited + <=35 non-accredited investors | Only in-state investors | Unlimited |
| Time restriction to raise max capital amount | 12 months | 12 months | 12 months | 12 months | None | None |
| Special accounting standards | None | None | None | None | None | Sarbanes-Oxley |
| Prospectus writing | Limited version called “offering circular” | “Sufficient” information | Limited version called “offering circular” | “Sufficient” information | “Sufficient” information | Required |
| Shares defined as “restricted” by SEC | Yes | Yes | Yes | Yes | Yes | No |
| Needs state approval for federal filing | Yes | No | No | No | Yes | No |
| Ongoing reporting required | No | No | Yes | No | No | Yes |
| Raising capital | Allowed, if not listed* | Allowed | Allowed, if not listed* | Allowed | Allowed | Yes |
| Presence of issued shares | Allowed, if not listed* | Allowed | Allowed, if not listed* | Allowed | Allowed | Yes |
| Limited to one state | No | No | No | No | Yes | No |
| Shared info must respect antifraud provisions? | Yes | Yes | Yes | Yes | Yes | Yes |
*This rule changed in December 2020 – See Discussion Below
NOTE: If you’re having trouble seeing the above table, you probably won’t be able to see the others below. Instead, download a free Excel sheet of the tables here:
Note that a company only raises money when it issues new shares; when shareholders sell their existing shares, they take the cash with them. This is an important relationship that we’ll need to keep in mind.
The above table contains a lot of information to digest, so let’s break it down by private placement and direct public offering in the next sections.
Private Placement in Regulation A and Regulation D
As a reminder, regulation A and D define different criteria for exemptions to registering shares. It’s from these exceptions that we deduce two core paths: DPO and private placement. What this means is that depending on the regulation, our private placements will look slightly different.
This table shows how private placements look different between them:
| Item | Private Placement (Tier 2 of Reg A) | Private Placement (Rule 506 of Reg D) |
|---|---|---|
| Lockup period | None | None |
| Maximum capital allowed (M) | $50M | None |
| Limit on insider (Affiliate) transferable amounts (M) | $15M | None |
| Type of investors allowed | Accredited (or all if listed) | Accredited + <=35 non-accredited investors |
| Time restriction on max amount accumulation (Months) | 12 months | 12 months |
| Accounting standards | None | None |
| Prospectus writing | Limited version called “offering circular” | “Sufficient” information |
| Shares defined as “restricted” by SEC | Yes | Yes |
| Needs state approval | No | No |
| Ongoing reporting required | Yes | None |
| Raising capital | Allowed, if not listed* | Allowed |
| Presence of issued shares | Allowed, if not listed* | Allowed |
| Limited to one state | No | No |
| Shared info must respect antifraud provisions? | Yes | Yes |
Direct Public Offering in Regulation A, Regulation D, & Intrastate Offering
The term “direct public offering” is a catch-all phrase for a number of different situations both on and off the stock exchanges (i.e. NYSE, NASDAQ).
A common myth, and a source of confusion for many, is that direct public offerings do not raise capital for the company since they offer shares from existing shareholders, but not newly issued shares.
Although companies are not allowed to directly issue shares without a firm-commitment underwriter on public exchanges, such as Spotify in 2018 on the NYSE, this is not the case for non-listed companies.*
In fact, many unlisted companies, such as Ben & Jerry’s, have issued new shares to raise capital through a direct public offering. Here’s a table that outlines the specific criteria of a direct public offering across regulations.
| Item | Direct Public Offering (Tier 1 of Reg A) | DPO (Rule 504 of Reg D) | DPO Intrastate Offering Exception (All) |
|---|---|---|---|
| Lockup period | None | None | 6 months |
| Maximum capital allowed (M) | $20M | $5M | None |
| Limit on insider (Affiliate) transferable amounts (M) | $6M | None | In-state for first 6 months |
| Type of investors allowed | All | All | Only in-state investors |
| Time restriction on max amount accumulation (Months) | 12 months | 12 months | None |
| Accounting standards | None | None | None |
| Prospectus writing | Limited version called “offering circular” | “Sufficient” information | None |
| Shares defined as “restricted” by SEC | Yes | Yes | Yes |
| Needs state approval | Yes | No | Yes |
| Ongoing reporting required | No | No | None |
| Raising capital | Allowed, if not listed* | Allowed | Allowed |
| Presence of issued shares | Allowed, if not listed* | Allowed | Allowed |
| Limited to one state | No | No | Yes |
| Shared info must respect antifraud provisions? | Yes | Yes | Yes |
DPO vs Private Placement: Which is Better?
Now that we have a clear understanding of what DPOs and PPs are, the obvious question is which is better? Both of them benefit from not paying underwriting fees, but which should you choose?
In short, DPOs are better for companies that want to raise a small amount of capital (between $5M and $20M) in a short amount of time, with very minimal filing obligations, and whose shareholders don’t want to exit, OR for companies that don’t want to raise capital but want to go public. Private placements, on the other hand, are better for companies that want to raise a lot of capital, quickly, without burdensome filing and registration requirements, and whose shareholders want to exit.
You may be wondering why shareholders wanting to exit don’t simply sell their shares in a private company transaction. The most common reason for this is that most private investors injecting millions of dollars of capital don’t want to see exiting shareholders, so the only choice for the company is DPO or PP.
Sarbanes-Oxley Doesn’t Apply to DPOs and Private Placements
One of the key points to take away from all SEC share registration exemptions is that the issuing companies are not obligated to go through the very lengthy and detrimentally-expensive accounting standardization process as outlined in the Sarbanes-Oxley Act of 2002.
This process often involves auditors and legal professionals reviewing company processes during a period of 3-6 months. Then, the company must change its internal processes during a period of another 3-9 months. It’s a lengthy and expensive endeavor that many companies cannot justify pursuing.
“Accredited” and “Sophisticated” Investors Can Include Employees
It’s easy to see the benefit of a private placement for a company that wants to share the full wealth of its success with investors. But the drawback is that these investors must be accredited. In other words, it means you cannot sell the stock to your employees. For many, this can be a dealbreaker, since rewarding and including employees is a huge part of going public.
The SEC created another special exemption to the Securities Act of 1933 called Rule 701. It allows the use of securities as compensation to employees, barring some restrictions. In other words, if you’re interested in Private Placement, don’t let not including employees hold you back — there is a way.
State and Other Federal Regulations
It’s important to note that in general, unregistered stocks must almost always be registered with state securities administrations. In the tables above, we show that only direct public offerings under Regulation A require state approval for federal applications.
However, all regulations require companies to comply with state-level laws when issuing shares within that state. Since there are 50 states, listing these requirements goes beyond the scope of this article. However, you shouldn’t worry too much if you’re planning a DPO or PP. Most state administrations align their requirements with those of the SEC. Always consult a local securities professional to make sure you comply with those requirements.
*In 2020 the Rules for DPOs Loosened Up with Primary Direct Listings
Most of this article has discussed DPOs as non-issuing, and therefore non-raising, tools when it comes to listed companies. But this rule was overturned in December 2020 by the SEC after the NYSE petitioned to allow companies to list and issue new shares without an underwriter.
Now, companies can go public with a DPO AND issue new shares. This is important since it removed the expensive cost of getting underwriters for listed public offerings. However, they will still need to register the shares, as well as sell a minimum of $100M in directly offered shares, or have a total of $250M in total outstanding stock. This procedure is called a Primary Direct Listing.
