By Will Michener & Bob Newkirk

“Know what you own, and know why you own it.”
– Peter Lynch

Markets have been unsettled for over a year. Inflation persists. Economic uncertainty remains. Federal budget deficits climb and may drive future tax increases. Stock and bond values have fallen simultaneously, a rarity. (See The 2022 Bear Market: No Place to Hide) Prognosticators raise concerns that the stock market may be entering a long period of stagnation. These conditions drive increased interest in alternatives to the public markets. However, private market investments differ from publicly traded securities in several important ways. Knowing those differences is a key to picking wisely.

Private Markets, Defined
In a simple sense, private investments are those that are not public. The Securities & Exchange Commission (SEC) regulates public offerings of securities. Issuers offering investments to the general public must comply with a variety of disclosure requirements. This process is intended to make available to all investors accurate and comparable information on which to base a decision.

Private market securities generally operate within one or more exceptions to the rules governing public issuances. These rules, including Regulation D of the SEC, are complex. One set of restrictions is on marketing. A reason private investments may seem exclusive or uncommon is that it is often illegal to market these offerings to the public through a “general solicitation.” General solicitation can include unrestricted public websites, newspaper and magazine advertisements, television or radio broadcasts, and certain types of seminars.

In addition, private securities often may be sold only to “accredited investors.” The concept is to restrict sales to more sophisticated individuals. In some cases, an accredited investor has to meet financial requirements. For example, Regulation D may require a net worth in excess of $1,000,000 (excluding a primary residence), or annual net income at or above certain levels.

Types of Private Investments

There is a remarkably wide range of private, alternative investments. These can range from real estate facilities to collectibles to bricks-and-mortar businesses. The graphic below describes a few of these categories.

Private Investments: Pros and Cons
Private investments can provide opportunities for investors to manage their portfolios that may be difficult to achieve using only public markets. Diversification is one reason to use private markets. Investors can often diversify their portfolio into much more specific industries or geographies using smaller, private offerings. In addition, it is often easier to invest in parts of a business’s capital structure that provide a mix of risk and return that is a better fit for a particular investor. Finally, certain private offerings may provide tax benefits that are not otherwise available.

The benefits of private investments may be coupled with certain restrictions that a savvy investor makes sure to understand. One is less liquidity – the ability to sell quickly for cash – than for a publicly traded security. Private market investors are often expected or required to hold their investments for several years before a full return is available. Private investors need to understand the extent of these restrictions. Typically, private market investments are only a good fit for long-term investment capital.

Investors should also be aware that private investments are not subject to the same type of disclosure requirements and regulations as public offerings. More extensive “due diligence” and investigation is often necessary to confirm that projections by the sponsors of these investments are on sound footing.

Three Examples

Let’s look at three examples of differing private market opportunities. Each is based on recent, real-world private investment opportunities evaluated by Wambolt & Associates.

Multi-family real estate financing (mixed use, townhomes, apartments)

This model is a return-driven, inflation-protected investment for investors who are seeking to earn higher returns than for conventional bonds in exchange for taking more risk, but do not want exposure to the even greater risk of a standard equity investment.

$100,000 to $250,000 minimum commitment
Preferred equity or mezzanine debt
Floating rate returns provide inflation hedge
Targeted annual return of 10%-16%
5 year term
1% origination and exit fee
No specific tax benefits

Oil & gas exploration projects

This model can provide immediate and extensive tax benefits for high-income investors seeking
to reduce their annual tax bill, coupled with protected returns over a period of several years.

$100,000 minimum commitment (7% discount for Registered Investment Advisor clients)
General partner, limited partner and limited liability company units
Income distributions based on oil & gas well production
5 year commitment
8% distribution fee
Deductions of up to 92% of investment amount used for intangible drilling costs
Depletion deductions and other possible tax benefits

Qualified opportunity zone, real estate development projects

This model is well-suited to investors who recently exited an investment and are seeking to
avoid immediate capital gains taxes, together with making a long-term investment with
additional possible future tax benefits.

Real Estate Investment Trust interests
$100,000 minimum investment
Returns based on specific project financial performance
Capital gains may be deferred through 2026 in most cases
Step-up in basis equal to appreciation if held for 10 years

As these examples illustrate, understanding a private market investment may require more detailed knowledge of a number of technical topics than for a typical public stock investment. Most publicly traded shares are of “common stock”; private investments may involve more complex capital structures with multiple tiers of ownership. The tax treatment of dividends, interest and capital gains and losses of exchange-traded securities is relatively well-known; private market opportunities often have specific tax benefits for which tax accounting expertise may be essential.

The Benefit of Experience
Choosing a private market investment requires sophistication. Investors must understand and evaluate capital structures, tax strategies, a range of underlying investment types – and understand the implications of holding an investment for many years. A Registered Investment Advisor (RIA), like Wambolt & Associates, is in a position to evaluate the details of private market opportunities based on experience across this broad field. In addition, RIAs may have access to private market opportunities that individual investors do not. Working with an RIA can also help investors choose whether and what private market investments are a good fit with their individual portfolio.

Will Michener is a Wealth Management Planner at Wambolt & Associates and specializes in the private market investments for the firm. Bob Newkirk is a registered C.P.A, former investment banker, and prior Fellow in Law and Economics at the University of Chicago.

The views expressed in this article reflect the personal opinions, viewpoints and analyses of the Wambolt & Associates, LLC employees or contractors providing such comments, and should not be regarded as a description of advisory services provided by Wambolt & Associates, LLC or performance returns of any Wambolt & Associates, LLC client. The views reflected in this whitepaper are subject to change at any time without notice. This whitepaper is intended to provide education about the financial industry. It is NOT intended to provide investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Wambolt & Associates, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the whitepaper. Past performance is no guarantee of future results. Please remember that all investing involves the possible risk of loss of principal capital. Wambolt & Associates, LLC is a registered investment adviser. Advisory
services are only offered to clients or prospective clients where Wambolt & Associates, LLC and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Wambolt & Associates, LLC unless a client service agreement is in place.