Securities and the Private Market

Selena Romero
March 4, 2022
4 minute read
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If you’re a seasoned investor, the term “securities” is a no-brainer. But to the general public, it might get confusing…no, securities doesn’t refer to mall cops or levels of protection. Securities are financial assets that hold monetary value.

The term serves as a catch-all to represent fungible, tradeable financial instruments that can be bought, sold and traded, like ETF shares, stocks and bonds.

By the end of this article, you'll feel more confident investing in securities in the private markets through understanding:

1. How securities came to be

2. What the most common securities in the private markets are and how they differ

3. Why to invest in securities

The history of securities

The securities market and stock exchanges we see today are the results of economic and technological growth, all stemming from when the Dutch East India Company became the world’s first publicly-traded company in the early 1600s.

The shipping conglomerate was known for trading spices between Asia and Europe and held a stronghold on the trading routes throughout the 17th and 18th centuries. To finance its reign over the seas, the Dutch East India Company offered shares to investors. This resulted in the Amsterdam Stock Exchange, which is now considered the oldest, functioning stock exchange in the world.

Back then, investors would receive paper documents, a “secure” financial contract, as evidence of investment. Today, “securities” might not include a piece of paper, but they still serve as evidence of a financial contract.

Types of securities

Securities fall into two main categories: equity and debt. Each serves its own purpose and risk profile that you should consider when looking to invest.

Equity: equity securities represent direct ownership of a company. When investing in equity securities, you are buying a piece of the company itself. This means if it does well—makes a profit, increases in value, etc.—you may see a direct benefit as a part-owner. Subsequently, this also means that you can lose your entire investment if a company does poorly as well. Notably, stocks are a form of equity securities.

Debt: debt securities see you, as an investor, loaning a company money, which you then have a right to be repaid at a later date. When investing in debt securities there may be additional privileges specified in the original agreement (more on that below). The most common form of debt securities is a bond.

How securities work in the private markets

29986 abstract startup concept 20220304182807494When investing in the private markets, you are essentially buying securities of a company before the potential benefits can be realized. Unlike buying securities on a publicly-traded stock market, realizing returns on private market investments depends on one of two factors happening: the company being acquired or an initial public offering (IPO). Because of its illiquidity, private market investing is considered high-risk, however, due to the nature of investing in the early stages of a company, it does offer the potential for a higher return.

The most common forms of securities in private market investments are as follows:

- Common Shares or Common Stock (equity)

- Preferred Shares or Preferred Stock (equity)

- Convertible Debt (debt)

- Simple Agreement for Future Equity, or SAFE (debt)

Common Shares or Common Stock

The simplest form of equity security, common shares or common stock gives you direct shares in a company. They usually come with voting rights (to vote for the directors of the company, for example) and are what most founders, employees and early investors tend to have.

Preferred Shares or Preferred Stock

Preferred shares or preferred stock are similar to common stock but come with additional rights and privileges. It does not usually come with voting rights, so its appeal comes from its similarities to debt. In other words, it provides a more stable, if less promising, potential return than common stock. Additionally, these shares have priority on assets over common shareholders if the company goes bankrupt. Preferred shares may have unique terms, so you should read any preferred share documentation carefully. This type of stock is favoured by large institutions, which can negotiate the terms of the shares when making an investment.

Convertible Debt

This type of debt security sees a company borrow money from investors with the intention of turning that debt into equity at a later date (usually in conjunction with a future financing round). How the debt is converted into equity—and the terms of this agreement—is specified in the documents you review when making your investment.

SAFE (Simple Agreement for Future Equity)

A SAFE is another type of debt security. However, unlike convertible debt, with a SAFE, the investor’s “loan” does not automatically turn into equity. Instead, a SAFE gives investors the right to buy equity in a company in a future investment round. The specific terms of these rights are outlined in the SAFE, and vary from company to company.

Is one type of security better than the other?

That depends. As laid out, each of the four most common security types in the private markets offers a different level of risk and reward. When browsing investment opportunities, it’s important to factor in what kind of outcome—good and bad—you’re comfortable with.

Each company will choose a security option that best works with its own goals for growth. So if you have questions regarding their plans, you should see if a company is holding a Q&A session to ask the source directly. Additionally, read all agreements thoroughly.

While investment opportunities on FrontFundr go through a thorough due diligence process, there is always the risk of never seeing a return. You should never invest outside your means but there are processes in place, like a cap on how much everyday investors can invest in a private company, to help prevent that from happening.

Why invest in securities

Securities offer everyday citizens a secure and relatively easy way to invest their money into companies they believe will do well, in the hopes of a return on their investment.

Due to its high-risk nature, investing in private market securities can allow investors to align their investments with companies they believe in and want to see succeed. There’s usually a strong correlation between personal values and the companies one chooses to invest in. The possibility of a better-than-average return is the cherry on top.

Like any investment, securities come with risks. By researching what securities are, you’ve taken the first step into being an informed investor. Now it’s time for you to decide what you’d like to invest in.

Illustration by Natasha Remarchuk from Ouch!

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Selena Romero