The sale of private securities is a manner of raising capital for a business venture by offering a profit on investments. The first of the four specific requirements that define a private security is the investment of capital. Second, the reason the investor elects to invest the capital must be an expectation of profits. The last two requirements are that the profits must come from a common enterprise and that the enterprise rest solely on the efforts of a third party.
The first requirement defining private securities that a person must contribute capital to a business venture is pretty straightforward. There does not need to be any particular manner or type of contribution. For instance, one investor may contribute cash, while another contributes a physical asset and they both may be investing in a security depending on the presence of other factors.
For a contribution of capital to fall into the category of private securities, that contribution must be given with the promise or expectation of a return on the investment. In other words, the individual must expect to receive not only the money he or she contributed, but a percentage of the profits made by the venture on top of that amount. Conversely, if someone lends money to fund a business venture but only expects to receive the money back that he or she lent, then it would not satisfy this second requirement to qualify as a security. A security rests on the return on the investment.
The third requirement for a classification of private securities is that the return on the investment be derived from a common enterprise. In this context, common enterprise refers to any business venture that is presented to the investor as the reason he or she should invest his or her capital. For instance, a business person may present an investment opportunity to a potential investor that entails purchasing a commercial property for the purpose of renting it to a business. In this case, the common enterprise is the purchasing of that rental property.
The fourth and final requirement for private securities is that the scope of the investment be limited to the capital contributed and not participation in managing the business. Taking the previous example, if the investor contributes money to the venture, but does nothing else to contribute, it would qualify as a security. On the other hand, if the investor were to take a hands-on approach and work on improving the property, or otherwise manage the venture, then it would not satisfy this fourth and final requirement and the investment would not fall under the category of private securities.