Private placement definition
/What is a Private Placement?
A private placement is the sale of a security to a small number of investors. Issuing entities are interested in private placements because these transactions avoid the time-consuming process of having securities registered for sale to the general public through the Securities and Exchange Commission. Examples of the types of securities that may be sold through a private placement are common stock, preferred stock, and promissory notes. If promissory notes are involved, then they have a mixed maturity date and require periodic interest payments, rather than a single interest payment on the maturity date.
Many of these transactions are covered by the Regulation D exemption from the normal reporting rules, which limit these placements to investors having a high net worth or income, as well as experience in or knowledge of financial reporting. By implication, Regulation D eliminates sales to investors that may not have sufficient knowledge to understand the level of risk they are undertaking.
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Advantages of a Private Placement
The main advantage of a private placement is that a company can complete the transaction within quite a short period of time, which can be critical when there is an immediate need for the cash. If the company is issuing a bond, this type of placement allows it to avoid the time required to obtain a rating from a credit rating agency. These cash needs may include an acquisition, stock buyback, or an attempt to take the company private. Another advantage is that these placements tend to cover a long period of time, so there is no immediate need to pay back an investor. Yet another advantage is that these placements can be handled privately, so news of the arrangement is not made public. Finally, a private placement allows a private company to remain private, without having to go through the onerous and expensive process of selling shares to the public through an initial public offering.
Disadvantages of a Private Placement
A key disadvantage of a private placement is that the company may have to offer a substantial inducement to investors to participate. For example, this could involve a price that is discounted from the market price, a guaranteed dividend payment, or perhaps the addition of warrants to the securities. In addition, investors may demand collateral in exchange for buying the firm’s bonds.
Who Can Invest in a Private Placement?
The type of investor that usually participates in a private placement is a wealthy individual or a well-funded buy-side firm, such as a pension fund, hedge fund, or insurance company. Given their size, they typically drive a hard bargain, seeking to obtain the lowest possible price per share. These investors must meet the SEC’s requirements for an accredited investor.
How to Select a Private Placement Investor
There are several factors to consider when selecting a private placement investor. A major item is that they have a history of following through on their funding commitments, so that you can develop funding projections with confidence. Another factor is that they are willing to continue investing over an extended period of time, even as the market cycle changes. This means that you will have less work finding investors for later investment rounds, since this investor can be relied on to participate. Yet another issue is whether the investor is simply attracted to a good return on investment, or actually wants to partner with the company for the long term; the latter situation is greatly preferred, since it implies that there will be few conflicts with the investor. A final factor to consider is whether the investor can act quickly, providing funds shortly after you make a request. This greatly improves the reliability of company cash flows. The ideal investor should meet all of these requirements, which means that you need to put a major effort into reviewing the characteristics of all available investors.
Private Placements vs. Public Offerings
A private placement differs from a public offering, where securities are offered for sale to the general public via an underwriter. A public offering requires that a detailed prospectus be issued, which is not the case for a private placement. Another difference is that the cost of a private placement is substantially lower than would be the case for a public offering. A further difference is that a private placement allows the issuer to avoid a commitment to making ongoing public filings with the Securities and Exchange Commission, which is a massive burden.