A private placement is a sale of securities to a pre-selected number of individuals and institutions. Compared to sales of securities on the open market, private placements relatively have no regulation.
On the other hand, private sales are now common for startups. It allows the company to obtain the money they need to grow while delaying or foregoing an IPO (Initial Public Offering).
Investors invited to participate in private placement programs. The programs are wealthy individual investors, banks and other financial institutions, mutual funds, insurance companies, and pension funds.
One advantage of a private placement is its relatively few regulatory requirements.
Understanding Private Placement
There are minimal regulatory requirements and standards for a private placement even though, like an IPO, it involves the sale of securities. The regulation is the Securities Act of 1933 for the sale of stock on the public exchanges.
The same regulation allows an issuer to sell securities to a pre-selected group of investors that meet specified requirements. Instead of a prospectus, private placements use a PPM (Private Placement Memorandum) to sell to the investors. In addition, it cannot market broadly to the general public.
Advantages and Disadvantages of Private Placement
Buyers of private placements demand higher returns than they can get on the open markets. Private placements have become a common way for startups to raise financing. It is particularly those in the internet and financial technology sectors.
A Speedier Process
The light regulation of private placements allows the company to avoid the time and expense of registering with the SEC (Security Exchange Commission). That means the process of underwriting is faster, and the company gets its funding sooner.
If the issuer is selling a bond, it also avoids the time. And also, it expenses of obtaining a credit rating from a bond agency. It allows the issuer to sell a more complex security to accredited investors who understand the potential risks and rewards.
A More Demanding Buyer
The buyer of a private placement bond issue expects a higher rate of interest than can be earned on a publicly-traded security. A buyer may not buy a bond unless it is secured by specific collateral. It may also demand a higher percentage of ownership in the business or a fixed dividend payment per share of stock.