Private Placement of Shares

What is the Private Placement of Shares?

The term “private placement of shares” refers to the private alternative to the issuance or sale of publicly offered securities as a tool to raise capital. In the private placement of shares, the issuer offers and sells equity shares to selected investors. In some cases, there may be as few as just one investor for a private placement.

There are three important features based on which issuance of shares can be classified as a private placement:

• The equity shares are not offered publicly
• The issuance doesn’t need to be registered with the regulators
• Very few investors are involved in the process

Purpose of Private Placement of Shares

Both private and public companies issue shares through the private placement route for various purposes. The companies seek access to long-term capital, diversify their financing sources, or maintain confidentiality in the case of already privately held companies. The capital raised through issuing shares in a private placement is mostly used to support long-term initiatives. Some capital used to raise through private placements are acquisitions, expansion/ growth capital, recapitalization/ stock buyback, a private-public company, or an employee stock ownership plan (ESOP).

How does Private Placement of Shares work?

Although the private placement of shares involves the sale of securities, it is still governed by minimal regulatory requirements and standards. The issuance doesn’t require registering with the regulator (SEC in the case of the US). On the other hand, the issue of shares on the public exchanges is regulated by the regulator, who ensures that the investors are provided sufficient disclosure at the time of their purchase. The issuer isn’t even mandated to provide a prospectus to the potential investors and has the option of not disclosing detailed financial information. Instead of a prospectus, the shares are issued using a private placement memorandum (PPM).

Issue of Private Placement of Shares

The procedure for the issue of a private placement of shares takes the following way:

• Call for a Board Meeting: Notice and agenda of the meeting should be issued at least one week before the date of the Board Meeting.
• Hold the Board Meeting: The Board Meeting is held to identify the potential investors for the private placement offer, prepare the offer for the private placement, and issue notice of the General Meeting at least three weeks before the meeting date. The Board Resolution should be filed with the State Business Department within one month of passing the resolution.
• Hold a General Meeting: The offer letter for the private placement is presented to the company’s members for approval. Once the members approve, a special resolution is passed for the issuance, which is then filed with the State Business Department within one month of passing the resolution.
• Circulation of the Offer Letter: The offer letter is sent to the selected investors identified by the members of the Board. The offer letter should be sent within one month after recording the names of the investors.
• Open a Separate Bank Account: All the capital raised through the private placement of shares will be received in a separate bank account. The money must be deposited within the period mentioned in the offer letter.
• Hold the Second Board Meeting: Once the offer period is over, another Board Meeting is held to resolve the allotment of shares. Allotment returns must be filed within 15 days of passing the resolution.
• Issue Certificate of Shares: After filing the required documents with the State Business Department, the share certificates are issued to the investors or shareholders. Post issuance of the share certificates, the company should pay the stamp duty within one month.

Advantages

Some of the major advantages are as follows:

• Private placements are usually done with a buy-and-hold strategy. So, the issuer can benefit from having such a long-term relationship with the investors.
• These investors provide useful strategic inputs that can be instrumental in running the company.
• The issuers don’t need to register and market these fundraising initiatives with the regulators. So, the process can be completed in less time and at a lower cost.
• It is one of the most effective ways for companies to raise capital, especially when market liquidity conditions are not decent.

Disadvantages

Some of the major disadvantages are as follows:

• One of the most challenging private placement tasks is finding the perfect set of suitable investors.
• The investors who participate in such fundraising may ask for higher equity ownership or even board positions, given the liquidity risk they take up.

Key Takeaways

Some of the key takeaways of the article are:

• Private placement of shares refers to selling equity shares to a pre-selected number of very few individuals and institutions.
• Companies usually opt for private placement for business expansion, diversification of capital, strategic investor participation, share buyback, ESOP, etc.
• These fundraising initiatives are relatively unregulated, less time-consuming, and less costly than selling other financial securities in the open market.
• The private placement investors usually enter the picture with a buy-and-hold strategy, providing strategic inputs that help run the company.

Conclusion

So, the private placement of shares can be a useful financing tool for companies if implemented appropriately. It is used for various reasons, from business expansion to funding ESOPs. However, the most difficult part of this process is finding the right set of investors for the business.

Recommended Articles

This is a guide to the Private Placement of Shares. Here we also discuss the definition, purpose, working, issues, and advantages and disadvantages. You may also have a look at the following articles to learn more –

1. Private Placement 
2. Merchant Bank
3. Accredited Investor
4. How to Get Into Project Finance