Introduction to Private Placement
Private Placement is the offering of shares or bonds by companies to accredited investors directly instead of placing them in market for public. This is extremely popular way to generate finance for private companies who are at the initial stage of growth.
It is done by companies who needs money to finance their business but are not eligible enough to list their companies in Stock Market. Private companies prepare presentation for accredited investors who have knowledge regarding the business and do thorough analysis of the company before investing. Private Equity funds are the main players in this segment. They have the cash and are ready to invest in companies whose future prospects are high.
Purpose of Private Placement
The main purpose of this is to generate funding from wealthy individuals, institutions banks without having to go through the rigorous legal and documentation process involved in raising funding from public. This process is very less transparent and no such restrictive rules are present to disclose functions of company to public. In US disclosure for private placement is exempted. So they can raise money through this placement by issuing private placement memorandum which need not to be disclosed to public. So the relaxation that is there in case of private placement makes it attractive.
Example of Private Placement
During 2008 crisis when all the Investment banks were on the verge of collapse after the fall of Lehman Brothers due to Sub-Prime Mortgage crisis, Goldman Sach reached Warren Buffet to offer 5% stake. This investment made by Warren buffet was a private placement and due to the trust that market had on Warren Buffet, more investors invested in Goldman Sach and it was saved.
It is not only done by private companies. Public companies can also go for private placements if the situation calls for it.
Uses of Private Placement
- It is considered as stage investing. Stage 1 investing is done on companies who have not started yet. Say a group of person is planning to work on alternative energy. They have done some initial research and needs funding to start a company to carry on further research. The investment that will be done now is considered as private placement. So it can be done at several stages of business cycle.
- Private Equity funds are extremely sophisticated. They are being formed by experts from different fields. So they have the knowledge and connection to make any company successful. Taking funding from private Equity in the form of Private Placement is beneficial for the private company. The Private Equity fund will help the private company to grow by helping that company with the In-House expertise they have.
- These are done to accredited investors, so it is known that investors will come with knowledge about the business and the company. So the private company will have to be actually be enriched with positive ideas to receive the funding.
Private Placement vs Private Equity
It refers to the funding that is being generated by the companies who are willing to generate money with limited legal documentation.
Private Equities are investors who are willing to invest in private placements. Private equities are funds who are designed to invest in private businesses with the hope that greater alpha will be generated by selling the company when the business flourishes. So the relation between Private Equity and Private placement is that one is the investor and other is the lender.
Advantages and Disadvantages
Below are mentioned some advantages and disadvantages:
Some of the advantages are:
- It is good for small companies who are planning to grow and doesn’t meet the requirements to be listed in an exchange, as it requires very less documentation and disclosure
- These are done to private equity funds are beneficial to small businesses as Private Equity funds come with expertise teams who help the businesses to grow
- The process of raising money through Private placement is much faster than raising money through public offering as lots of legal procedures need to be followed during public offering.
- During the start-up phase the Idea is new, so the competition is huge. In a public offering, there is a huge requirement for the disclosure to the public, regarding the planning and documentation of the company. This may lead to leakage of ideas. So this kind of guarantees finances without leakage.
- The cost of maintaining a public company is huge as there needs to be a board set up for shareholders and separate teams for audit, capital budgeting, and for deciding executive payment structures. The disclosures are done quarterly which is expensive and acts against confidentiality. It let the company to remain private, so additional cost saved.
Some of the disadvantages are:
- As the investment in a private company is illiquid, so the investor may ask for greater returns than what is prevailing in the market. So if bonds are issued in a private placement, then investors may ask for greater interest than what is prevailing in the market. In case of equity share being issued as a private placement, the investor may ask for a higher dividend
- Investors who participate in this may demand for higher ownership and in turn, will indulge in the decision-making process. This may be difficult for management to take independent decisions.
It is extremely popular for budding companies, who can’t generate capital through public issues. Many companies have flourished from this placement investments, as they are easy to avail and doesn’t force new companies to disclose plans for the future. As the company lies with the management, so the management doesn’t have to bother about the share price all the time. He can take decisions for long term good of the company.
This is a guide to Private Placement. Here we also discuss the introduction to private placement along with the purpose, uses, advantages, and disadvantages. You may also have a look at the following articles to learn more –