Private Placements – A Primer

Private placements likely have the potential to provide prudent investment opportunities for investors, especially long-term investors. Private placement programs can also help broaden financing options for both small and mid-sized enterprises (SMEs) in the US.

If you run a business, you know that the one constant in the lifecycle of your small or medium-sized business is the requirement for a cash infusion to jumpstart sales revenue, continue to sustain corporate growth, or expand into new and overseas markets.  Small and mid-sized businesses often face the challenge of raising sufficient capital affordably to fund their business operations.

Although there are many financing sources available to business owners in the US, each source of funding has its unique limitations and legal requirements.

Commercial bank loans, for example, are most suitable for businesses and companies around for a while and who show a consistent stream of profitability, making them safe bets. In contrast, for new and growing businesses, private placement programs are an attractive and feasible alternative.

You have probably heard the term ‘private placements’ and ‘private placement of securities.’ Private placement programs have become quite popular, especially in recent years. You can grow your business with the private placement of securities.

What is a Private Placement?

Also known as a non-public offering, a private placement offering is where businesses sell corporate shares or bonds to investors without offering these securities for sale on the open market. It may be worth noting that these investors could be high-net-worth individuals or insurance companies.

So, what is the difference? When most bonds or shares are issued, these securities are made available to the general public, registered with the US Securities and Exchange Commission, and also traded on a public exchange. However, with a private placement offering, bonds and shares are listed on any public exchange, hence the term private placement. 

Although you can imagine that the term “private placement offering” leaves a lot to the imagination, note that the SEC Act provides considerable guidance about the situations and circumstances in which a security offering will be considered a private placement of securities. Keep in mind that most private placements comply with Rule 506 of Regulation D.

Note that established companies and businesses may choose the route of an IPO (initial public offering) to raise capital through the sale of shares of company stock. This strategy, however, can be complex and even costly, and, as a result, may not be appropriate for smaller or less-established businesses.

Also, it is worth noting that a private placement offering may occur when companies need to raise funds from investors. However, a private placement of securities is quite different from taking money from many private investors, such as venture capitalists and angel investors.

Pros of a Private Placement Offering

Quicker Turnaround Time

With private placement programs, the security underwriting process is considerably faster. This means that your investors can quickly get proceeds from the issue of shares or bonds in less time.

Cost Savings 

 Your company can usually issue a private placement of securities for a significantly lower all-in cost than it could manage in a conventional public offering. For most public issuers, the SEC (Security and Exchange Commission) related registration, underwriting fees, and legal documentation for a public offering can be quite expensive.

Additional Capacity 

Did you know that many companies in the US issue a private placement of securities because they have outgrown their current borrowing capacity? These companies often need capital beyond the amount their existing lenders, such as banks, credit unions, and private equity firms, etc. can offer.

Private placement programs usually focus on various cash flow lending metrics. Also, they can be efficiently completed on a secured or an unsecured basis, depending on your current capital structure.

Different Asset Types

Since you do not have to register with the SEC, quickly selling bonds is possible. And that is not all; your company does not need to obtain a credit rating from an agency. Also, you can sell securities to accredited investors who can understand more complicated bond offerings.

Cons of Private Placements

Higher Interest Rates 

Private placement bonds and securities earn a higher rate of interest than bonds and stocks issued by many publicly traded entities. This is because the buyer of a private placement offering expects a high rate of interest than the rate on publicly-traded securities.

Note that due to the additional risk of not obtaining a credit rating, many private placement buyers may not purchase a bond unless it’s secured by specific collateral, leaving your business on the hook for considerably larger payouts.

Collateral Requirement

Private placement of securities offers little assurance to buyers without a credit rating. Your company may, therefore, have to offer some collateral to entice buyers.

Regulatory and Legal Requirements for Private Placement Programs

The US Securities and Exchange Commission mandates a company to meet an extensive list of requirements when the company decides to issue shares in an initial public offering. Your company will have to provide detailed financial reporting after the initial public offering.

A private placement offering is available to a small group of selected investors (accredited) rather than the public. As a result, companies employing private placement programs do not have to comply with the same disclosure and reporting regulations (Private Placement Memorandums). Private placement offerings and deals are exempt from the US SEC regulations under Regulation D.

Issuing a Private Placement Offering – Here is what you need

  • You will need a sound and comprehensive business plan.
  • You will probably need a law firm or lawyer with experience in private placement programs.

Final Thoughts

Private placement programs can offer investors a great opportunity that is not available to the public. Private placement of securities can also provide businesses the funding they need without requiring them to register with the US SEC or disclose plenty of financial information. A private placement offer is a viable and affordable form of business financing without the limitations of taking a company public and losing control. Sometimes, it requires your business to issue a private placement memorandum.

However, all investments usually carry some risk. While covered by several antifraud portions of securities laws, note that private placement programs can withhold more information from investors than public offerings of securities.