Private placements involve the issuance of debt or equity securities, and are an alternative to an initial public offering (IPO) for a company looking to raise capital. They are regulated by the United States Securities and Exchange Commission under Regulation D, and are sold through a private placement memorandum (PPM). Private placements are different from private equity and private debt, since they involve the sale of shares or bonds to pre-selected investors and institutions instead of doing so publicly on the open market. The buyer of a private placement bond issue expects a higher interest rate than what they can get with a publicly traded security.
Therefore, the capital obtained by issuing a private placement is more often used to support long-term initiatives than to cover short-term needs, such as working capital. In addition, a loss of control could occur if private placements translate into greater ownership by investors. There are minimum regulatory requirements and standards for a private placement, although, like an IPO, it involves the sale of securities. The most common type of private placement is preferential long-term fixed-rate debt, but there are endless structuring alternatives.
Investors invited to participate in private placement programs include wealthy individual investors, banks and other financial institutions, mutual funds, insurance companies and pension funds. An investor in privately placed shares may also demand a higher percentage of ownership in the company or a fixed dividend payment per share. Private placements have become a common way for startups to obtain funding, particularly in the Internet and financial technology sectors. A private placement allows the issuer to sell a more complex security to accredited investors who understand the potential risks and benefits.
Therefore, private placements can be a more practical and faster method for companies to raise capital compared to public offerings, resulting in lower fees. Privately placed debt securities are similar to bank bonds or loans and can be secured, meaning they are backed by collateral, or unsecured, when no collateral is required. By opening their doors to pre-selected investors through private placements, companies can raise funds to expand without having to meet the numerous regulatory requirements that require an initial and public offering. The process is carried out privately, hence the name, which means that a company does not have to overcome the regulatory obstacles of an initial public offering and be a public company, but can instead raise external funds to expand the business.
