Generally, shares and securities of an organization or corporation are sold or made available to investors publicly through stock exchange or other similar means. Private placement refers to the sale of securities to a previously chosen tight knit group of investors, where the general public is not involved.
The group of investors may be chosen in a personal capacity, such as friends and family, or in a professional capacity, such as preferred investors or long term associates. It may also include select individual banks, insurance and pension companies, and other institutions. Mostly private placements are sold and disbursed through investment banks.
Understanding the concept of Private Placement
Some of the basic components and ideas of a private placement are enumerated below.
- Start ups often make use of private placements in order to launch businesses safely and more intimately. Hedge funds too frequently use this tactic to raise necessary investment funds.
- A detailed prospectus is always necessary for public offerings, but this is not the case for private placements. Hence, it may be less time consuming and more convenient on the part of the issuing authority.
- They are however required to prepare a private memorandum for the sale of the same.
- An important example of a private placement is an instance of 2008 during the financial crisis. Goldman Sachs had been known to offer a significant share to Warren Buffet through a private placement in order to ride through the crisis, among other investors.
- There are many regulations that come with a private placement, including a specific time period in which the shares cannot be sold to a third party. Aside from the obvious restrictions regarding who is eligible to invest in these securities, the securities themselves are bound by several clauses which must be followed by all investors.
Advantages of Private Placements
- The biggest advantage with respect to private placements is the fact that most regulations governing public offerings do not come into play. Transactions are smoothers and a lot of crucial time is saved by not having to register through the Stock Exchange.
- The acquiring of necessary capital becomes a much speedier process. It also becomes safer for the start up or company in question, since such acquisitions can be risky in the early growing stages of any enterprise.
- Investors have a good opportunity to negotiate and reduce the cost of the securities to a price they can afford and that is lucrative for their personal business.
- Long term and complex financings of lesser known companies can be made possible through this. It also allows a company flexibility in terms of choosing their own investors and remaining a private company.
Disadvantages of Private Placements
- Agreements may not always be clearly spelt out due to the lack of a detailed prospectus, and one’s expectations of performance may not be realized.
- The shares and bonds are always required to be placed at a discounted price in order to offer incentives for investment. This increases risks for loss.
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.