What is Private Placement? | Definition, Concept, Advantages vs Disadvantages

Generally, shares and securities of an organization or corporation are sold or made available to investors publicly through a stock exchange or other similar means. Private placement refers to selling securities to a previously chosen tight-knit group of investors where the general public is not involved.

The group of investors may be chosen personally, 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. Most private placements are sold and disbursed through investment banks.

Key Takeaways

1. A private placement is a method of raising capital by selling securities to a select group of investors rather than offering them to the general public.
2. Companies use a private placement to avoid public offerings’ costs and regulatory requirements.
3. A private placement can include a variety of securities, such as stocks, bonds, and warrants, and is subject to securities laws and regulations.

Understanding the concept of Private Placement

Some basic components and ideas of a private placement are enumerated below.

1. Start-ups use private placements to launch businesses safely and more intimately. Hedge funds too frequently use this tactic to raise necessary investment funds.
2. A detailed prospectus is always necessary for public offerings, but this is not true for private placements. Hence, it may be less time-consuming and more convenient for the issuing authority.
3. They are, however, required to prepare a private memorandum for the sale of the same.
4. 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 to ride through the crisis, among other investors.
5. Many regulations come with a private placement, including a specific period when 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 all investors must follow.

Advantages of Private Placements

1. The biggest advantage concerning private placements is that most regulations governing public offerings do not come into play. Transactions are smoother, and a lot of crucial time is saved by not having to register through the Stock Exchange.
2. The acquiring of necessary capital becomes a much speedier process. It also becomes safer for the start-up or company since such acquisitions can be risky in the early growing stages of any enterprise.
3. Investors have a good opportunity to negotiate and reduce the cost of the securities to a price they can afford, which is lucrative for their business.
4. Long-term and complex financings of lesser-known companies can be made possible through this. It also allows the company flexibility in choosing its investors and remaining a private company.

Disadvantages of Private Placements

1. Agreements may not always be spelt out due to lacking a detailed prospectus, and one’s performance expectations may not be realized.
2. The shares and bonds must always be placed at a discounted price to offer incentives for investment. This increases risks for loss.

References

1. https://heinonline.org/HOL/LandingPage?handle=hein.journals/fedred80&div=6&id=&page=
2. https://www.tandfonline.com/doi/abs/10.2469/faj.v31.n4.33?journalCode=ufaj20

Last Updated : 11 June, 2023