James R. Balmforth: What Are The Advantages Of Private Placements?

One major advantage of a private placement is that the issuer isn’t subject to the SEC’s strict regulations for a typical public offering. With a private placement, the issuing company isn’t subject to the same disclosure and reporting requirements as a publicly offered bond. Furthermore, privately placed bonds don’t require credit-agency ratings. Another advantage of private placement is the cost and time-related savings involved. Issuing bonds publicly means incurring significant underwriter fees, while issuing them privately can save money. Similarly, the process can be expedited when done in a private manner. Furthermore, private placement deals can be custom-built to meet the financial needs of both the issuer and investors.

Some Advantages Of A Private Placement

• Speed in raising finance: If a company goes in for a fresh issue through public issue there are lot of procedures to be followed which take a lot of time. On the other hand, it is possible to raise resources through private placement within 1 or 2 months.
• Low cost: The company need not spend money in preparation and printing of prospectus, printing of application forms, transporting them to different places, advertisements of the issue in the media etc
• Confidentiality: The Company can maintain strict confidentiality. In the case of issue through prospectus many disclosures have to be made. But in the case of private placement disclosures made are less and they are made to a select few. Therefore confidentiality can be maintained.
• Small amounts can be raised: Even small amounts can be raised through private placement.
• Stable market: The private placement market is more stable when compared to the stock markets. Volatility is less and issues are marketed in a professional manner.
• The primary advantage of the private placement is that it bypasses the stringent regulatory requirements of a public offering. You have to conduct public offerings in accordance with SEC regulations; however, investors and the issuing company privately negotiate the private placements. Furthermore, they do not have to register with the SEC, do not require the issuing company to publicly disclose its financial statements, and ultimately avoid the scrutiny of the SEC.
• Another advantage of private placement is the reduced time of issuance and the reduced costs of issuance. Issuing securities publicly can be time-consuming and may require certain expenses. It forgoes the time and costs that come with a public offering.
• Also, because the investors and the issuing company privately negotiate private placements, they can be tailored to meet the financing needs of the company and the investing needs of the investor. This gives both parties a degree of flexibility.
Now, let’s look at the disadvantages of private placement. The main disadvantage of private placement is the issuer will often have to pay higher interest rates on the debt issuance or offer the equity shares at a discount to the market value. This makes the deal attractive to the institutional investor purchasing the securities.
• Small businesses face the constant challenge of raising affordable capital to fund business operations. Equity financing comes in a wide range of forms, including venture capital, an initial public offering, business loans, and private placement. Established companies may choose the route of an initial public offering to raise capital through selling shares of company stock. However, this strategy can be complex and costly, and it may not be suitable for smaller, less-established businesses.
• As an alternative to an initial public offering, businesses that want to offer shares to investors can complete a private placement investment. This strategy allows a company to sell shares of company stock to a select group of investors privately instead of the public. Private placement has advantages over other equity financing methods, including less burdensome regulatory requirements, reduced cost and time, and the ability to remain a private company.

Regulatory Requirements for Private Placements

When a company decides to issue shares of an initial public offering, the U.S. Securities and Exchange Commission requires the company to meet a lengthy list of requirements. Detailed financial reporting is necessary once an initial public offering is issued, and any shareholder must be able to access the company’s financial statements at any time. This information should provide enough disclosure to investors so they can make informed investment decisions. Private placements are offered to a small group of select investors instead of the public. So, companies employing this type of financing do not need to comply with the same reporting and disclosure regulations. Instead, private placement financing deals are exempt from SEC regulations under Regulation D. There is less concern from the SEC regarding participating investors’ level of investment knowledge because more sophisticated investors (such as pension funds, mutual fund companies, and insurance companies) purchase the majority of private placement shares.

Saved Cost and Time

Equity financing deals such as initial public offerings and venture capital often take time to configure and finalize. There are extensive vetting processes in place from the SEC and venture capitalist firms with which companies seeking this type of capital must comply before receiving funds. Completing all the necessary requirements can take up to a year, and the costs associated with doing so can be a burden to the business. The nature of a private placement makes the funding process much less time-consuming and far less costly for the receiving company. Because no securities registration is necessary, fewer legal fees are associated with this strategy compared to other financing options. Additionally, the smaller number of investors in the deal results in less negotiation before the company receives funding. The greatest benefit to a private placement is the company’s ability to remain a private company. The exemption under Regulation D allows companies to raise capital while keeping financial records private instead of disclosing information each quarter to the buying public. A business obtaining investment through private placement is also not required to give up a seat on the board of directors or a management position to the group of investors. Instead, control over business operations and financial management remains with the owner, unlike a venture capital deal.

Reasons to Issue A Private Placement

• Privacy and Control: Private placements enable companies that value privacy to remain private. In contrast to public debt and equity offerings which require public filings, disclosures of company information and financing documents and terms private placement transactions are negotiated confidentially, and public disclosure requirements are limited. With a private placement, companies would not be beholden to public shareholders.
• Long Maturities: Private placements provide longer maturities than typical bank financing arrangements. They are ideal for companies seeking to extend or layer their refinancing obligations out beyond the typical 3-5-year bank tenor. Additionally, longer maturities often allow for limited amortization, which can be attractive to companies seeking to invest in capital assets, acquisitions and/or invest in projects that have a longer investment return runway.
• Fixed Rate: Typically, private placements are offered at a fixed-interest rate, minimizing interest rate risk. Through a fixed-rate financing, companies can avoid the concern commonly associated with floating-rate coupons, should underlying interest rates rise. A fixed coupon generally allows companies to allocate the cost of debt capital for specific project financings, acquisitions or large capital investment programs. “Creating capital access in both the private debt and bank markets can allow companies to optimize their access to debt capital.”
• Diversify Capital Sources: Private placements help diversify a company’s sources of capital and capital structure. The stable investment appetite shown by insurance companies and other large institutional investors in the private placement market is typically independent from many of the market variables that impact bank market lending activity. Since the terms of private placements can be customized, these transactions are typically crafted to complement existing bank credit facility capacity as opposed to directly competing with these relationships. Creating capital access in both the private debt and bank markets can allow companies to optimize their access to debt capital. Diversification of financing sources becomes particularly important during market cycles when bank liquidity may be tight.
• Additional Capacity: Many companies issue private placements because they have outgrown their borrowing capacity and need capital beyond what their existing lenders (banks, private equity firms, etc.) can provide. Private placements typically focus on cash flow lending metrics and can be completed on either a secured or unsecured basis, depending on the issuer’s existing capital structure.
• Buy-and-Hold: Private placements are typically “buy-and-hold,” meaning the debt investment wouldn’t be purchased with the intent to sell to another investor. Thus, private placement borrowers benefit from the ability to create a long-term relationship with the same investor throughout the life of the financing.

• Ease of Execution: Private placement financings are regularly completed by both privately-held, middle-market companies as well as large public companies. These transactions provide issuers with access to capital on a scale that rivals underwritten public debt offerings, but without certain pre-conditional requirements, such as ratings, public registrations or minimum size restrictions. For public companies, private placements can offer superior execution relative to the public market for small issuance sizes as well as greater structural flexibility.
• Cost Savings: A company can often issue a private placement for a much lower all-in cost than it could in a public offering. For public issuers, the Security and Exchange Commission (SEC) related registration, legal documentation and underwriting fees for a public offering can be expensive. Additionally, in contrast to banks that often rely on ancillary services and fee generation to enhance investment return, private placement lenders rely exclusively on the yield from the notes that they purchase. Taking into consideration the yield-equivalent savings on avoided underwriting fees, in conjunction with the yield premium often associated with first time issuers and small issuance premiums, private placements can provide a very attractive alternative to the public debt market. “In many cases, private placements are completed with a single large institutional investor.”
• Fewer Investors: Unlike issuing securities on the public market, where companies issuing debt securities often deal with hundreds of investors, private placement transactions typically involve fewer than 10-20 investors, and in many cases, are completed with a single large institutional investor. This approach can materially simplify the investor tracking burden for issuers as well as allow them to concentrate their investor-relationship efforts on a few key financial partners.
• Familiar Pricing Process: The process for pricing private placements debt transactions is very similar to that of public securities. The coupon set for fixed-rate notes issued reflects the underlying U.S. Treasury rate corresponding to the tenor of the notes issued, plus a credit risk premium (a “credit spread”). This process allows for general transparency as to the approach that institutional investors undertake when establishing the economics of the transaction.
• Speed of Execution: The growth and maturity of the private placement market has led to improved standardization of documentation, visibility of pricing and terms as well as increased capacity for financings. As a result, the private market can accommodate transactions as small as $10 million and as large as $1-$2 billion. That, when combined with standardized documentation and a smaller universe of investors, fosters quick execution of an investment, generally within 6-8 weeks (for an initial transaction, with follow-on financings executed within a shorter time frame). As noted, it can be much faster to issue a private placement versus a public corporate bond (particularly for first-time issuers) due to the elimination of prospectus drafting, rating agency diligence and registering requirements with the SEC.

Restrictions Affecting Private Placement

The SEC formerly placed many restrictions on private placement transactions. For example, such offerings could only be made to a limited number of investors, and the company was required to establish strict criteria for each investor to meet. Furthermore, the SEC required private placement of securities to be made only to “sophisticated” investors—those capable of evaluating the merits and understanding the risks associated with the investment. Finally, stock sold through private offerings could not be advertised to the public and could only be resold under certain circumstances. In 1992, however, the SEC eliminated many of these restrictions in order to make it easier for small companies to raise capital through private placements of securities. The rules now allow companies to promote their private placement offerings more broadly and to sell the stock to a greater number of buyers. It is also easier for investors to resell such securities.

Although the SEC restrictions on private placements were relaxed, it is nonetheless important for small business owners to understand the various federal and state laws affecting such transactions and to take the appropriate procedural steps. It may be helpful to assemble a team of qualified legal and accounting professionals before attempting to undertake a private placement. Many of the rules affecting private placements are covered under Section 4(2) of the federal securities law. This section provides an exemption for companies wishing to sell up to $5 million in securities to a small number of accredited investors. Companies conducting an offering under Section 4(2) cannot solicit investors publicly, and the majority of investors are expected to be either insiders (company management) or sophisticated outsiders with a preexisting relationship with the company (professionals, suppliers, customers, etc.). At a minimum, the companies are expected to provide potential investors with recent financial statements, a list of risk factors associated with the investment, and an invitation to inspect their facilities. In most respects, the preparation and disclosure requirements for offerings under Section 4(2) are similar to Regulation D filings. Regulation D which was adopted in 1982 and has been revised several times since consists of a set of rules numbered 501 through 508. Rules 504, 505, and 506 describe three different types of exempt offerings and set forth guidelines covering the amount of stock that can be sold and the number and type of investors that are allowed under each one. Rule 504 covers the Small Corporate Offering Registration, or SCOR. SCOR gives an exemption to private companies that raise no more than $1 million in any 12-month period through the sale of stock. There are no restrictions on the number or types of investors and the stock may be freely traded. The SCOR process is easy enough for a small business owner to complete with the assistance of a knowledgeable accountant and attorney. Rule 505 enables a small business to sell up to $5 million in stock during a 12-month period to an unlimited number of investors, provided that no more than 35of them are non-accredited. To be accredited, an investor must have sufficient assets or income to make such an investment. According to the SEC rules, individual investors must have either $1 million in assets (other than their home and car) or $200,000 in net annual personal income, while institutions must hold $5 million in assets.

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