Private Placement

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What is a 'Private Placement'

A private placement is the sale of securities to a relatively small number of select investors as a way of raising capital. Investors involved in private placements are usually large banks, mutual funds, insurance companies and pension funds. A private placement is different from a public issue, in which securities are made available for sale on the open market to any type of investor.

BREAKING DOWN 'Private Placement'

Since a private placement is offered to a few select individuals, the placement does not have to be registered with the Securities and Exchange Commission (SEC). In many cases, detailed financial information is not disclosed and the investment is not sold by prospectus.

How Securities Are Regulated

The SEC regulates how securities are sold to the public through the Securities Act of 1933. This law was put into place after the stock market crash of 1929 to ensure that investors receive sufficient disclosure when they purchase securities. If a company wants to issue stocks or bonds to the public, it must register with the SEC and sell the security using a prospectus.

Regulation D of the 1933 Act provides an exemption to the prospectus requirement. The regulation allows an issuer to sell securities to a limited number of accredited investors or sophisticated investors with a high net worth. Instead of a prospectus, these securities are sold using a private placement memorandum (PPM) and cannot be broadly marketed to the general public.

Factoring in Advantages

The private placement regulations allow an issuer to avoid the time and expense of registering with the SEC and creating a prospectus. The process of underwriting the security is faster, which allows the issuer to receive proceeds from the sale in less time. If an issuer is selling a bond, it can also avoid the time and expense to get a credit rating from a bond agency. A private placement issuer can sell a more complex security to sophisticated investors who understand the potential risks and rewards, and the firm can remain a privately owned company, which avoids the need to file annual disclosures with the SEC.

Disadvantages

The buyer of a private placement bond issue expects a higher rate of interest than he earns on a publicly traded security. Because of the additional risk of not obtaining a credit rating, a private placement buyer may not buy a bond unless the bond is secured by specific collateral. A private placement stock investor may demand a higher percentage of ownership in the business or a fixed dividend payment per share of stock.

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