Initial Public Offering (IPO) vs. Private Placement: An Overview

Private companies that seek to raise capital through issuing securities have two options: offering securities to the public or through a private placement. Regulations on publicly traded securities are subject to more scrutiny than those for private placements.

Each offers the necessary capital, but the criteria for issuing, ongoing financial reporting and availability to investors differs with each type of issue.

IPO

An IPO is under the regulation by the Securities and Exchange Commission (SEC) and require strict financial reporting criteria on a regular basis to remain available for trade by investors.

In an IPO, the issuer obtains the assistance of an underwriting firm to help determine what type of security to issue, the best offering price, the number of shares to be issued and the time to bring it to market.

Though the underwriting firms such as Goldman Sachs (GS) or Morgan Stanley (MS) that bring the issue to market hold shares to sell to their clients at the initial sales price, average investors can obtain the shares once they begin trading in the secondary market. IPOs can be a risky bet for investors, as there is no previous market activity to evaluate. This is why reading the IPO prospectus report, and gaining any knowledge about the company is crucial before investing.

IPOs became friendlier to small businesses as a result of the passage of the Jumpstart Our Business Startups Act, which was created to support hiring and lessen the otherwise extensive financial reporting burden on small businesses filing for an IPO. 

Private Placement

Private placement offerings are securities released for sale only to accredited investors such as investment banks, pensions or mutual funds. Some high-net-worth individuals may also purchase the shares through these options.

Companies using private placements generally seek a smaller amount of capital from a limited number of investors. If issued under Regulation D, these securities are exempt from many of the financial reporting requirements of public offerings, saving the issuing company time and money.

A private placement issuer can sell a more complex security to accredited investors who understand the potential risks and rewards, allowing the firm to remain as a privately-owned company and avoiding the need to file annual disclosures with the SEC. Marketing an issue may be more difficult for private placements, as these investments can be quite risky with lower liquidity than publicly traded securities. Private placements can also be done quicker than IPOs. For a company that values its position as a private entity, they don't have to sacrifice that privacy but can still gain access to liquidity, or cash, from the deal.

Key Takeaways

  • Private companies that seek to raise capital through issuing securities have two options: offering securities to the public or through a private placement.
  • An IPO is underwritten by investment banks, who then make the securities available for sale on the open market.
  • Private placement offerings are securities released for sale only to accredited investors such as investment banks, pensions or mutual funds.