What is a Private Placement?

Raising adequate capital is integral to building and growing a business, and companies usually go the initial public offering (IPO) route. An alternative is the capital raising event known as a private placement. A private placement involves the sale of securities to a relatively small number of select investors. Investors targeted include wealthy accredited investors, 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.


Private Placement

Understanding Private Placement

A private placement has minimal regulatory requirements and standards that it must abide by. While it is a capital raising event involving the sale of securities, it does not have to be registered with the U.S. Securities and Exchange Commission (SEC). The offering is usually aimed at small pooled entities and wealthy individuals (accredited investors). The investment does not require a prospectus and in many cases, detailed financial information is not disclosed.

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 a registration exemption for private placement offerings. Regulation D allows an issuer to sell securities to a targeted group of accredited investors that meet specified requirements. Instead of a prospectus, private placements are sold using a private placement memorandum (PPM) and cannot be broadly marketed to the general public.

Key Takeaways

  • A private placement is a capital raising event involving the sale of securities to a relatively small number of select investors.
  • A private placement offering does not have to be registered with the SEC and it has minimal regulatory requirements and standards that it must abide by.
  • A private placement is far less expensive and faster than other means of raising capital.
  • Investors in private placement offerings often expect higher returns for taking greater risks.

Accredited Investors

An important aspect of raising capital in a private placement is the involvement of accredited investors. While private placements do not require the issuer to register its securities with the SEC, it does require that the issuer only sell the private securities to investors that qualify as accredited investors under the standards set forth by the SEC in Regulation D of the Securities Act of 1933.

Accredited investors can be either individuals or entities that qualify under the SEC’s terms. Entities often include venture capital firms. For detailed standards and requirements defining an accredited investor, see also accredited investor.

Private Placement Investments

Private placements can be used for a range of purposes. A company may utilize a private placement to raise capital for its business. Private placements are also common in newly emerging financial technology product offerings. Below are two examples:

1. Lightspeed POS raised $166 million in a private placement Series D financing round. The funds will be used for business development.

2. Fundrise offers online investing in real estate through private placement offerings. Its wealth management services include offerings specifically for accredited investors and capital is generated through private placement.

Private Placement Advantages

The private placement regulations allow an issuer to avoid the time and expense of registering with the SEC. 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 accredited 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.

Private Placement 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.