A private placement is when a company chooses to raise money through a controlled stock sale, rather than an IPO. (Initial public offering) While an IPO is stock sales to the open market, private placements are stock sales to pre-approved investors. Private placements are not required to file with the Securities and Exchange Commission, making it a much faster way for companies to raise capital than an IPO. This allows smaller businesses to raise money from investors without going through the costly process of going public.
There are a few similarities between an IPO and private placement, as the main goal is to raise money for the company issuing stock. While IPOs launch a company's stock for open trading, a private placement only offers stock to a few approved investors outside the stock exchange. The main participants in private placements are wealthy investors, institutional investors, and large family offices.
These investors are pre-approved, meeting specific requirements. Private placements issue a private placement memorandum rather than a prospect and don't have to present the same amount of financial data as companies going public. Private placements are often used for startups or small companies requiring funding to continue their growth. This allows entrepreneurs to raise money by selling stakes in their company to known pre-approved investors.
The main reason companies choose to go for a private placement rather than public offering is time and control. Regulatory restrictions on private placements are much less strict than public offerings. They are allowing for a faster way to raise capital from investors.
Private placements aim at pre-approved investors, giving more control to the issuer. This is an excellent way for small and medium companies to sell parts of their companies but still hold on to control by choosing who to sell the stakes. Private placements also offer companies a way to involve outside investors without reporting to the SEC. Another great perk of raising capital through private placement, rather than IPO, is the company's ability to stay private.
A private placement can be both debt and equity. A company can choose to do a private placement for a bond or decide to sell shares through a private placement. As the term, Private placement doesn't describe what is being sold, but rather how something is sold.
What most people think about when talking about private placements is venture capitalism. Huge new tech companies are raising funding rounds of $50-$100 million to continue their growth, only offering stocks to corner investors. These deals are mostly out of reach for investors outside of select groups.
Next out is a far more common way of private placements, one that you've probably not thought much about. This is private placements done by family and friends. Someone you know starting up their own company, offering you a stake in their company for $10.000? That's also a private placement, as it is not provided on the stock market or to the public market.
Hedge funds raising new capital for investment purposes from their investors. Even though these are often funneled back into publicly traded stocks, the money is a private placement done by the hedge fund.
As we see above, most private placements are aimed at institutional investors or ultra-high net worth individuals due to the vast amounts of money drawn upon for private placements. Companies going through with private placements are often not ready for the stock market yet or have a long-term growth strategy that requires long-term ownership. Companies specialize in private placements, as the risk involved is much higher than with public stock trading.
A private placement offering memorandum is a document presenting potential investors with risks and terms for a private placement. Similar to IPO summaries, you'll find financial statements, management bios, operational descriptions, and plans for the placement.
These documents are used by business owners to present their company as an investment for outside investors. The memorandum contains a detailed business plan, together with explanations of terms and growth expectations from management. After being produced, the memorandum is presented to select investors in a closed circuit. These companies then evaluate the potential return on the investment, measured against the Offering memorandum's proposed terms.