Advantages and Disadvantages of Private Placement

by Rusith

A private placement is a capital-raising method. Stocks are traded through a private offering to institutional investors, such as banks and pension funds, or high-net-worth individuals. Private placements are a type of unregistered securities offering

Following are the advantages and disadvantages of the private placement issue,

Advantages (Pros / Positives / Benefits) of Private Placement

1) Generate Capital with Less Cost

Public issuing incurs significant underwriter fees and advertisement fees. The private issue can save most of these expenses of the company.

In a private issue, the company does not require expense in preparation of prospectus list, generate application forms, advertise the issue in various media channels, administrate the whole process, external consultant fees, etc.

2) Fewer Regulations

Private placements are less regulated when compare to a public offering. The company does not require to adhere to strict regulations of the Securities and Exchange Commission (SEC). The company will be able to have less hazel with the complex regulations when raising capital.

The company can negotiate the deal privately with its potential investors.

3) Long Term Investment

Private placements present more extended maturities than typical debt financing. This is ideal for when a business forecast potential long term growth opportunity where they could not see the return shortly.

Private placement investors are normally more patient than other investors, such as venture capitalists.

4) The Company can Attract the Most Suitable Investors

In a private placement, an investment opportunity is offered to a small group of investors. Hence, there is a high chance of having the most suitable investors for the company, who knows about the business environment well and could provide business assistance.

Investors may be able to offer precious support to the company’s management on harmonizing the corporate strategy and company vision.

5) Privacy of the Investment Process

‍Private placement investments are negotiated confidentially because of less interference with the Securities and Exchange Commission’s (SEC) regulations. Public disclosure obligations are limited, compared to those found in the public issuing.

6) Obtain Capital without Going Public

A private placement is a capital-raising method where the stocks are sold through a private offering. Stocks are not offered through a public offering in a private placement.

Private placements are one of the limited choices for risky ventures or start-up firms to raise capital. Private placements enable small businesses to maintain their private status of the company.

7) Speedy Process to Obtain Capital

The private placement process is faster on raising finance than the public issuing and other financing methods. There will be rigorous and complex processes applicable for the company if a company chooses to issue shares through public issues. On other hand, a company can raise capital using private placement within 1 or 2 months

Disadvantages (Cons / Negatives / Drawbacks / Risks) of Private Placement

1) Limits the Number of Potential Investors

The private placement could be challenging for the company because of only a limited number of potential investors. Private placement may cause the company to spend more effort and expenses to attract investors than a public offering would require.

A private placement can result in a poor number of potential investors, who do not want to invest substantial amounts individually.

2) High Expectations of the Investors

Investors usually demand more return because of the risk they are taking by investing privately. The company management should support the demand of the investors and should work to achieve the relevant profit margin. This could be a challenging situation for a startup company.

3) Difficult to Find Suitable Investors

An investment opportunity is offered to a small group of investors in a private placement. Also, private placements are one of the limited choices for risky ventures or start-up firms to raise capital. These firms will not promise their investors to generate significant returns over the immediate years.

Investors see these start-up firm investments as high risk which it would be difficult to find investors who are willing to accept this risk. Also, privately placed securities are often sold at a deep discount below their market value to compensate for the risk.

4) May Require to have a Good Credit Rating

Credit rating can be an advantage to find investors for private placement. However, this is time-consuming and will be an added cost to the capital generation process.

Learn more about Private Placement,

What is a Private Placement? | Definition, Usage & Examples