A Private Placement is a common method of raising business capital by offering equity shares. Private placements can be done by either private companies wishing to acquire a few select investors or by publicly traded companies as a secondary stock offering. Private placement is also referred to as an unregistered offering. While an IPO requires a company to be registered with the Securities and Exchange Commission (SEC) before it sells securities, a private placement is exempt from that requirement. A private placement might take place when a company needs to raise money from investors. Yet it is different from taking money from other private investors, like venture capitalists. It’s still regulated by the Securities and Exchange Commission (SEC), but under different rules, collectively known as Regulation D. Reg D allows companies to issue securities based on the investors buying them. It distinguishes between accredited and non-accredited investors, as defined by the SEC. Any number of accredited investors can take part in private placements.
Though private placements can issue securities to non-accredited investors, only 35 such investors can be included. If you’re looking to invest in a private placement as an accredited investor, you’ll need to meet some requirements, including:
• A net worth of over $1 million (either independently or with a spouse).
• Earned income more than $200,000 a year (or $300,000 with a spouse).
However, private placement does exist for the small business owner and is often less expensive and easier than taking your company public. And, in the United States, private placement often does not need to be registered with the Securities Exchange Commission. Regulation D is the most popular form of non-public private placement. When a publicly-traded company issues a private placement, existing shareholders often sustain at least a short-term loss from the resulting dilution of their shares. However, stockholders may see long-term gains if the company can effectively invest the extra capital obtained and ultimately increase its revenues and profitability.
Understanding Private Placement
Private placement is an issue of stock either to an individual person or corporate entity, or to a small group of investors. Investors typically involved in private placement issues are either institutional investors, such as banks and pension funds, or high-net-worth individuals. A private placement has minimal regulatory requirements and standards that it must abide by. The investment does not require a prospectus and, quite often, detailed financial information is not disclosed. For an individual investor to participate in a private placement offering, he must be an accredited investor as defined under regulations of the Securities and Exchange Commission (SEC). This requirement is usually met by having a net worth in excess of $1 million or an annual income in excess of $200,000. Private placement can offer investors an exclusive opportunity that isn’t available to the public. It can also offer companies funding without requiring them to register with the SEC or disclose a lot of financial information. However, all investments carry risk. Though still covered by antifraud portions of securities laws, private placements can withhold more information than investors than public offerings. Companies should know that non-accredited investors still require financial disclosures. Meanwhile, potential investors should consider gathering information beyond what’s offered before sinking their money into a private placement.
Private Placement and Share Price
If the entity conducting a private placement is a private company, the private placement offering has no effect on share price because there are no pre-existing shares. With a publicly-traded company, the percentage of equity ownership that existing shareholders have prior to the private placement is diluted by the secondary issuance of additional stock, since this increases the total number of shares outstanding. The extent of the dilution is proportionate to the size of the private placement offering. For example, if there were 1 million shares of a company’s stock outstanding prior to a private placement offering of 100,000 shares, then the private placement would result in existing shareholders having 10 percent less of an equity interest in the company. However, if the company offered an additional 1 million shares through the private placement, that would reduce the ownership percentage of existing shareholders by 50 percent.
Motivation for Private Placement
The dilution of shares commonly leads to a corresponding decline in share price—at least in the near-term. The effect of a private placement offering on share price is similar to the effect of a company doing a stock split. The long-term effect on share price is much less certain and depends on how effectively the company employs the additional capital raised from the private placement. An important factor in determining the long-term share price is the company’s reason for the private placement. If the company was on the verge of insolvency and did the private placement as a means of avoiding bankruptcy, it would not bode well for the company’s shareholders. However, if the motivation for the private placement was a circumstance in which the company saw an outstanding opportunity for rapid growth that simply required additional financing, then the eventual extra profits realized from the company’s expansion may push its stock price substantially higher. Another possible motivation for doing a private placement could be that the company cannot attract large numbers of institutional or retail investors. This might be the case if the company’s market sector is currently considered unattractive, or there are only a few analysts covering the company.
Benefits of Private Placement
• High degree of flexibility in the amount of financing ranging from $100,000 to $10 to $20 million dollars consisting of combinations of debt, equity, or debt and equity capital.
• Investors are more patient than venture capitalists, often seeking 10 percent to 20 percent return on investments over a longer term of 5 to 10 years.
• Much lower costs than approaching venture capitalists or selling the stock to the public as an IPO (Initial Public Offering).
• A quicker form of raising money than usual venture capital markets.
Who Is a Candidate for Private Stock Offerings?
The ideal small business candidate is a company that’s in the third stage of finance and is looking for growth or expansion funding. Small business owners might think private placement applies to start-ups when the company has completed product development and conducted a market-feasibility study and business planning but start-up funding often comes from angel investors.
Where You Can Find Private Placements?
The money from private placements can come from accredited investors defined by the SEC Rule 501 under Regulation D as:
• An individual earning $200,000 per year
• A household with an income of $300,000 per year or a household with a net worth in excess of $1 million dollars
• Venture funds, some banks, and other institutions
To find these private placements, connect with bankers, attorneys, and accountants who can network your small business with the right private investor.
What You Need for a Private Placement?
• You need a sound business plan.
• You should have a private placement memorandum (PPM) disclosing the full facts surrounding the investment and business.
• You’ll need a law firm or lawyer that’s experienced in private placements.
With the limited infusion of capital into the stock market, the private investor market is an attractive alternative for investors and small businesses. Private placement offers a viable form of business financing without the constraints of taking a company public and conceding control.
How Private Placement of Securities Works
A company can be more selective about who buys its shares if it sells them in a private placement. Shares sold in an initial public offering or IPO, are offered to the general public and tend to attract more attention. However, private placement allows a company to raise money without going public and having to disclose financial information. A company can remain private while still gathering shareholder investments.
Restrictions of Private Placements
There are some limitations of private placements, especially when it comes to what types of investors are allowed to participate. A number of rules within the SEC’s regulation D cover those restrictions.
Rule 504
Issuers can offer and sell up to $1 million of securities a year to as many of any type of investor as you want. They aren’t subjected to disclosure requirements.
Rule 505
This rule says issuers can offer and sell up to $5 million of securities a year to unlimited accredited investors and 35 non-accredited investors. If you’re selling to a non-accredited investor, you’ll need to disclose financial documents and other information. With accredited investors, the issuer can choose whether or not to disclose information to investors. But if you provide that information to accredited investors, you must also share that information with their non-accredited ones.
Rule 506
An unlimited amount of money can be raised if the issuer doesn’t participate in solicitation or advertising. While an unlimited amount of accredited investors can be brought in, 35 non-accredited can take part if they meet specific criteria. They need to have enough financial knowledge or have a purchaser representative present to understand and evaluate the investment.
A private company can issue shares via:
• Private placements
• Right issue or bonus issue
• If any company want to issue shares to general public, via IPO it should be converted into public company
Requirements for Private Company for Private Placement
As per Section 23 of the Companies Act, 2013 a private company may issue shares by:
• An offer of private placement can be made to a maximum of 200 individuals in a single financial year.
• The value of the investment should be at least INR 20,000 (on the face value of the securities).
• A private placement letter is sent to applicants (coded with serial numbers) electronically or in writing.
• In the case of issue of shares, a special resolution needs to be passed by the existing shareholders. (Form MGT 14)
• The value of the shares should be certified by a Chartered Accountant (CA) with at least 10 years of experience.
• The payment for securities should be made directly from the bank account for the individual subscribing.
• Securities should be allocated within 60 days of receipt of the application money. If securities are not allocated (because of oversubscription or inability to raise enough capital), then the application money should be refunded within 15 days post the expiry of 60 days. If a company still fails to do so, then the company is liable to pay a 12% interest on the application amount.
The company must file the following with the Registrar of Companies:
• PAS-3 (The return of security allotment within 30 days of allotment)
• PAS-4 (Private placement offer letter)
• PAS-5 (Complete record of private placement)
Way of Rights Issue
As per Section 62 of the Companies Act, 2013 right shares can be offered to:
• Employees under Employee Stock Options (ESOPs) by way of passing a special resolution.
• Any person authorized by way of passing a special resolution.
• To existing shareholders based on the Articles of Association. Shareholders are given 15-30 days to accept right issue.
Preferential Allotment
Preferential allotment is the allotment of shares to a select group of people on a preferential basis. This does not include an offer of shares through a public issue, right issue, bonus issue, ESOP, etc. The issue of preferential allotment should be authorized and stated in the Articles of Association of the company. The issue of shares should be fully paid up at the time of allotment. Preferential allotment should be made within 12 months of passing the special resolution. The valuation of shares will be valued by a registered valour.
Conversion of Loan or Debentures into Shares
By passing a special resolution, a company can convert its loans or debentures into shares. For shares to be convertible, a term has to be attached to the loan or debentures permitting the company to convert them into shares.
Bonus Issue
Bonus issue of shares should be authorized by the Articles of Association. A resolution needs to be passed at a general meeting. All existing shares must be paid-up fully. The company has not defaulted in any repayments (statutory dues, debt securities or fixed deposits). Bonus issue can be made from Capital Redemption Reserve, free reserves and security premium accounts. Once a bonus issue is announced, it cannot be nullified or withdrawn.
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