Private Placement Definition

Private Placement Definition

7 min read

Most investors are used to buying shares, ETFs, mutual funds, and other securities in the open market. The public determines the price, and each security has a supply and demand. What happens when private companies want to raise capital? They do it via private placements. These investments are usually reserved for wealthier and institutional investors. However, there are also ways to invest in a private placement through the open market. Let’s find out more about the private placement definition.

Let’s look at the private placement definition. Just like public companies, private companies can also issue shares and bonds. However, they do this via a private placement.

Different types of investors can participate in a private placement. They include accredited investors, financial institutions, insurance companies, pension funds, and mutual funds. Yes, you read correctly.

Mutual funds and ETFs can invest in private placements but with certain restrictions. We will expand on that and accredited investors later. But first, let’s keep talking about the private placement definition.

Regulatory Requirements for Private Placements

When learning the private placement definition, learn the requirements. There are fewer requirements for a private placement than for an IPO or public securities. Why?

Because the sale isn’t monitored by the Securities and Exchange Commission (SEC), unlike for an IPO or a public company, a prospectus, and financial documents aren’t required to be disclosed to potential investors. 

This allows the issuer to be more flexible on their terms for the placement. Therefore, to satisfy their specific needs, they can structure the private placement unconventionally. This flexibility is one of its key advantages.

Private Placement Advantages

Flexibility: Private placement definition provides flexibility. The placement’s structure and terms are much more flexible than public placements. There is a wide range of debt issuances available for the issuer. They include term and revolving loans, asset-backed loans, leases, and other debt instruments. Some of these options aren’t always available for public companies.

Long-term: Financial institutions offer shorter-term loans. A longer-term loan is more beneficial when a business is in its early stages of growth. Lenders also have the opportunity to build strong relationships with the companies. In addition, they can see their progress.

Speed: The execution time is a crucial aspect for some companies. The process for private companies is generally quick. Instead of filing with the SEC, they contact the private sector.

Privacy and control: The private sector is good with privacy. The public is generally unaware of what happens behind closed doors. This is one of the main reasons why private placements are only available to knowledgeable investors.

Diversity in financing:  Diversification isn’t only intended for investments. It can also apply to debt. Financial institutions are more reluctant to give funds to companies that haven’t proven themselves yet, especially during economic uncertainty. 

Private Placement Uses

Like public companies, private ones need funds for various reasons. They often depend on the growth stage of the company. Some private companies may very well be near the top of their industry but may need some funding for a large project. Many big multi-national names remain private. What are some private placement definition examples?

Examples include Huawei, Koch Industries, Rolex, Deloitte, and IKEA. They are all multi-billion dollar companies that choose to remain private. However, they got here thanks to private placements, which helped them with various needs such as the following.

Capital for expansion and growth: Many tech companies had to start somewhere. If we look at Amazon, Airbnb, Uber, and other tech giants, they began as private companies. Thanks to their secured capital, they could grow, pay their employees and become multi-national billion-dollar companies.

Acquisitions: Mergers and acquisitions help a company complement a business segment or to branch out into new strategic territories. This requires funds.

Employee stock ownership plans (ESOP): Hiring and keeping quality employees requires a good business plan, money, and incentives. Employees who believe in the business and get compensated fairly for their work will perform well. Good employees are essential to a successful company.

Paying debt: It takes money to make money. So borrow – pay – repeat.

We spoke of the various characteristics surrounding private placements. Now, it’s time to discover different investment opportunities for the public.

Investing in a Private Placement with the Stock Market

What else should we know about the private placement definition? First, there exist different ways to invest in private placements. The first is as an accredited investor. The second is via mutual funds and ETFs. 

What Is an Accredited Investor?

Accredited investors can invest in securities that aren’t registered with the SEC.

How does one become an accredited investor? First, yearly personal income over the last two years must be at least $200,000 or a spousal of $300,000.

Furthermore, individual or joint net worth must exceed $1M. The primary residence is excluded from this number. The list also expands to individuals well-versed in the art of investments. 

Once individuals meet the above criteria, they are set to purchase investments outside the SEC scope. It’s up to the company selling the financial instrument to perform the necessary due diligence before selling the security.

There is no membership card, governing body to report to, or online application to become an accredited investor. However, becoming an accredited investor opens the door to new investments, such as REITs, hedge funds, and private placements. 

Often, a minimum investment is required to participate as an accredited investor. Depending on the firm, this sum can range between $250k to $25M. Blackrock (NYSE: BLK) is a good example. 

Mutual Funds, ETFs and Stocks

Finally our private placement definition, we take a look at investments available to everyday investors. There is a distinction between mutual funds and ETFs. Keep in mind that private placements are typically illiquid investments. Therefore, according to the SEC, mutual funds can hold up to 15%.

On the other hand, ETFs can follow an index of publicly traded companies investing in private equities. In both cases, there are management fees. As a result, it becomes less profitable to do it via these funds than by ourselves. Now, let’s look at a few funds investing in the private sector. 

Three main ETFs are dealing in the private equity sector. The VanEck BDC Income ETF (NYSEARCA: BIZD) tracks the performance of business development companies. Invesco Global Listed Private Equity ETF (NYSEARCA: PSP) and ProShares Global Listed Private Equity ETF (BATS: PEX) invest in global and financial private equity companies.

It is also possible to invest directly in some stocks. For all three funds, a few names are repeated in the top 10 holdings: Ares Capital Corporation (NASDAQ: ARCC), Hercules Capital Inc (NYSE: HTGC), and 3i Group (OTCMKTS: TGOPY).

They finance companies and develop their business. Most other names in these funds are similar companies investing in the same field. Their returns are nowhere near the S&P or other major indexes. Invest here with caution and do your due diligence carefully.

Now You Know the Private Placement Definition

To conclude, the private placement definition is that it helps private companies secure the necessary funds to grow and conduct their day-to-day business. Since the SEC isn’t involved, they follow different rules than public companies.

They can also secure capital under more flexible terms and conditions. Investors can also invest in these companies. For accredited investors, there are more options available. Every day investors have to go with funds or by investing in companies operating in this business.

In both cases, it is a risky investment, and investors should perform sufficient due diligence before venturing into this industry.

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