Most investors are used to buying shares, ETFs, mutual funds and other securities in the open market. The price is determined by the public and there is a supply and demand for each security. 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.
What Is the Private Placement Definition?
Let’s look at the private placement definition. Just like public companies, private companies can also issue shares and bonds. 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 are allowed to invest in private placements, but with certain restrictions. We will expand on that and accredited investors later. Let’s keep talking about the private placement definition.
Regulatory Requirements for Private Placements
When learning the private placement definition, learn the the requirements. There are fewer requirements for a private placement than for an IPO or for 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. 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 structure and the terms of the placement are much more flexible than for 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. When a business is in its early stages of growth, a longer-term loan is more beneficial. Lenders also have the opportunity to build a strong relationship with the companies. 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 reach out to 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 out funds to companies that haven’t proven themselves yet, especially during a period of economical uncertainty.
Private Placement Uses
Similar to public companies, private ones need funds for a variety of 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, IKEA and others. They are all multi-billion dollar companies that choose to remain private. 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 the capital they secured, they were able to 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. If employees believe in the business and get compensated fairly for the work they put in, they will perform well. Good employees are essential to a successful company.
Paying debt: It takes money to make money. 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 with the private placement definition? 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 are allowed to make investments in securities that aren’t registered with the SEC.
How does one become an accredited investor? Yearly personal income over the last 2 years must be at least $200,000, or 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 an individual meets 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. Becoming an accredited investor opens the door to many new investments such as REITs, hedge funds and private placements.
Oftentimes, there is a minimum investment required to participate as an accredited investor. Depending on the firms, this sum can range anywhere between $250k to $25M. Blackrock (NYSE: BLK) is a good example.
Mutual Funds, ETFs and Stocks
Finally the 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. It becomes less profitable to do it via these funds than by ourselves. Now, let’s take a look at a few funds investing in the private sector.
There are 3 main ETFs 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 3 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 of the 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 own due diligence carefully.
Now You Know the Private Placement Definition
To conclude, the private placement definitions is that it help 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. For everyday investors, they 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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