Private Placement of Shares

What is the Private Placement of Shares?

Private Placement of Shares refers to the sale of shares of the company to the investors and institutions that are selected by the company which generally includes the banks, mutual fund companies, wealthy individual investors, insurance companies, etc rather than issuing it in the open market for the public as a whole and the same generally have the few regulatory requirements.

In this Placement, the securities are issued to a limited number of investors who are “accredited”.  An accredited investor is the one who: –

  • Meets a certain threshold of financial net worth and qualifications.
  • Is more experienced in making investments and making prudent financial decisions.
  • Could afford taking risks and losses arising from such an investment.

Eg.: New York Life Insurance picked up 22.51% stake in Maxx ventures in January 2017 at Rs 78 per share by way of this placement

Private Placements v2

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For eg:
Source: Private Placement of Shares (wallstreetmojo.com)

Differences Between Private Placement Program and Public Offering

  • The securities are sold to a group of investors in the private placement of shares whereas in public offering the securities are offered to the public.
  • Private placement of shares can be issued by both public and private Companies whereas in case of public offering the Company is either listed or will be listed after the offer is made.
  • This placement deals may not be required to be registered with a regulator whereas the deals in which securities are offered publicly have to be registered with a regulator.

How Does Private Placement Program Affect the Share Price of a Company?

The private placement of shares, if done by a private company will not affect the share price because they are not listed. However, for a public listed Company, this placement will lead to a decline in share price at least in the near term.

This placement leads to dilution of the ownership of the existing shareholders to a proportion of the size of this placement. This is because new shares are issued and the holdings of the existing shareholders remain the same. Let us see an example:

Let the number of shares outstanding before the private placement of shares by 10 million and the Company has proposed to offer 1 million equity shares in the private placement. Thus, this would result in dilution of ownership of the existing shareholders by 10%.

This dilution of a share normally leads to the decline of the share price; the impact of this placement can be considered as similar to that of a stock splitStock SplitStock split, also known as share split, is the process by which companies divide their existing outstanding shares into multiple shares, such as 3 shares for every 1 owned, 2 shares for every 1 held, and so on. The company's market capitalization remains unchanged during a stock split because, while the number of shares grows, the price per share decreases correspondingly.read more. However, such an impact can be seen only in the short-term, a long-term effect on the price would take into account the utilization of funds by the Company raised during this placement. If the Company does a private placement of shares to raise capital for a project which could provide better returns; extra profits and revenue from such a project will impact the share price thus pushing it higher.

Private Placement Program Advantages

Following are the top 5 private placement advantages

  • Long Term Advantage – If it is a debt security, the Company issues private placement bonds which generally have a longer time to mature than a bank liability. Thus, the Company will have more time to pay back the investors. This is ideal for the situations where the Company is investing in new businesses that would require time to earn and grow. Further, if this placement is done on equity shares; they are generally done to strategic investors with a “buy-and-hold” strategy. These investors invest for a longer duration and also provide strategic inputs on running the business. Thus, the Company benefits from having a long-time relationship with the investor.
  • Less Execution timeframe –  As the market for this placement has matured this has increased standardization of documentation, better terms, and pricing and increased the size of raising funds. Further, the issuer does not have to register and market such a fundraising exercise with the regulator, hence it can be executed in lesser time and cost. If the issuer is issuing private placement bonds that will be privately held, he may not be required to get credit rating which will further reduce the cost to be paid to the credit agency.
  • Diversification of Fundraising – Fundraising by this placement helps the Company to diversify Company’s funding sources and its capital structure. It aids the Company in raising capital when market liquidity conditionsLiquidity ConditionsLiquidity shows the ease of converting the assets or the securities of the company into the cash. Liquidity is the ability of the firm to pay off the current liabilities with the current assets it possesses.read more are not good. It helps the Company to organize the capital structure in terms of debt-equity structure and help it to manage its debt obligations.
  • Lesser Regulatory Requirements – This placement requires limited public disclosures and is prone to less regulatory requirements than that would be needed in a public offering. Thus, the Company would negotiate the deal privately and offer the securities at a negotiated and fixed price.
  • Sell to Accredited Investors – This placement issuer can sell complex securities to the investors participating in the issue because such an issue will be limited to a select group of investors (accredited investors). Further, they would understand the potential risk and return on such securities.

Private Placement Program Disadvantages

Following are the top 2 private placement disadvantages

  • Difficulty in Finding a suitable investor – First and foremost, the disadvantage of a private placement of shares would be to find a suitable investor. Further, the investor may have a limited amount of funds to invest and may set certain targets to be achieved whereby he would invest the funds.
  • Higher Returns Requirement – The investors may require more return because of the risk they are taking by investing privately. If the investment is for private placement bonds, they may ask for higher interest rates or annual coupons because of the risk they take for unrated bond securities and illiquid securities. If investment in a private Company is by an issue of equity shares, they may ask for higher equity ownership or board positions because of the liquidity risk of their investment. Further, even if the Company is publicly traded and it chooses to offer private placement shares, the investors would do a due diligence and some clauses on such an offer like annual dividends or shares to be issued at cheaper than market rates as they would have to lock-in their stake (not to be sold in open market) for a certain time period.

Conclusion

Private placement of shares is issuance of securities of a Company to a selected individual, group of individuals, corporates or group of corporates. The securities during this placement are not publicly offered. Thus, the Company raises capital by selling securities to a few selected investors whereas in a public offering the securities are open for sale in the market for all types of investors.

We have looked into the advantages and disadvantages of private placements of shares. A Company may have a number of reasons to go for private placement like debt refinancing, expansion of business, capital diversification, strategic investor participation, Differences between mergers and acquisitions, share buyback, ESOP plan etc. However, the most important part of this placement is to find a suitable like-minded investor for the business.

This has been a guide to the private placement of shares, its definition, and its meaning. Here we also discuss how it affects the share prices, advantages, and disadvantages of private placement along with its differences with the public offering. You may also have a look at the following articles on Corporate Finance –

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