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Advantages & Disadvantages of Private Placement of Bonds

Original post by Dana Griffin of Demand Media

Private companies get to choose their shareholders, public companies sell to anyone.

Most businesses require regular injections of capital to enter new markets, generate growth or develop new product lines. Generally, they use one of two methods to raise that money: a public sale of shares, or a private placement of bonds. Shares are sold on public markets like the New York Stock Exchange, and anyone can buy them. Conversely, private placements focus on choice investors and long-term involvement.

Private Placement

A private placement is when a company sells bonds or shares to specific investors, rather than to the general public. Unlike a public offering, private placement doesn’t require underwriters or registration with the Securities Exchange Commission. While often used by small companies, private placement is equally beneficial to companies of all sizes because they require less time and expense than a public offering.

Types of Placements

Private placements fall into one of two categories: structured or traditional. Traditional private placements act as long-term loans from a separate or groups of investors. These investors receive their investment money back, plus the agreed upon additional profit percentage, as soon as the company reaches the required profit margin and can pay them. Conversely, structured private placements offer investors the opportunity to make additional income as the stock prices increases, while protecting them if the stock price falls. That protection, sometimes called a reset, allows shareholders to gain additional stock up to the value of their original investment if the stock price falls.

Advantages

Private placements provide several advantages over public offerings or venture capital for both large and small companies. Staying private allows your company to choose its own investors, unlike a public offering which is open to the general public. It saves your company the time and money required to make a public offering and maintain the financial records for the SEC. Because private investors often are more patient than public investors, with a private placement you can take more time to arrive at the agreed upon return. Finally, the options for type and amount of funding give you more flexibility and get you capital much faster than searching for venture capitalists, or waiting for your shares to sell on the public market.

Drawbacks

Private placement, especially when structured, can have disadvantages in both the long and short term. If only a few investors are interested, and don’t want to invest a large amount of money it becomes difficult to raise the required amount of capital. Sometimes, private investors only buy in when the shares cost substantially less than the projected cost of the company, requiring you to sell more shares for the same amount of income. The reset feature of structured private placement allows private investors to gain additional shares, thereby reducing the number of shares you can sell to new investors, especially if you decide to go public in the future.

                   

References

About the Author

Dana Griffin has written for a number of guides, trade and travel periodicals since 1999. She has also been published in "The Branson Insider" newspaper. Griffin is a CPR/first-aid instructor trainer for the American Red Cross, owns a business and continues to write for publications. She received a Bachelor of Arts in English composition from Vanguard University.

Photo Credits

  • Scott Olson/Getty Images News/Getty Images

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