Private Placement: Meaning, Types

What is Private Placement?

Generally, when companies want to expand, they raise capital via an initial public offering (IPO). It is a public phenomenon where all investors are allowed to buy shares of the company. This process takes place in primary markets. Later on, the shares sold in primary markets are traded in secondary markets.

There is another process of raising capital that is known as private placement. In private placements, shares are sold especially to wealthy investors, banks, pension funds, etc. It is a completely private process where the public cannot take part. In such a process, the share-issuing company invites potential investors to buy its shares. Rather than selling shares in the primary market, they are sold directly to private players in a private placement.

In India, private placements are governed by section 42 of the Companies Act, 2013. According to it, private placement refers to any invitation or offer to subscribe or issue of securities to a selected group of persons by a company (and not by way of a public offer). This includes the use of private placement offer-cum-application form, which must satisfy the conditions specified in section 42 of the Companies Act, 2013.

According to Section 42 of the Companies Act, 2013, the maximum allotment that can be done via private placement in a year is 200. If it exceeds the issue is considered public and the company must follow the public issue procedure in such cases.

The private placement is also different from an IPO in the sense that no prospectus is issued in the process of the former.

Types of Private Placement

There are generally two types of private placements which are the following −

Preferential Allotment

In preferential allotment, shares are publicly sold to a group of entities, such as mutual funds, other financial institutions, and promoters. Usually, the price of shares in the preferential allotment is pre-set. The share-issuing company conveys the information related to shares and the process of the share issue to the entities while inviting the potential inventors to invest in them.

The preferential allotment procedure has to follow the guidelines of Chapter XIII of SEBI (DIP) guidelines. Moreover, there can be a lock-in period in such cases where the companies may take some time to issue the shares to the investors.

Qualified Institutional Placement

In QIP shares are generally issued only to qualified institutional investors. This process encourages companies to raise capital from domestic institutions. It also tends to keep the process of share sale more hidden from the public.

Qualified Institutional Placement is governed by Chapter XIIIA of SEBI (DIP) guidelines.

Advantages of Private Placement

The following are the major advantages of the private placement process.

Speedier financing process

The process of raising capital via IPO requires a lot of documentation and procedural tasks before the public offer of shares. However, private placement can be completed within months if required. Faster access to funds is one of the most attractive features of private placement.

Confidential process

In comparison to IPO, private placement is a more confidential process that lets companies intending to raise capital stay away from the public eye. The process can be completed completely confidentially without divulging financial and procedural information to the public.

Cost-effective

The general process of issuing shares via IPO requires a lot of documentation, and preparation tasks, as companies need to prepare their financial infrastructure according to the Securities and Exchange Board of India’s (SEBI) guidelines, they need to spend a lot on preparation, advertisement, and other functions. All these costs can be saved by opting for the private placement method.

Market stability

The general market that deals in shares is a volatile market where the IPO takes place. In comparison, the private placement market is more stable. Market stability offers a due advantage to companies that cannot be obtained in the IPO issue process. Market stability is a prime reason why many companies tend to raise capital via private placement rather than IPO.

Good for raising a small amount of capital

If the requirement of funds is small, it is more convenient to raise it via private placement. Whereas, public offering is a preferred way to raise more capital. Therefore, companies that need small capital tend to raise it via private placement.

Disadvantages of Private Placement

Buyers of stocks in private placement may be more demanding

• The buyer of shares through private placement usually seeks more interest or more rate of return in the shares he has invested in. Therefore, companies issuing private shares of stock must be prepared for a more interest rate that has to be paid to the shareholders.

• As there is always a risk of not obtaining a credit rating, the private placement shareholder may ask for the shares to be backed by collateral. So, companies issuing shares via private placement must have a palpable value for their assets.

• Private placement shareholders may also ask for a high percentage of ownership in the firm. They may also ask for a higher and regular payout of dividends from the company in which they will invest.

Key Takeaways

• Generally, when companies want to expand, they raise capital via an initial public offering (IPO).

• There is another process of raising capital that is known as a private placement. In private placements, shares are sold especially to wealthy investors, banks, pension funds, etc.

• Rather than selling shares in the primary market, they are sold directly to private players in a private placement.

• In India, private placements are governed by section 42 of the companies act, 2013.

• According to Section 42 of the Companies Act, 2013, the maximum allotment that can be done via private placement in a year is 200.

• There are generally two types of private placements which are preferential allotment, and qualified institutional placement.

• The advantages of private placement include a speedier process, market stability, cost-effectiveness, confidentiality, etc.

• The disadvantage of the private placement is that the buyer of shares may be more demanding in terms of payout and ownership.

Conclusion

As private placement has some unique features, it is increasingly becoming a preferred choice of firms to raise capital. Knowing what private placement is and its advantages can help entrepreneurs to be more aware of the prospective financing options. That is why it is an important topic for all.

FAQs

Qns 1. What is meant by private placement?

Ans. In private placements, shares are sold especially to wealthy investors, banks, pension funds, etc. It is a completely private process where the public cannot take part. In such a process, the share-issuing company invites potential investors to buy its shares. Rather than selling shares in the primary market, they are sold directly to private players in a private placement.

Qns 2. What are the types of private placements?

Ans. Preferential allotment and qualified institutional placement are the two types of private placement.

Qns 3. Provide an example of any three advantages of private placement.

Ans. A private placement is speedier, more cost-effective, and has a more stable market.