As the name suggests, a private placement is a private alternative to issuing, or selling, a publicly offered security as a means for raising capital. In a private placement, both the offering and sale of debt or equity securities is made between a business, or issuer, and a select number of investors. There may be as few as one investor for any issue. The three most important features that would classify a securities issue as a private placement are: This affords the issuer the opportunity to avoid certain costs associated with a public offering as well as allows for more flexibility regarding structure and terms. One of the key advantages of a private placement is its flexibility. The most common type of private placement is long-term, fixed-rate senior debt, but there is an endless array of structuring alternatives. One of the key advantages of a private placement is its flexibility. Private placement debt securities are similar to bonds or bank loans and can either be secured, meaning they are backed by collateral, or unsecured, where collateral is not required. In addition to senior debt, other types of private placement debt issuance include: A private placement issuance is a way for institutional investors to lend to companies in a similar fashion as banks, with a buy-and-hold approach, and with no required trading or public disclosures. Historically, insurance companies refer to investments as purchasing notes, while banks make loans. Types of Capital Available to BusinessesWhen businesses are started, they are often funded by the owners or a family loan. However, as they grow, many companies are unable to finance all needs solely from internal cash flows. When capital needs exceed cash-on-hand, businesses can utilize the following types of capital: Private Placement AdvantagesPrivate placements present the following advantages: Long TermPrivate placements provide longer maturities than typical bank financing, at a fixed-interest rate. This is ideal for when a business is presented with a growth opportunity where they wouldn’t see the return on their investment right away; a business would have more time to pay back the private placement while having certainty of financing cost over the life of that investment. Also, private placements are typically buy-and-hold, so the company would benefit from having a long-term relationship with the same investor throughout the life of the financing. Speed in ExecutionThe growth and maturity of the private placement market has led to improved standardization of documentation, visibility of pricing and terms, increased capacity for financings as well as overall increase of size and depth of the market ($10MM – $1B+). Thus, the private placement market fosters an environment that allows for quick execution of an investment, generally within 6-8 weeks (for the first transaction. Follow-on financings can be executed within a shorter time frame). Additionally, it is typically faster to issue a private placement versus a corporate bond in the public market because the issuer is not required to expend time and resources creating a prospectus and registering with the SEC. Private Placements can complement existing bank debt versus compete with it. Complement to Existing FinancingPrivate placements also help diversify a company’s sources of capital and capital structure. Since the terms can be customized, private placements can complement existing bank debt versus compete with it, and can allow a company to better manage its debt obligations. Diversification of funding sources is particularly important during market cycles when bank liquidity may be tight. Private placements enable privately-held, middle-market companies and public companies to access capital just as they would with an underwritten public debt offering, but without certain requirements, such as ratings, registrations, or minimum size. And for public companies, private placements can offer superior execution relative to the public bond market for small issuance sizes as well as greater structural flexibility. Privacy and ControlPrivate placement transactions are negotiated confidentially. Also, public disclosure requirements are limited, compared to those found in the public market. Companies would not be beholden to public shareholders. Capital UsesLong-term capital is congruent with a company’s long-term investments. Thus, capital raised from issuing a private placement is most commonly used to support long-term initiatives versus short-term needs, such as working capital. Companies, both public and private, use the capital raised from private placements in the following ways: Private Placement SecuritiesIn a private placement, the shares of stock or debt instrument are considered securities under both federal and state securities laws. Consequently, any transaction involving the shares or debt must be registered under such securities laws or be exempt from registration. Typically, the offeror is an emerging growth company that has few capital alternatives, although more mature companies tend to be more successful in this process. Securities laws generally require that offers are made mainly to accredited investors. There are two basic types of private placement offerings: Private Placement Equity OfferingThe company sells partial ownership via the sale of stock or a membership unit in order to raise capital. Equity offerings are preferred by early-stage companies, because there is no set repayment schedule with this offering. Private Placement Debt OfferingThe company raises debt financing by selling a note instrument to investors with a set annual rate of return and a maturity date that dictates when the funds will be paid back to investors in full. A debt offering is similar to a business loan, except the financing is provided by investors instead of an institution. Although private placements are exempt from full SEC registration requirements, they still must comply with federal and state regulations. The most important private placement rules fall under Regulation D, promulgated by the SEC. Regulation D Debt OfferingA debt offering involves the sale of a promissory note to investors. The note sets forth the terms and conditions of the loan arrangement between the company and the investor. For instance, the interest rate, payment periods, and maturity date are described in the note. Notes are sold in fractional amounts providing flexibility for accommodating investors. For example, in a typical debt offering the company raises $1,000,000, which might involve the sale of 20 notes at $50,000 per note. Regulation D: Private Placement Rules and ExemptionsReg D is a series of six rules, Rules 501-506, establishing three transactional exemptions from the registration requirements of the 1933 Act. Rules 501-503 set forth definitions, terms and conditions that apply generally throughout the regulation. Specific exemptions are set out in Rules 504-506. Rule 504Rule 504 is the most popular of the Reg D rules. Raising capital for a small business can be expensive and time consuming, but a private placement under Rule 504 of Reg D can minimize costs and delays while giving the issuer access to debt or equity capital. In a Rule 504 offering, a business can raise a maximum of $1 million in any year. Rule 504 has no prescribed disclosure requirements, no limit on the number of purchasers, and no investor sophistication standards. Offerings that are exempt under Rule 504 are relatively simple to prepare and can generally be undertaken by the offeror without substantial outside professional expenses. The JOBS Act of 2012 allows offerings to be made through any form of general solicitation or advertising. Rule 504 does not mandate that specified disclosure be provided to purchasers. However, the offeror must provide enough information to meet the full disclosure obligations under the anti-fraud provisions of the securities laws. Rule 505A Rule 505 offering may not exceed $5 million in any given 12-month period. This exemption limits the number of non-accredited investors to 35, but has no investor sophistication standards and no limit on the number of accredited investors. Rule 505 was adopted by the SEC to provide small businesses more flexibility in raising capital than under Rule 504. If only accredited investors are involved in the offering, there is no specific information the issuer must furnish to investors. However, if the offering involves one or more non-accredited persons, the issuer must furnish all purchasers with the same kind of information specified by Regulation D. As with a 504 offering, prior to the JOBS Act of 2012, this offering could not be made by means of general solicitation or general advertising. For Rule 505 offerings over $2 million, financial statement conditions include the following: Rule 506Rule 506 provides an exemption for limited offers and sales without regard to the dollar amount of the offering. There is no ceiling on the amount of money which may be raised. The JOBS Act of 2012 permits general solicitation and advertising. There is no limit to the number of accredited investors, but the number of non-accredited investors may not exceed 35. If only accredited investors are involved in the offering, the issuer is under no obligation to furnish specific information to investors. If the offering involves one or more non-accredited persons, however, the issuer must furnish all purchasers with the same information required by Reg D. Rule 506 requires detailed disclosure of relevant information to potential investors; the extent of disclosure depends on the dollar size of the offering. For offerings over $2 million, the issuer must provide audited financial statements. Offerings under $2 million follow Reg A as a guide, with an additional requirement for a certified balance sheet. The securities sold are restricted under the same stipulations in Rules 504 and 505. A company is required to file a notice of the offering on Form D at SEC headquarters within 15 days after the first sale in the offering. There is no requirement to file the offering memorandum with the SEC. From an investor’s perspective, here are some important compliance features of Regulation D: Selecting a Private Placement InvestorThere are important considerations for a company when determining whether to issue a private placement. When choosing a private placement investor or lender, some key characteristics to look for are: Free Initial Consultation with LawyerIt’s not a matter of if, it’s a matter of when. Legal problems come to everyone. 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