A public offering of securities can reach an enormous number of potential investors, but it might also require extensive public disclosure of company information. Offering your bonds in a private placement may reduce the number of investors you can reach, but your potential investors will likely be more familiar with the workings of the securities markets and therefore require less disclosure.
Exempt Nonpublic Offerings
When a company offers bonds to the general public, the Securities Exchange Act demands that the company present investors with financial information in its registration statement. However, under Section 4(a)(2) of the Securities Act of 1933, certain nonpublic offerings of securities are exempt from these requirements. The rationale for this is that a private placement will only go to a limited number of savvy investors who know which questions to ask and what sort of information to demand; these investors won't need the same protections as less experienced public investors. But a placement only qualifies as private if it meets the act's requirements for a nonpublic offering.
Public vs. Private Placement
To decide whether a bond offering is public or private, the Securities and Exchange Commission considers how many parties have been offered an opportunity to invest, the number of bonds being offered and their price and how the bonds are being offered (if the company is soliciting investors by mail or advertising, for example, this might suggest a public offering).
But the biggest factors are the relationship of the company to the potential investors and the relationship of these investors to one another. If the company has a long-standing relationship with these investors, or if the investors are a close-knit group that invests together often, these factors could weigh in favor of finding the offering private. If a company wants to be sure that its bonds meet the requirements for a private placement, the SEC has released Regulation D, which offers three clear-cut ways to qualify for private placement.
Advantages of Private Placement
The big advantage of private placement is that the company doesn't need to provide as much disclosure to investors. A typical public offering of bonds requires at least two documents: a public registration statement filed with the SEC and a statutory prospectus that goes to investors. But in a qualifying private placement, you only need to provide these types of documents if you have nonaccredited investors who aren't often involved in similar deals. Unlike a public offering, the typical private placement will not require an underwriter who charges fees for his services. Private placement can also be useful if you wish to keep your bond offering confidential or if you hope to raise a lot of money from only a few people.
Disadvantages of Private Placement
One disadvantage of a private placement is that it significantly narrows the range of investors you can reach. This narrow range means your investors will probably need to have more capital to invest in your bonds. Because you typically can't advertise on a wide scale and qualify for private placement, you may also need to expend more effort and expense to sell your bonds than in the typical public offering. A wide market will not exist for your bonds, so investors may also demand more equity in your company to protect their investments.
- SECLaw: Introduction to Private Placements – A Securities Lawyer Guide
- The 'Lectric Law Library: Information on Uniform Public Offerings for Start-up Capital
- Securities and Exchange Commission: Regulation D Offerings
- Securities and Exchange Commission: Securities Act of 1933
- Securities and Exchange Commission: Securities Exchange Act of 1934
Erika Johansen is a lifelong writer with a Master of Fine Arts from the Iowa Writers' Workshop and editorial experience in scholastic publication. She has written articles for various websites.