W.B.C.S. Main 2018 Question Answer – Commerce And Accountancy – Private Placement And Its Types.

Private placement

Private placement occurs when a company makes an offering of securities not to the public, but directly to an individual or a small group of investors. Such offerings do not need to be registered with the Securities and Exchange Commission (SEC) and are exempt from the usual reporting requirements. Private placements are generally considered a cost-effective way for small businesses to raise capital without “going public” through an initial public offering (IPO).Continue Reading W.B.C.S. Main 2018 Question Answer – Commerce And Accountancy – Private Placement And Its Types.

“Although most business owners dream of taking their company public someday, many have had to wait years for a traditional public offering,” Gary D. Zeune and Timothy R. Baer explained in an article for Corporate Cashflow Magazine. “For them, a private placement of equity or debt has been a quicker, less expensive way to raise a limited amount of capital from a limited number of investors. A private placement has been appropriate when a company still lacks the financial strength or reputation to appeal to a broad base of investors and cannot afford the expense of a public offering.”

ADVANTAGES AND DISADVANTAGES

Private placements offer small businesses a number of advantages over IPOs. Since private placements do not require the assistance of brokers or underwriters, they are considerably less expensive and time consuming. In addition, private placements may be the only source of capital available to risky ventures or start-up firms. “With loan criteria for commercial bankers and investment criteria for venture capitalists both tightening, the private placement offering remains one of the most viable alternatives for capital formation available to companies,” Andrew J. Sherman wrote in his book The Complete Guide to Running and Growing Your Business.

A private placement may also enable a small business owner to hand-pick investors with compatible goals and interests. Since the investors are likely to be sophisticated business people, it may be possible for the company to structure more complex and confidential transactions. If the investors are themselves entrepreneurs, they may be able to offer valuable assistance to the company’s management. Finally, unlike public stock offerings, private placements enable small businesses to maintain their private status.

Of course, there are also a few disadvantages associated with private placements of securities. Suitable investors may be difficult to locate, for example, and may have limited funds to invest. In addition, privately placed securities are often sold at a deep discount below their market value. Companies that undertake a private placement may also have to relinquish more equity, because investors want compensation for taking a greater risk and assuming an illiquid position. Finally, it can be difficult to arrange private placement offerings in multiple states.

RESTRICTIONS AFFECTING PRIVATE PLACEMENT

The SEC formerly placed many restrictions on private placement transactions. For example, such offerings could only be made to a limited number of investors, and the company was required to establish strict criteria for each investor to meet. Furthermore, the SEC required private placement of securities to be made only to “sophisticated” investors—those capable of evaluating the merits and understanding the risks associated with the investment. Finally, stock sold through private offerings could not be advertised to the public and could only be resold under certain circumstances.

In 1992, however, the SEC eliminated many of these restrictions in order to make it easier for small companies to raise capital through private placements of securities. The rules now allow companies to promote their private placement offerings more broadly and to sell the stock to a greater number of buyers. It is also easier for investors to resell such securities. Although the SEC restrictions on private placements were relaxed, it is nonetheless important for small business owners to understand the various federal and state laws affecting such transactions and to take the appropriate procedural steps. It may be helpful to assemble a team of qualified legal and accounting professionals before attempting to undertake a private placement.

Many of the rules affecting private placements are covered under Section 4(2) of the federal securities law. This section provides an exemption for companies wishing to sell up to $5million in securities to a small number of accredited investors. Companies conducting an offering under Section 4(2) cannot solicit investors publicly, and the majority of investors are expected to be either insiders (company management) or sophisticated outsiders with a preexisting relationship with the company (professionals, suppliers, customers, etc.). At a minimum, the companies are expected to provide potential investors with recent financial statements, a list of risk factors associated with the investment, and an invitation to inspect their facilities. In most respects, the preparation and disclosure requirements for offerings under Section 4(2) are similar to Regulation D filings.

Regulation D—which was adopted in 1982 and has been revised several times since—consists of a set of rules numbered 501 through 508. Rules 504, 505, and 506 describe three different types of exempt offerings and set forth guidelines covering the amount of stock that can be sold and the number and type of investors that are allowed under each one. Rule 504 covers the Small Corporate Offering Registration, or SCOR. SCOR gives an exemption to private companies that raise no more than $1 million in any 12-month period through the sale of stock. There are no restrictions on the number or types of investors, and the stock may be freely traded. The SCOR process is easy enough for a small business owner to complete with the assistance of a knowledgeable accountant and attorney. It is available in all states except Delaware, Florida, Hawaii, and Nebraska.

Rule 505 enables a small business to sell up to $5 million in stock during a 12-month period to an unlimited number of investors, provided that no more than 35of them are non-accredited. To be accredited, an investor must have sufficient assets or income to make such an investment. According to the SEC rules, individual investors must have either $1 million in assets (other than their home and car) or $200,000 in net annual personal income, while institutions must hold $5million in assets. Finally, Rule 506 allows a company to sell unlimited securities to an unlimited number of investors, provided that no more than 35of them are non-accredited. Under Rule 506, investors must be sophisticated. In both of these options, the securities cannot be freely traded.

Types of Private Placements

• C Corporation & S Corporation Common Stock Offering
• C Corporation & S Corporation Preferred Stock Offering
• C Corporation & S Corporation Debt Offering
• C Corporation & S Corporation Convertible Debenture or Equity offering with warrants
• Limited Liability Company Membership Interest Offering
• Limited Liability Company Debt Offering
• Limited Partnership Equity Offering
• Limited Partnership Debt Offering
• Limited Liability Partnership Equity Offering
• Limited Liability Partnership Debt Offering

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