Updated July 10, 2023
What is the Private Placement of Shares?
The term “private placement of shares” refers to the private alternative to issuing or selling publicly offered securities as a tool to raise capital. In the private placement of shares, the issuer offers and sells equity shares to selected investors. In some cases, there may be as few as just one investor for a private placement.
There are three important features based on which the issuance of shares can be classified as a private placement:
- Does not publicly offer equity shares.
- Does not need to register the issuance with the regulators.
- Only a small number of investors are involved in the process.
Purpose of Private Placement of Shares
Both private and public companies issue shares through the private placement route for various purposes. The companies seek access to long-term capital, diversify their financing sources, or maintain confidentiality in the case of already privately held companies. The company primarily utilizes the capital raised through issuing shares in a private placement to support long-term initiatives. Some capital used to raise through private placements is acquisitions, expansion/ growth capital, recapitalization/ stock buyback, a private-public company, or an employee stock ownership plan (ESOP).
How Does Private Placement of Shares Work?
Although the private placement of shares involves selling securities, minimal regulatory requirements and standards govern it. The issuer does not need to register with the regulator (such as the SEC in the case of the US). Conversely, the regulator regulates the issuance of shares on public exchanges and ensures that investors receive adequate disclosure when purchasing. The issuer can withhold a prospectus from potential investors and decide not to disclose detailed financial information. Instead of a prospectus, the issuer issues shares using a private placement memorandum (PPM).
Issue of Private Placement of Shares
- Call for a Board Meeting: The issuing of the notice and agenda of the meeting should occur at least one week before the date of the Board Meeting.
- Hold the Board Meeting: The company holds the Board Meeting to identify potential investors for the private placement offer, prepare the offer for the private placement, and issue notice of the General Meeting at least three weeks before the meeting date. The company must file the Board Resolution with the State Business Department within one month of passing the resolution.
- Hold a General Meeting: The company’s members are presented with the offer letter for the private placement and approved. After approval, they pass a special resolution for the issuance and file it with the State Business Department within one month of passing the resolution.
- Circulation of the Offer Letter: The members of the Board identify the selected investors and send the offer letter to them within one month after recording their names.
- Open a Separate Bank Account: The company will receive all the capital raised through the private placement of shares in a separate bank account. The company must deposit the money within the period mentioned in the offer letter.
- Hold the Second Board Meeting: After the offer period ends, the board convenes another meeting to determine the allotment of shares. The company must file the allotment returns within 15 days of passing the resolution.
- Issue Certificate of Shares: After the State Business Department receives the required documents, it issues share certificates to the investors or shareholders. The company must pay the stamp duty within one month after issuing the share certificates.
Advantages
- Private placements are usually done with a buy-and-hold strategy. So, the issuer can benefit from having such a long-term relationship with the investors.
- These investors provide useful strategic inputs that can be instrumental in running the company.
- The issuers don’t need to register and market these fundraising initiatives with the regulators. So, the process can be completed in less time and at a lower cost.
- It is one of the most effective ways for companies to raise capital, especially when market liquidity conditions are not decent.
Disadvantages
- One of the most challenging private placement tasks is finding the perfect set of suitable investors.
- The investors who participate in such fundraising may ask for higher equity ownership or even board positions, given the liquidity risk they take up.
Key Takeaways
- Private placement of shares refers to selling equity shares to a pre-selected number of very few individuals and institutions.
- Companies usually opt for private placement for business expansion, diversification of capital, strategic investor participation, share buyback, ESOP, etc.
- These fundraising initiatives are relatively unregulated, less time-consuming, and less costly than selling other financial securities in the open market.
- The private placement investors usually enter the picture with a buy-and-hold strategy, providing strategic inputs that help run the company.
Conclusion
So, the private placement of shares can be a useful financing tool for companies if implemented appropriately. It is used for various reasons, from business expansion to funding ESOPs. However, the most difficult part of this process is finding the right set of investors for the business.
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