Private placement involves the company to sell the entire issue to a single purchaser (it is generally a financial institution or a wealthy individual) or a group of such purchaser. Contrary to public issue, the company negotiates directly with the investors over the term of the offering.
Financial institutions that invest in private placement are financial intermediariessuch as insurance companies, commercial banks or pension funds. They accept money from savers and use those funds to make loans and other financial investments.
As you know, a company can issue debt (that is a contractual agreement by the borrowers to pay) or equity (part of ownership in the company owned by shareholders). In this part we will focus on the private placement of debt issues.Now we are going to look the advantages of private placement:
The main advantage of private placement is the speed with which the private deal is transacted. Indeed, private placements are not subject to SEC registration requirements contrary to public issues. (SEC registration requires the company to prepare prospectuses and to negotiate with the SEC. All this takes a lot of time. ) This canbe explained because persons or institutions are able to acquire on their own the kind of information that registration would disclose.
Second advantage: with private placement the terms can be negotiated directly with the borrowers and financing can be consumed quickly. We can negotiate all the terms of the issue, so the exact timing in the market is not a critical problem because it is mucheasier to deal one investor than with a large number of security holders.
Third advantage: it gives flexibility to the company. For example, the actual borrowing does not necessarily have to take place all at once. The company can enter an arrangement whereby it can borrow up to a fixed amount over a period of time. It allows the company to borrow only when it needs the funds.
Otheradvantage: because private placements not have to be registered with the SEC, the company avoids making public certain information that it may deem (considerer) better left confidential.
Development in the Market:
Advantage: with private placement we can avoid event risk - which increases the price of the bond outstanding- (risk that existing debt will suffer a decline in creditworthiness) withtightly written protective covenants. Indeed, with this covenant, if corporations undergo a substantial change in capital structure, the bonds are immediately payable at their face value to the lenders. It is different from the public issues where the lenders can’t protect themselves against corporate restructuring, so any bonds previously outstanding becomes less creditworthy and drop in price.Another advantage: through Rule 144a, the SEC allows institutional investors to resell securities generated in the private placement market to other large institutions. As a result, the market becomes broader and more liquid.
There are some alternatives to private placement. One of them is private placement with registration rights. It combines a standard private placement with a contractrequiring the issuer to register the securities with the SEC for possible resale in the public market. With registration rights purchasers are virtually guaranteed that they will have a publicly issued, more marketable security, usually within a month.
The benefit to the issuer is he gets security sale proceeds right away, receives additional time to work out registration details, and he has a lowerinterest cost than would be the case without registration.
Another variation on the traditional private placement is the underwritten Rule 144a transaction. In this arrangement, the issuer outsources the marketing and distribution of the securities. Indeed, he sells its securities initially to an investment bank. The investment bank then resells these securities to the same institutional...
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