# What Is a Private Placement? Definition, Examples, Pros, and Cons

## What Is a Private Placement?

 A private placement involves selling stock shares directly to chosen investors and institutions instead of the open market. It is an alternative to an initial public offering (IPO) for a young company seeking to raise money to expand.

Startups and early-stage companies may choose a private placement to raise capital, avoiding the transparency requirements of a securities registration. The process is sometimes referred to as a 4(a)(2) private placement. Buyers in these sales tend to be sophisticated investors with high expectations on their returns.

### Key Takeaways

*   Private placements allow companies to raise funds quickly without the rigorous regulations and requirements of an initial public offering (IPO), making it particularly attractive for startups.  
    
*   The process involves pre-selected and accredited investors, which means access to these investments is generally limited to individuals or institutions with significant financial resources.  
    
*   While private placements provide companies with a quicker, less regulated fundraising option, they often require offering investors higher returns, compounding risks for both issuers and buyers.  
    
*   Regulation D offers exemptions for private placements, permitting the sale to an unlimited number of accredited investors without full SEC registration, which contrasts with the public scrutiny accompanying IPOs.  
    
*   Despite avoiding extensive public disclosures, companies utilizing private placements must convince sophisticated investors of their potential, balancing risk and reward without the traditional prospectus.  
    

![Private Placements: Selling securities to a pre-selected number of individuals and institutions rather than publicly on the open market.](https://www.investopedia.com/thmb/TjYW3Io7imvsht0j3xgLaLm_bHk=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/privateplacement.asp-finalv2-f8327aa785bd4295a67657a04765e829.png)

*— Investopedia / NoNo Flores*

## In-Depth Look at Private Placements

Private placements have become a popular way for startups to raise money, particularly in the Internet and financial technology sectors. They allow these companies to grow and develop while avoiding the full glare of government and public scrutiny that accompanies an initial public offering (IPO).

There are minimal regulatory requirements and standards for a private placement even though, like an [IPO](https://www.investopedia.com/ask/answers/021015/what-difference-between-ipo-and-private-placement.asp), it involves the sale of securities. The sale does not have to be registered with the U.S. Securities and Exchange Commission (SEC). The company is not required to provide a prospectus to potential investors and detailed financial information may not be disclosed.

Companies that sell shares privately can do so under either of two exemptions to the usual SEC rules requiring full registration:

*   A 4(a)(2) exemption permits a company to sell a limited number of shares to a limited number of accredited investors.
*   A [Regulation D](https://www.investopedia.com/terms/r/regulationd.asp) or Reg D sale permits the sale of an unlimited number of shares to an unlimited number of accredited investors.

In any case, accredited investors are defined as individuals and institutions that have a sophisticated knowledge of the securities industry and considerable financial resources.

That restricts access to private placements to wealthy individual investors, financial institutions like banks, mutual funds, insurance companies, and pension fund managers.

### Comparing Private and Public Stock Sales

The sale of stock on public exchanges is regulated primarily by the [Securities Act of 1933](https://www.investopedia.com/terms/s/securitiesact1933.asp). The law was enacted after the market crash of 1929 to ensure that investors receive sufficient disclosure when they purchase securities.

Regulation D of that act provides an exemption for private placement offerings.

The same regulation allows an issuer to sell securities to a pre-selected group of investors that meet specified requirements. Private placements use a private placement memorandum (PPM) instead of a prospectus. They can't be widely marketed to the public.

## Pros and Cons of Private Placements

### Benefits: Expedited Process for Fundraising

A private placement lets a young company avoid the difficult process of registering for a public offering. Going public requires quarterly and annual filings, which many new companies find burdensome.

A private company is relatively lightly regulated, as are private placements of stock shares.

That means the process of [underwriting](https://www.investopedia.com/terms/u/underwriting.asp) is faster, and the company gets its funding sooner. If the issuer is selling a bond, it also avoids the time and expense of obtaining a credit rating from a bond agency.

A private placement allows the issuer to sell a more complex security to accredited investors who understand the potential risks and rewards.

### Drawbacks: Increasing Investor Demands

The buyer of a private placement bond issue expects a higher rate of interest than can be earned on a publicly traded security. Because of the additional risk, a private placement buyer may not buy a bond unless it is secured by specific collateral.

A private placement stock investor may also demand a higher percentage of ownership in the business or a fixed dividend payment per share of stock. This puts pressure on the company to perform at a higher level, which could lead it to ignore the careful process of healthy growth.

There also is a risk of a loss of control if private placements result in increased ownership by investors rather than founders.

## How Does a Private Placement Work?

Private placements are conducted at invitation-only events, real or virtual. The prospective buyers are all accredited investors. They have registered with the SEC as investors who have the knowledge and the resources to participate in the sale.

The company raising money has to make its case for being a sound investment. However, it does not have to produce the full financial prospectus that is required of a company undergoing an initial public offering.

## What Is the Difference Between a PO and an IPO?

An initial public offering or IPO is a sale of stock, conducted on a stock exchange and open to the general public.

Down the road, the company may offer a public offering or PO. The company issues another round of shares to raise more money.

## Why Do Companies Go for Private Placements?

There are many benefits to a private placement. These include a faster process than an IPO and fewer regulatory requirements than an IPO. There are also fewer regulatory obligations on an ongoing basis than being a public company entails.

## The Bottom Line

Private placements allow business owners to raise capital while foregoing the IPO process, which can be long, difficult, and burdensome. It also allows them to skip the transparency requirements of registration. They also allow businesses to benefit from the expertise of a more sophisticated group of investors.

There is a downside, given the demands of private investors seeking high returns for the increased risk. A private placement does not eliminate the need to manage investor expectations.

> **Article Sources**
>
> 1.  U.S. Securities and Exchange Commission. "[Private Placements - Rule 506(b)](https://www.sec.gov/smallbusiness/exemptofferings/rule506b)."
>     
> 2.  U.S. Securities and Exchange Commission. "[Private Placements - Rule 506(b)](https://www.sec.gov/resources-small-businesses/exempt-offerings/private-placements-rule-506b)."
>     
> 3.  Investor.gov. "[Regulation D Offerings](https://www.investor.gov/introduction-investing/investing-basics/glossary/regulation-d-offerings)."
>     
> 4.  U.S. Securities and Exchange Commission. "[Private Placements Under Regulation D - Investor Bulletin](https://www.sec.gov/oiea/investor-alerts-and-bulletins/private-placements-under-regulation-d-investor-bulletin)."
>     
> 5.  U.S. Securities and Exchange Commission. "[The Laws That Govern the Securities Industry](https://www.sec.gov/answers/about-lawsshtml.html)."