Financial Planning and Capital Formation

Capital Formation FAQs

What is a private placement?
Why would a company consider a private placement?
Who invests in private placements?
What are the key success factors in closing a private placement transaction?

1. What is a private placement?

A private placement is a capital formation transaction, privately negotiated with individual or institutional sources, which provides funding to support a company's financing requirements or shareholders' liquidity needs.

Strict legal rules govern private placements. These transactions are typically completed under registration exemptions from Section 5 of the Securities Act of 1933. Private placements fall within alternative Regulation D rules and requirements, depending upon the size of funding and the nature and number of investors. Transactions less than $1 million are frequently structured for and directed toward individual investors while larger transactions generally target private equity funds and institutions. While disclosure requirements differ, depending upon deal size and investor attributes, the general preparation and process for completing a successful private placement transcend specific transaction categories.

Private placements may take the form of senior debt, subordinated debt, convertible debt, preferred stock, common stock and hybrid or combined forms of these instruments. Key structural determinants include development phase, historical and projected operating performance, current capital structure, designated use of proceeds, future funding expectations, time horizon for return realization and desired exit (return on investment) strategy.

2. Why would a company consider a private placement?

The private placement market is accessed by a diverse group of companies for a wide variety of purposes. Some of the more common transaction contexts are described in the following:

Secured credit sources may not be available to support an internal expansion initiative, given the company's relatively leveraged capital structure, lack of collateral or early phase of development;

Shareholders may wish to execute a liquidity strategy (such as a recapitalization or management buyout) which does not involve the public capital markets or sale of the company to a strategic buyer;

The public capital market may not be a viable long-term source of funds given the company's size, development stage, management organization or industry dynamics;

A significant strategic opportunity (such as an acquisition) may unexpectedly present the company with a consequential financing issue. A private placement can be tailored to the project's specific capital requirements and completed relatively quickly;

While shareholders may ultimately desire to take their company public, the firm's current market capitalization may prevent it from securing a quality underwriter. Alternatively, the timing of the company's funding may not coincide with favorable public capital market conditions. A private placement can bridge this gap, providing interim funds in anticipation of a subsequent public offering, and

A private placement transaction can help secure outside investors for the business to assist with business strategy formation, future financial support and financial strategy execution.

3. Who invests in private placements?

The ultimate source of financing for a given private placement transaction primarily depends upon deal size, phase of company and investment structure. For new and early stage companies, individual investors and venture capital firms are more likely to provide equity financing. Private equity partnerships, Small Business Investment Companies and mezzanine funds serve as the principal sources for equity and hybrid transaction structures involving expansion phase to mature companies. For larger transactions, institutional credit sources (insurance companies, pension funds, banks and other credit institutions) usually consider direct purchases of relatively large debt instruments.

4. What are the key success factors in closing a private placement transaction?

Capital formation transactions pose important implications for any company. Additionally, while significant capital is available within the private placement market, creditors and investors remain very discriminating with respect to their choices. As a result, management should invest the necessary resources and thoroughly prepare in identifying appropriate long term funding solutions and attracting suitable financing sources. In differentiating their company as a high-quality credit or investment opportunity, management should:

Structure the financing to accomplish achievable organizational goals. Identify logical and specific uses for the requested funds;

Develop realistic expectations with respect to prospective operating performance, entry and exit valuations and ownership dilution;

Prepare a descriptive but concise financing memorandum to professionally present the industry, company, management team, business strategy and return prospects to investors;

Target the solicitation effort. Approach investors that clearly understand issues confronting companies within your development phase. In addition, select creditors or investors with favorable experiences and continuing, expressed interest in your industry;

Ensure that current shareholders' time horizon for creating and realizing value is consistent with the investor's desired time horizon;

Approach credit institutions or investors that are comfortable with the size of the proposed transaction and capable of providing follow-on financial support to the business, and

Present reasonable financial strategy scenarios to investors with respect to return generation.