What Is A Private Placement Debt?

What Is A Private Placement Debt

As the name suggests, a private placement is a private alternative to issuing, or selling, a publicly offered security as a means for raising capital. In a private placement, both the offering and sale of debt or equity securities is made between a business, or issuer, and a select number of investors. There may be as few as one investor for any issue.

The three most important features that would classify a securities issue as a private placement are:
• The securities are not publicly offered
• The securities are not required to be registered with the SEC
• The investors are limited in number and must be accredited
Companies, both public and private, issue in the private placement market for a variety of reasons, including a desire to access long-term, fixed-rate capital, diversify financing sources, add additional financing capacity beyond existing investors (banks, private equity, etc.) or, in the case of privately held businesses, to maintain confidentiality. Since private placements are offered only to a limited pool of accredited investors, they are exempt from registering with the Securities and Exchange Commission (SEC).

This affords the issuer the opportunity to avoid certain costs associated with a public offering as well as allows for more flexibility regarding structure and terms. One of the key advantages of a private placement is its flexibility. The most common type of private placement is long-term, fixed-rate senior debt, but there is an endless array of structuring alternatives. One of the key advantages of a private placement is its flexibility. Private placement debt securities are similar to bonds or bank loans and can either be secured, meaning they are backed by collateral, or unsecured, where collateral is not required.

In addition to senior debt, other types of private placement debt issuance include:
• Subordinated Debt
• Term Loans
• Revolving Loans
• Asset Backed Loans
• Leases
• Shelf Issues
Traditionally, middle-market companies have issued debt in the private placement market through two primary channels:
• Directly with a private placement investor, such as a large insurance company or other institutional investor
• Through an agent (most often an investment bank) on a best efforts basis who solicits bids from several potential investors – this is typically for larger transactions: $100MM+

A private placement issuance is a way for institutional investors to lend to companies in a similar fashion as banks, with a buy-and-hold approach, and with no required trading or public disclosures. Historically, insurance companies refer to investments as purchasing notes, while banks make loans.

Types of Capital Available to Businesses

When businesses are started, they are often funded by the owners or a family loan. However, as they grow, many companies are unable to finance all needs solely from internal cash flows. When capital needs exceed cash-on-hand, businesses can utilize the following types of capital:

Private Placement Advantages

Private placements present the following advantages:

Long Term

Private placements provide longer maturities than typical bank financing, at a fixed-interest rate. This is ideal for when a business is presented with a growth opportunity where they wouldn’t see the return on their investment right away; a business would have more time to pay back the private placement while having certainty of financing cost over the life of that investment. Also, private placements are typically buy-and-hold, so the company would benefit from having a long-term relationship with the same investor throughout the life of the financing.

Speed in Execution

The growth and maturity of the private placement market has led to improved standardization of documentation, visibility of pricing and terms, increased capacity for financings as well as overall increase of size and depth of the market ($10MM – $1B+). Thus, the private placement market fosters an environment that allows for quick execution of an investment, generally within 6-8 weeks (for the first transaction. Follow-on financings can be executed within a shorter time frame). Additionally, it is typically faster to issue a private placement versus a corporate bond in the public market because the issuer is not required to expend time and resources creating a prospectus and registering with the SEC. Private Placements can complement existing bank debt versus compete with it.

Complement to Existing Financing

Private placements also help diversify a company’s sources of capital and capital structure. Since the terms can be customized, private placements can complement existing bank debt versus compete with it, and can allow a company to better manage its debt obligations. Diversification of funding sources is particularly important during market cycles when bank liquidity may be tight. Private placements enable privately-held, middle-market companies and public companies to access capital just as they would with an underwritten public debt offering, but without certain requirements, such as ratings, registrations, or minimum size. And for public companies, private placements can offer superior execution relative to the public bond market for small issuance sizes as well as greater structural flexibility.

Privacy and Control

Private placement transactions are negotiated confidentially. Also, public disclosure requirements are limited, compared to those found in the public market. Companies would not be beholden to public shareholders.

Capital Uses

Long-term capital is congruent with a company’s long-term investments. Thus, capital raised from issuing a private placement is most commonly used to support long-term initiatives versus short-term needs, such as working capital. Companies, both public and private, use the capital raised from private placements in the following ways:
• Debt refinancing
• Debt diversification
• Expansion/Growth capital
• Acquisitions
• Stock buyback/Recapitalization
• Taking a public company private
• Employee Stock Ownership Plan (ESOP)

Private Placement Securities

In a private placement, the shares of stock or debt instrument are considered securities under both federal and state securities laws. Consequently, any transaction involving the shares or debt must be registered under such securities laws or be exempt from registration. Typically, the offeror is an emerging growth company that has few capital alternatives, although more mature companies tend to be more successful in this process. Securities laws generally require that offers are made mainly to accredited investors. There are two basic types of private placement offerings:

Private Placement Equity Offering

The company sells partial ownership via the sale of stock or a membership unit in order to raise capital. Equity offerings are preferred by early-stage companies, because there is no set repayment schedule with this offering.

Private Placement Debt Offering

The company raises debt financing by selling a note instrument to investors with a set annual rate of return and a maturity date that dictates when the funds will be paid back to investors in full. A debt offering is similar to a business loan, except the financing is provided by investors instead of an institution.

Although private placements are exempt from full SEC registration requirements, they still must comply with federal and state regulations. The most important private placement rules fall under Regulation D, promulgated by the SEC.

Regulation D Debt Offering

A debt offering involves the sale of a promissory note to investors. The note sets forth the terms and conditions of the loan arrangement between the company and the investor. For instance, the interest rate, payment periods, and maturity date are described in the note. Notes are sold in fractional amounts providing flexibility for accommodating investors. For example, in a typical debt offering the company raises $1,000,000, which might involve the sale of 20 notes at $50,000 per note.

Regulation D: Private Placement Rules and Exemptions

Reg D is a series of six rules, Rules 501-506, establishing three transactional exemptions from the registration requirements of the 1933 Act. Rules 501-503 set forth definitions, terms and conditions that apply generally throughout the regulation. Specific exemptions are set out in Rules 504-506.

Rule 504

Rule 504 is the most popular of the Reg D rules. Raising capital for a small business can be expensive and time consuming, but a private placement under Rule 504 of Reg D can minimize costs and delays while giving the issuer access to debt or equity capital. In a Rule 504 offering, a business can raise a maximum of $1 million in any year. Rule 504 has no prescribed disclosure requirements, no limit on the number of purchasers, and no investor sophistication standards. Offerings that are exempt under Rule 504 are relatively simple to prepare and can generally be undertaken by the offeror without substantial outside professional expenses. The JOBS Act of 2012 allows offerings to be made through any form of general solicitation or advertising. Rule 504 does not mandate that specified disclosure be provided to purchasers. However, the offeror must provide enough information to meet the full disclosure obligations under the anti-fraud provisions of the securities laws.

Rule 505

A Rule 505 offering may not exceed $5 million in any given 12-month period. This exemption limits the number of non-accredited investors to 35, but has no investor sophistication standards and no limit on the number of accredited investors. Rule 505 was adopted by the SEC to provide small businesses more flexibility in raising capital than under Rule 504. If only accredited investors are involved in the offering, there is no specific information the issuer must furnish to investors. However, if the offering involves one or more non-accredited persons, the issuer must furnish all purchasers with the same kind of information specified by Regulation D. As with a 504 offering, prior to the JOBS Act of 2012, this offering could not be made by means of general solicitation or general advertising.

For Rule 505 offerings over $2 million, financial statement conditions include the following:
• Only financial statements for the most recent fiscal year need be certified by an independent public accountant.
• If an issuer other than a limited partnership cannot obtain audited financial statements without unreasonable effort or expense, only the issuer’s balance sheet (to be dated within 120 days of the start of the offering) must be audited.
• Limited partnerships unable to obtain required financial statements without unreasonable effort or expense may furnish financial statements prepared on the basis of federal income tax requirements and examined and reported on by an independent public or certified accountant in accordance with generally accepted auditing standards.
• The issuer must also be available to answer questions by prospective purchasers about the issuer or the offering.

Rule 506

Rule 506 provides an exemption for limited offers and sales without regard to the dollar amount of the offering. There is no ceiling on the amount of money which may be raised. The JOBS Act of 2012 permits general solicitation and advertising. There is no limit to the number of accredited investors, but the number of non-accredited investors may not exceed 35. If only accredited investors are involved in the offering, the issuer is under no obligation to furnish specific information to investors. If the offering involves one or more non-accredited persons, however, the issuer must furnish all purchasers with the same information required by Reg D. Rule 506 requires detailed disclosure of relevant information to potential investors; the extent of disclosure depends on the dollar size of the offering. For offerings over $2 million, the issuer must provide audited financial statements. Offerings under $2 million follow Reg A as a guide, with an additional requirement for a certified balance sheet. The securities sold are restricted under the same stipulations in Rules 504 and 505. A company is required to file a notice of the offering on Form D at SEC headquarters within 15 days after the first sale in the offering. There is no requirement to file the offering memorandum with the SEC.

From an investor’s perspective, here are some important compliance features of Regulation D:
• No offerings are exempt from the anti-fraud and civil liability provisions of the various federal securities laws.
• Issuers are not relieved of their obligation to provide investors with information needed to make any required disclosures not misleading.
• Regulation D provides transactional exemptions to issuers only. An investor whose purchase was exempt from registration cannot resell their interest without establishing an independent basis of exemption.
Pricing and Payment Structure
Private placement debt is predominantly a fixed-income note that pays a set coupon, on a negotiated schedule. Private placements are priced similarly to public securities, where pricing is determined by the U.S. Treasury rate, with the addition of a credit risk premium. Repayment of the principal can be accomplished in several ways, depending on the credit quality and needs of the issuer, such as sinking fund payments (amortization) or “bullets” as well as tailored/bespoke amortization. Interest is typically paid quarterly or semi-annually. A private placement allows for tailored terms and structures to meet the specific financing needs of the issuer.

Selecting a Private Placement Investor

There are important considerations for a company when determining whether to issue a private placement. When choosing a private placement investor or lender, some key characteristics to look for are:
• They are relationship-oriented rather than transaction-orientated. It’s important that they show interest in the businesses they finance as well as work to understand the needs of the business and how it functions.
• Because private placement debt is typically long-term, it is vital for the private placement investor to have the capacity to grow as a financial partner and have the knowledge and experience to help a company navigate during challenging times.
• They are fast-acting, responsive and have access to key decision-makers within their organization.
• The private placement investor demonstrates a constant appetite for private placement debt throughout market cycles and the calendar year.
• They follow through on their commitments.
Ultimately, it is most important to find a private placement investor who can offer financing best fitted for the goals of your business. If you’re interested in issuing a private placement, Ascent Law LLC can help.

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Is Section 42 Applicable To Private Companies?

Is Section 42 Applicable To Private Companies

A private placement is a sale of stock shares or bonds to pre-selected investors and institutions rather than on the open market. It is an alternative to an initial public offering (IPO) for a company seeking to raise capital for expansion. Investors invited to participate in private placement programs include wealthy individual investors, banks and other financial institutions, mutual funds, insurance companies, and pension funds. Private placement is a cost effective way of raising capital without going public. A private placement is a method for both public and private companies to raise capital through the private sale of corporate debt or equity securities, to a limited number of qualified investors (aka lenders); it is an alternative to traditional capital sources, such as bank debt, or issuing securities on the public bond market.

Who can issue private placement?

A public company or private company can issue shares on private placement basis.

Maximum number of person to whom private placement can be made
Private placement can be made to maximum 50 persons or higher number prescribed in a financial year, excluding (a) Qualified Institutional Buyer (QIB)(b) employees under stock option scheme under section 62(1)(b) of Companies Act, 2013.

Maximum limit for making offer for Private placement

Offer or invitation can be made to not more than two hundred persons in the aggregate in a financial year, excluding offer to QIB and Employees stock option. This restriction would be reckoned individually for each kind of security that is equity share, preference share or debenture [i.e. 200 for equity shares, 200 for preference shares and 200 for debentures]. However, unless allotment with respect to one kind of security is completed, another kind of security shall not be issued. For example, if equity shares are issued first, preference shares or debentures cannot be issued unless allotment of equity shares is completed. This restriction does not apply to issues by NBFC registered with RBI and housing finance companies registered with NHB (National Housing Bank). If RBI or NHB has not specified similar regulation, the provision of Companies Act shall apply.

What is the time limit for making allotment?

Allotment must be made within 60 days. If not made within 60 days, amount should be refunded within 15 days. Otherwise, interest @ 12% will be payable. The money shall be kept in a separate bank account, either for allotment or for repayment. The offer shall be made to specific persons by name and complete information and record of such offer shall be filed with ROC within 30 days of circulation of private placement offer. No advertisement through media, marketing or distribution channels or agents shall be made of such offer. Return of allotment with complete details of security holders shall be filed with Registrar.

Payment only from bank account of person making application

The payment for subscription to securities shall be made from the bank account of the person subscribing to such securities only. The company shall keep the record of the Bank account from where such payments for subscriptions have been received. Monies payable on subscription to securities to be held by joint holders shall be paid from the bank account of the person whose name appears first in the application – Rule 14(2)(d) of Companies (Prospectus and Allotment of Securities) Rules, 2014.

Record of private placement

The company shall maintain a complete record of private placement offers in Form PAS.5. A copy of such record along with the private placement offer letter in Form PAS.4 shall be filed with the Registrar with prescribed fees, within 30 days from date of the private placement offer letter. If the company is listed, copy of such record shall also be submitted to SEBI, within 30 days from date of the private placement offer letter – Rule 14(3) of Companies (Prospectus and Allotment of Securities) Rules, 2014.

Return of allotment

A return of allotment of securities under section 42 (private placement) shall be filed with the Registrar within 30 of allotment in Form PAS.3 with fee. The return should be filed along with a complete list of all security holders containing –

• the full name, address, Permanent Account Number and E-mail ID of such security holder
• the class of security held
• the date of allotment of security
• the number of securities held, nominal value and amount paid on such securities; and particulars of consideration received if the securities were issued for consideration other than cash.

Pre-certification of form

The PAS.3 form filed by company (other than OPC and small company) shall be pre-certified by practicing CA, CMA or CS. (form filed by OPC or small company is not required to be certified by practicing CA, CMA or CS).

Requirements for Private Company for Private Placement In Utah

As per Section 23 of the Companies Act, 2013 a private company may issue shares by:
• An offer of private placement can be made to a maximum of 200 individuals in a single financial year.
• A private placement letter is sent to applicants (coded with serial numbers) electronically or in writing.
• In the case of issue of shares, a special resolution needs to be passed by the existing shareholders. (Form MGT 14)
• The value of the shares should be certified by a Chartered Accountant (CA) with at least 10 years of experience.
• The payment for securities should be made directly from the bank account for the individual subscribing.
• Securities should be allocated within 60 days of receipt of the application money. If securities are not allocated (because of oversubscription or inability to raise enough capital), then the application money should be refunded within 15 days post the expiry of 60 days. If a company still fails to do so, then the company is liable to pay a 12% interest on the application amount.
The company must file the following with the Registrar of Companies:
• PAS-3 (The return of security allotment within 30 days of allotment)
• PAS-4 (Private placement offer letter)
• PAS-5 (Complete record of private placement)

Ways Private Companies can Raise Capital

Running a business requires a great deal of capital. Capital can take different forms, from human and labour capital to economic capital. But when most of us hear the term financial capital, the first thing that comes to mind is usually money. While it can mean different things, it isn’t necessarily untrue. Financial capital is represented by assets, securities, and yes, cash. Having access to cash can mean the difference between companies expanding or staying behind and being left in the lurch. There are two types of capital that a company can use to fund operations: Debt and equity. Prudent corporate finance practice involves determining the mix of debt and equity that is most cost-effective.

Debt Capital

Debt capital is also referred to as debt financing. Funding by means of debt capital happens when a company borrows money and agrees to pay it back to the lender at a later date. The most common types of debt capital company use are loans and bonds—the two most common ways larger companies use to fuel their expansion plans or to fund new projects. Smaller businesses may even use credit cards to raise their own capital. A company looking to raise capital through debt may need to approach a bank for a loan, where the bank becomes the lender and the company becomes the debtor. In exchange for the loan, the bank charges interest, which the company will note, along with the loan, on its balance sheet. The other option is to issue corporate bonds. These bonds are sold to investors—also known as bondholders or lenders—and mature after a certain date.

Before reaching maturity, the company is responsible for issuing interest payments on the bond to investors. Because they generally come with a high amount of risk—the chances of default are higher than bonds issued by the government—they pay a much higher yield. The money raised from bond issuance can be used by the company for its expansion plans. While this is a great way to raise much-needed money, debt capital does come with a downside. This expense, incurred just for the privilege of accessing funds, is referred to as the cost of debt capital. Interest payments must be made to lenders regardless of business performance. In a low season or bad economy, a highly-leveraged company may have debt payments that exceed its revenue.

Debt Capital Scenarios

Let’s look at the loan scenario as an example. Assume a company takes out a $100,000 business loan from a bank that carries a 6% annual interest rate. If the loan is repaid one year later, the total amount repaid is $100,000 x 1.06, or $106,000. Of course, most loans are not repaid so quickly, so the actual amount of compounded interest on such a large loan can add up quickly. Now let’s take a look at an example of bonds as debt capital. Company A is an airline company that wants to finance a series of purchases for some new aircraft. Instead of going to the banks for a loan, the company may decide to issue debt in the form of bonds that mature within ten years. Investors can purchase these bonds in exchange for interest payments. Lenders are guaranteed payment on outstanding debts even in the absence of adequate revenue.

Equity Capital

Equity capital, on the other hand, is generated not by borrowing, but by selling shares of company stock. If taking on more debt is not financially viable, a company can raise capital by selling additional shares. These can be either common shares or preferred shares. Common stock gives shareholders voting rights, but doesn’t really give them much else in terms of importance. They are at the bottom of the ladder, meaning their ownership isn’t prioritized as other shareholders are. If the company goes under or liquidates, other creditors and shareholders are paid first. Preferred shares are unique in that payment of a specified dividend is guaranteed before any such payments are made on common shares. In exchange, preferred shareholders have limited ownership rights and have no voting rights.

The primary benefit of raising equity capital is that, unlike debt capital, the company is not required to repay shareholder investment. Instead, the cost of equity capital refers to the amount of return on investment shareholders expect based on the performance of the larger market. These returns come from the payment of dividends and stock valuation. The disadvantage to equity capital is that each shareholder owns a small piece of the company, so ownership becomes diluted. Business owners are also beholden to their shareholders and must ensure the company remains profitable to maintain an elevated stock valuation while continuing to pay any expected dividends. Debt-holders are generally known as lenders, while equity holders are known as investors. Because preferred shareholders have a higher claim on company assets, the risk to preferred shareholders is lower than to common shareholders, who occupy the bottom of the payment food chain. Therefore, the cost of capital for the sale of preferred shares is lower than for the sale of common shares. In comparison, both types of equity capital are typically more costly than debt capital, since lenders are always guaranteed payment by law.

Equity Capital Scenario

As mentioned above, some companies choose not to borrow more money to raise their capital. Perhaps they’re already leveraged and just can’t take on any more debt. They may turn to the market to raise some cash. A start-up company may raise capital through angel investors and venture capitalists. Private companies, on the other hand, may decide to go public by issuing an initial public offering (IPO). This is done by issuing stock on the primary market—usually to institutional investors—after which shares are traded on the secondary market by investors.

Private placements can be done by either private companies wishing to acquire a few select investors or by publicly traded companies as a secondary stock offering.

When a publicly-traded company issues a private placement, existing shareholders often sustain at least a short-term loss from the resulting dilution of their shares. However, stockholders may see long-term gains if the company can effectively invest the extra capital obtained and ultimately increase its revenues and profitability.

Private Placement Attorney Free Consultation

When you need legal help with PPM in Utah, please call Ascent Law LLC for your free consultation (801) 676-5506. We want to help you.

Michael R. Anderson, JD

Ascent Law LLC
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States

Telephone: (801) 676-5506

Ascent Law LLC

4.9 stars – based on 67 reviews

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