Pros and Cons of Private Placement for Your Business

Many business owners like the idea of raising cash via an initial public offering, but the expense and complexity of going public usually make it impractical for most small businesses. A simpler, less expensive alternative to raise capital and still maintain a high degree of control over the distribution of shares is a private placement.

A private placement is similar to an IPO except that rather than being sold to the general public, ownership shares are sold to a small group of private investors, usually large banks, mutual funds, insurance companies, and pension funds. Also known as nonpublic offerings, most private placements do not have to be registered with the Securities and Exchange Commission. In addition, businesses do not typically need to disclose detailed financial information, and the need for a prospectus is often waived. For these and other reasons, private placements are usually significantly less complicated and expensive than public offerings.

The Pros

Private placements offer a high degree of flexibility in terms of how much money can be raised, from as little as $100,000 to tens of millions of dollars. These investors tend to be more patient and have lower expectations than venture capitalists, giving companies a longer time frame for providing a return on their investments. The process is also usually faster and more streamlined than raising venture capital.

If you’re considering raising money via a private placement, first make sure you have a solid business plan that provides a strong case on why institutions would want to invest in your business:

• What is it about your company that is unique and sets you apart from the competition?
• How will you grow sales and profits consistently over the long term, year in and year out?
• Have you and your partners invested your own money in the enterprise? In other words, do you have some “skin in the game”?
• How strong is your management team? Do they have experience in growing similar businesses in your industry and providing a solid return for owners and investors?
• How do you plan to market and advertise your business? Your marketing strategy, telling how you will gain and keep new customers, should be crystal clear.
• What about your industry? Is it on the rise (think social media or green technologies) or in decline, such as travel agents and film manufacturers, which have virtually been replaced by the Internet and digital technologies?

The Cons

While a private placement may enable you to maintain a higher degree of control than an IPO or venture capital investment, keep in mind that it requires you to give up some degree of ownership and control over your business. New shareholders will have a voice in choosing your board of directors, and they may be able to vote on important decisions affecting the company. They will also have access to all of your books and financial records.

So is a private placement the right strategy for you and your company? If you are in search of capital to grow or expand your business, it can be a cost-efficient way to raise funds that do not have to be repaid, unlike a commercial loan, which must be repaid to a bank or a lender with interest.

The trade-off, however, is the relinquishing of some control over your company and the dilution of equity. Most owners, especially of fast-growth companies, are counting on the future growth and appreciation of their business as the long-term payoff for their years of sweat and blood. The future value of ownership shares you part with in exchange for cash today could end up being much more in the long term than the cost of debt financing.

Don Sadler is a freelance writer and editor specializing in business and finance.