Differences in Private Placements and Public Offerings - Coursework Example

Private Placements vs. Public Offerings - A Critical Comparison Decision making is extremely important for all types of business enterprises. Not only the accuracy of a decision is important but timing is crucial too; especially if a decision is to be made pertaining to long term debt financing where a company has to think about selling securities. A wrong decision in this regard can prove to be extremely detrimental for a company and that's why a critical comparison of available methods and options is essential where emphasis should be on understanding the differences, degree of flexibility, advantages, disadvantages, cost, convenience and speed. When it comes to securities, two types of basic methods are used by companies to offer those to investors. One of the methods used for this is called Initial Public Offering (IPO) or Public Offering. In this particular method securities are offered for sale to general public. Any one can be an investor in the case of initial public offering. Actually it is the first time when a corporation starts to offer a registered security to public. This practice helps companies to get immediate cash to increase their equity base along with positively affecting the stock value appreciation (Initial Public Offering (IPO). Private Placement is the other method used to offer securities. The basic difference in this particular method as compared to the other one is about selling the shares without the involvement of intermediary of a stockbroker. Both these methods are used in real world to achieve different types of objectives. Actually, the use of a particular method is directly related to the situations being faced by a corporation. By contemplating more on the details related to both these methods, it becomes quite evident that there are quite a few differences, advantages and disadvantages of using a particular method. A critical comparison of both these methods will help you to understand those advantages and disadvantages in a much better way. A comparison for better decision making: Let's start off with Public or Initial Public Offering. In this method, you will see that corporations have to go through an extensive process of registering them with the Securities and Exchange Commission (SEC). It is the duty of SEC to set regulations and specific standards for the investment market to function in a right way. Due to these standards and regulations, it is essential for a corporation to reveal a lot of information before making any offering. The information may be about inner workings of a corporation and the plan about using the funds obtained through the offering. Here, a corporation has to wait for the approval of SEC after setting a sales price for the offering along with providing the other necessary information. Now when you will compare this particular aspect of providing extensive information to SEC with the other method of Private Placement, you will understand why this other method is preferred by most of the corporations. Herein, such securities can be offered which may not be registered with SEC. What it means is that there will be no need to provide extensive information to Securities and Exchange Commission, which is unlike IPO. Since companies making use of this method exploits Securities Act of 1933, there remains no need to follow the rule of quarterly reporting. But, it is significant to mention that a Private Placement Memorandum (PPM) is not exempt from Anti-fraud provisions and state law. It implies the fact that though there will be no need to provide as much details as required in Public Offering but you will have to disclose enough information so an investor may become able to make an informed and rational decision. Apart from this particular aspect, it is important to compare the basic way in which both these methods actually work. While comparing the working process of both these methods, it is easy to see few important differences. For Private Placement, it is obligatory for a company to use Private Placement Memorandum which contains the information pertaining to companys financial background and other relevant information. Here, an appropriate Subscription agreement needs to be completed. On the other hand, IPO is a bit different in the sense that it involves the disclosure of more critical information. To go public a company requires a Registration Statement which can only be prepared after providing specific information to attorneys and accountants. Information pertaining to company, business product, business market, risk factors, officers, directors, shareholders, audited financials and proceeds use is important for Registration Statement. Also, unlike Private Placement, which is sales of shares to accredited and institutional investors, the IPO is all about selling shares to general public. Hence the process ought to be more complicated and extensive. Not to mention that showing sales of $10 to $20 million annually with profits amounting to $1 million is not an easy condition to meet. Moreover, the availability of costly underwriting fees can make IPOs a less attractive option. So, the comparison shows that going public is more expensive than private placement. In fact, cost can vary a lot between companies, depending upon the history, complexity and size of a company. Following is nothing more than an estimation of cost incurred on the completion of an IPO process as a great deal of variation can be seen in this respect. Legal - $50,000 to $150,000 Accounting - $20,000 - $75,000 Audit $30,000 - $200,000 Printing - $20,000 -$80,000 Fees $10,000 -$30,000 Plus underwriter commissions and expenses as well as numerous expenses on the part of the company (GOING PUBLIC / INITIAL PUBLIC OFFERINGS (IPO's) Private Placement, on the other hand, is a bit different in terms of cost. A company doesn't have to prepare official Offering Statements which is the reason why a saving from $20,000 to $30,000 is possible. As sophisticated and experienced investors interact in Private Placements, it becomes much simpler for company to achieve specific goals pertaining to capital accumulation in a much better way. In addition to the cost aspect, there are few other features that make private placement better than the other option. The time taken in order to make an offering to general public is one of the many differences between Public Offerings and Private Placements. Also, the absolute control of entering the market remains with the borrower and there are no limitations to enter the market at the end of a registration period, which is unlike a public offering. Thus, a buyer can take an appropriate step soon after seeing some changes in the market conditions (Peter et al, 2000). Here, it is important to mention that Section 4(2) of the Federal Securities Law needs to be considered before going for Private Placements. This section makes it somewhat different than public offering. It states that a company interested in selling securities of worth $5 million will enjoy an exemption but the securities have to be sold to a small number of "sophisticated investors" who may have the knowledge about the risks involved in buying those securities. But, a more extensive comparison can only be made by going through the Regulation D, which was introduced in 1982 but has gone through some changes. Rules 504, 505 and 506 are of immense importance as they give information about the amount of stock that can be sold to a specific number of investors. Rule 504 is more important for small business owners as it covers specific rules pertaining to Small Corporate Offering Registration. But, you must keep in mind that companies established in Hawaii, Florida, Nebraska and Delaware can not make use of this particular rule. Apparently it seems like Private Placement is the best option for a company as it saves it from dealing with the stringent requirements associated with Public Offerings. In fact, that's the reason why Andrew J. Sherman wrote in his book The Complete Guide to Running and Growing Your Business, "With loan criteria for commercial bankers and investment criteria for venture capitalists both tightening, the private placement offering remains one of the most viable alternatives for capital formation available to companies" Surely, Private Placement is a better option but a critical comparison reveals that there are certain risks involved in Private Placement. Although some of the risks are also associated with Public offerings but they are not as severe as in Private Placement. For instance, lack of liquidity of securities, absence of public market, limited public information about operating history, possibilities of immediate dilutions and other such types of risks are associated with Private Placements. Also, privately placed securities don't get sold at right price. A company may have to accept an offer from an investor which may not be according to the current market value. In publicly offered securities a company can find an investor who may be willing to pay a predetermined price. It is also quite significant to mention that relinquishment of more equity is a problem for a company offering privately placed security. It is to compensate the risk that investor has to take by opting for an illiquid position. Now, when you will further evaluate and compare the method of Initial Public Offering to Private Placement, you will find a set of advantages and disadvantages. For instance, stronger capital base, improvement in other financing prospects, owner diversification, growth in company and personal reputation and prestige, more chances of making acquisitions and executive compensation are few of the highlights of Public Offerings. On the other hand, there are few negative points that will become evident after comparing public offering with private placement. For instance, short-term pressure for growth, no confidentiality, higher initial costs, little or no control over management with restrictions on trading and loss of personal benefits are few of the differences that can be seen after making a comparison between Public and Private offering. When delving more into the details, it becomes quite evident that there is a good amount of difference between public offerings and private placements. For instance, one of the most commonly observed difference is about the availability of more sophisticated investors for private placements. Also, there is prerequisite requirement pertaining to the limitations on the number of investors for different types of private placements. But, it is a fact that although most business owners love to go public but they have to wait for years before the fulfillment of their desire. For most of them, private placement is the faster way of debt financing. They find it to be more inexpensive way to get desired capital by making specific number of investors to buy securities. If a company has just started to build reputation in business world, a private placement is the only feasible option for it. It is so because a growing company can not find a broad base of investors by paying a lot of money involved in public offering (Zeune et al, 1993). Many other differences can also be found by conducting a more detailed analysis but it is a fact that almost all of the publicly offered products are under CSRCs supervision. But, that's not the case with private placements as they are regulated by other regulatory bodies as well. CSRC, CBRC and PBOC are those regulatory bodies which are involved in the regulation process of private placements. Due to the involvement of different bodies it has become somewhat difficult to form uniform regulations on private placements (Han et al, 2008). So, the fact of the matter is that Private Placement is the only option for many companies for long-term debt financing. The companies with insufficient operating history can not utilize the option of Public Offering and that's when only Private Placement can help. Also, when time matters for companies, it is not possible to go with public offering because in some cases it can take as long as two years for an IPO process to complete. However, the comparison shows that if a company go public it becomes easier for it to acquire capital and that's too without considering the issue of interest as no interest charge is involved in this process. But, all factors should be considered along with conducting a thorough comparison of the both the methods before making a conclusion about using any particular method. References: GOING PUBLIC / INITIAL PUBLIC OFFERINGS (IPO's). Venture Associated. Website: http://www.venturea.com/public.htm Han C, Fu A. Analysis of Public Offerings and Private Placements Under PRCs Legal Framework. April 2008. Llinks Banking Law Bulletin. May 06. 2009. Website: www.llinkslaw.com "Initial Public Offering (IPO)." Gale Encyclopedia of U.S. Economic History. The Gale Group Inc. 1999. HighBeam Research. 6 May. 2009 Peter K. Nevitt, Frank J. Fabozzi . Project Financing. Euromoney Books, 2000 ISBN 1855647915, 9781855647916. May 06, 2006. Zeune, Gary D. ; Baer, Timothy R . Floating a stock offering: new buoyancy from the SEC. Aug, 1993. Corporate Cashflow Magazine. May 6, 2009. Website: http://www.accessmylibrary.com/coms2/summary_0286-9280349_ITM Read More