Capital Markets Insights

Unveiling the Power of Private Placements

In the realm of alternative investments, private placements have emerged as an option for businesses seeking to raise capital and for investors looking for enhanced returns. The agility of a private placement combines the interests of investors and issuers, fostering a symbiotic relationship.

Let’s unravel some of the mystery surrounding private placements and shed light on the potential benefits and risks.

Decoding Private Placements: Unleashing Potential for Businesses

Imagine a discreet world of securities trading, where businesses seek capital from a select group of investors on private markets.

Unlike public offerings, private placements bypass the regulatory hurdles in Canada and the United States, are exempt from registration requirements, and have unique disclosure requirements. For a company in growth mode, this often means a quicker and less expensive route to raise capital, avoiding costly legal fees to prepare financial documents and a shareholder prospectus. Trimming these fundraising expenses enables companies to retain a more significant portion of the invested funds and nurtures their growth potential.

The other advantage for companies to raise money in private capital markets is the benefit of remaining privately held. In addition to retaining control over the company's operations, board appointments and so forth, operating as a private business reduces the burden of ongoing reporting and financial disclosure requirements that public companies are obligated to bear, generating other cost savings.

While raising money from a limited pool of investors could be considered a risk, it is worth bearing in mind the amount of private equity estimated to be in financial ether. Global dry powder–the term for cash committed by investors but not yet allocated to an investment deal–sat at around $3 trillion at the start of 2023.

Therefore, businesses with good growth potential and who can work with the right investment banks should be able to access the capital they need through private placements.

The Art of Investment: An Opportunity for Investors

In 2022, as central banks raised interest rates to combat inflation, private markets stood tall when their public counterparts faltered. Over a more extended period, private markets outperform public shares significantly. Over the past 20 years, the average annual return from the S&P 500 and Dow Jones Industrial Average was around 6.5%, compared with almost 10.5% for private equity returns. Given that this timeframe included at least one recession and a global pandemic, it would be fair to assume that the returns could be even higher with more stable market conditions.

These returns often result from issuers raising money through a private placement at an early stage when valuations remain modest, yet the company is poised for exponential growth.

Within private placements, businesses engage directly with investors through brokerages. Various securities, including common and preferred stocks, debt instruments, and other equity-based assets, are available for purchase.

But who can take part in this exclusive investment landscape? First, meet accredited investors— experienced high-net-worth individuals and institutions. These financial stalwarts possess the resources and risk appetite to weather uncharted territories.

The second group falls under the umbrella term of retail investors–ordinary people looking to invest more modest amounts in deals. For this audience, Equity Crowdfunding provides a way for people to invest in companies raising capital through online portals where various exemption rules that regulators provide can allow them to participate in private placement deals.

Navigating Uncharted Waters: The Risks of Private Placements

Yet, along with the promise of positive returns, risks do exist. Liquidity is the primary concern, as private placement shares lack the ease of trading enjoyed by their publicly traded counterparts. This poses challenges for investors seeking swift exits. Some service providers, such as TZero, can support the secondary trading of securities.

Transparency is also a potential risk. With exemption from registration, private placements limit the available information on financials and operations, requiring diligent research to make informed investment decisions.

Charting a Course: Balancing Risk and Reward

While private placements offer enticing potential returns, investors must approach them with caution and a balanced perspective. Diligence is crucial, considering the associated risks of these investments. By comprehending the rewards and potential pitfalls, investors can navigate the private placement landscape to align with their own goals and risk tolerance.

In conclusion, private placements hold the promise of remarkable returns for investors and provide an attractive alternative for companies raising capital compared to the arduous journey of an Initial Public Offering. However, all parties must exercise careful judgment, armed with comprehensive knowledge, if they participate in this type of alternative investment.