Raising capital through private placements: definition, benefits, and alternatives
Raising capital is a complex endeavor, in which many entrepreneurs of middle-sized business fail. This has a grim impact on their business, making it more vulnerable to well-capitalized competitors and less able to grow. One of the crucial factors in getting fundraising right is to know which form of raising capital is the most suitable for you. We have a series of articles on different forms of business financing: private placements, IPO, STO, ICO, direct listing. In this article, we will discuss one of the most common and accessible ones: private placement.
What are the private placements?
The first thing we need to learn is the notion of public offerings. Their most distinguishing feature is that they are open to anyone and have no trade limits. The possibility to open an account with a brokerage firm and exchange their publicly traded stocks is open to everybody.
Private placements, on the other hand, are only available to a small number of individuals. The stocks can’t be publicly sold, and the amount you can collect is limited.
There are several other distinctions. To learn more about the differences between this type of funding and public offerings, watch our video on this topic.
Two forms of private placements
There are two forms in which this type of funding can be conducted:
1. Offering to large investors. A good example is a case where a startup receives funding from a venture capital firm.
2. Equity Crowdfunding. It is a form of crowdfunding that allows people to invest. You can sell shares to a large number of small investors in such a campaign, but the amount you can collect is capped, and trading is also restricted.
Pros and cons of private placements
Let’s start with advantages. The main benefit of the private placement is its inexpensiveness: while public offering can easily cost millions of dollars, the given type of raising capital doesn’t go beyond $100,000. Sometimes it’s free of charge – that may depend on the form.
However, the drawbacks are corresponding: if you stick with the private placement, you will collect a lot less money than if you do a public offering. Most of the reasons that businesses finally go public as they become bigger are that private markets are unable to meet their funding requirements.
The cost of capital for private companies is higher. If that sounds complicated, we have a video devoted to the cost of capital that you can watch.
Venture capitalists vs crowdfunding
It’s usually cheaper to turn to major financial institutions while doing the private placement. The disadvantage is that you lose ownership of your business; your investors can now guide you in whatever direction they choose.
Crowdfunding is typically more costly, especially in terms of publicity. Still, you can raise more funds and gain access to a powerful group of supporters. Watch our video that explores these solutions to learn more.
The common pitfall of both forms of the private placement is that investors cannot trade your shares, i.e. they are illiquid. In the last few years, it became possible to solve this problem with the use of blockchain technology. You can tokenize your shares (or other securities), that is to transfer them onto the blockchain. A digital security token is much more flexible in terms of how it can be traded. This is a huge benefit for investors that allows them to reduce investment risk, therefore, making your offering more attractive. We at Stobox provide the necessary legal and technical tools for tokenizing any kind of asset.
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What do you need for private placements?
The last stage is practical. Let’s take a second look at what things you will have to take care of to succeed in your campaign. The first and foremost factor to include would be a subtype of the private placement.
The common part for all types of fundraising is legal. An Offering Memorandum, a Share Purchase Agreement, and other documents are needed in the first place.
You’ll also need a technological platform to onboard customers, sell shares and process payments for some types of campaigns. You may use an established crowdfunding platform, but you would have to give them 10% of your income, so this will not be the safest option.
Finally, above all for crowdfunding, you’ll need a publicity plan. We have a three-part video series on seeking investors that you can watch.
I hope you found this material helpful. We have a variety of videos on legislation, raising capital, and innovative fundraising technology, so be sure to subscribe to our channel and go through all of our resources.