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Views 21082022.08.03

IPO vs. Private Placement: What's the Difference?

What is IPO?

To simplify, it means the first time one company sells its stocks in public on the stock exchange.

What is Private Placement?

Private Placement refers to one company sells its securities to a limited number of investors, such as investment banks, pensions, or mutual funds.

Do they have similarities?

Yes! IPO & Private Placement are both ways that private companies seek to raise capital through issuing securities.

What are the differences?

IPO

IPO Explained • Why are IPOs Important to Investors? | AvaTrade

1. Underwriting firms help a lot

In an IPO, the issuer obtains the assistance of an underwriting firm. They will help determine:

  • What type of security to issue

  • The best offering price

  • The number of shares to be issued

  • The time to bring it to market

Though the underwriting firms such as Goldman Sachs (GS) or Morgan Stanley (MS) that bring the issue to market hold shares to sell to their clients at the initial sales price, average investors can obtain the shares once they begin trading in the secondary market. 

2. No previous market activity as references

IPOs can be a risky bet for investors, as there is no previous market activity to evaluate. This is why reading the IPO prospectus report, and gaining any knowledge about the company is crucial before investing.

3. Friendlier to small businesses

IPOs became friendlier to small businesses as a result of the passage of the Jumpstart Our Business Startups Act, which was created to support hiring and lessen the otherwise extensive financial reporting burden on small businesses filing for an IPO.

The Jumpstart Our Business Startups (JOBS) Act is a piece of U.S. legislation that was signed into law by President Barack Obama on April 5, 2012, that loosens regulations instituted by the Securities And Exchange Commission (SEC) on small businesses. It lowers reporting and disclosure requirements for companies with less than $1 billion in revenue and allows advertising of securities offerings. It also allows greater access to crowd-funding, and greatly expands the number of companies that can offer stock without going through SEC registration.

Private Placement

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1. For a smaller amount of capital

Companies using private placements generally seek a smaller amount of capital from a limited number of investors. If issued under Regulation D, these securities are exempt from many of the financial reporting requirements of public offerings, saving the issuing company time and money.

Regulation D (Reg D) is a Securities and Exchange Commission (SEC) regulation governing private placement exemptions. It should not be confused with Federal Reserve Board Regulation D, which limits withdrawals from savings accounts. Reg D offerings are advantageous to private companies or entrepreneurs that meet the requirements because funding can be obtained faster and at a lower cost than with a public offering. It is usually used by smaller companies. The regulation allows capital to be raised through the sale of equity or debt securities without the need to register those securities with the SEC. However, many other state and federal regulatory requirements still apply.

2. More mature investors, more risks

A private placement issuer can sell a more complex security to accredited investors who understand the potential risks and rewards, allowing the firm to remain as a privately-owned company and avoiding the need to file annual disclosures with the SEC.

Marketing an issue may be more difficult for private placements, as these investments can be quite risky with lower liquidity than publicly traded securities. Private placements can also be done quicker than IPOs. For a company that values its position as a private entity, they don't have to sacrifice that privacy but can still gain access to liquidity, or cash, from the deal.

Source: Investopedia

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