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Is Private Placement Debt or Equity?

Is Private Placement Debt or Equity?

As the name suggests, a “private placement” is a private alternative to issuing, or selling, a publicly offered security as a means for raising capital. In a private placement, both the offering and sale of debt or equity securities is made between a business, or issuer, and a select number of investors. There may be as few as one investor for any issue.

The three most important features that would classify a securities issue as a private placement are:

• The securities are not publicly offered

• The securities are not required to be registered with the SEC

• The investors are limited in number and must be “accredited”*

Companies, both public and private, issue in the private placement market for a variety of reasons, including a desire to access long-term, fixed-rate capital, diversify financing sources, and add additional financing capacity beyond existing investors (banks, private equity, etc.) or, in the case of privately held businesses, to maintain confidentiality. Since private placements are offered only to a limited pool of accredited investors, they are exempt from registering with the Securities and Exchange Commission (SEC). This affords the issuer the opportunity to avoid certain costs associated with a public offering as well as allows for more flexibility regarding structure and terms. “One of the key advantages of a private placement is its flexibility.”

The most common type of private placement is long-term, fixed-rate senior debt, but there is an endless array of structuring alternatives. One of the key advantages of a private placement is its flexibility. Private placement debt securities are similar to bonds or bank loans and can either be secured, meaning they are backed by collateral, or unsecured, where collateral is not required.

In addition to senior debt, other types of private placement debt issuances include:

• Subordinated Debt

• Term Loans

• Revolving Loans

• Asset Backed Loans

• Leases

• Shelf Issues

Traditionally, middle-market companies have issued debt in the private placement market through two primary channels:

• Directly with a private placement investor, such as a large insurance company or other institutional investor

• Through an agent (most often an investment bank) on a best efforts basis who solicits bids from several potential investors – this is typically for larger transactions: $100MM+

A private placement issuance is a way for institutional investors to lend to companies in a similar fashion as banks, with a “buy-and-hold” approach, and with no required trading or public disclosures. Historically, insurance companies refer to investments as purchasing “notes,” while banks make “loans.”

Private Placement Advantages

Private placements present the following advantages:

• Long Term: Private placements provide longer maturities than typical bank financing, at a fixed-interest rate. This is ideal for when a business is presented with a growth opportunity where they wouldn’t see the return on their investment right away; a business would have more time to pay back the private placement while having certainty of financing cost over the life of that investment. Also, private placements are typically “buy-and-hold,” so the company would benefit from having a long-term relationship with the same investor throughout the life of the financing.

• Speed in Execution: The growth and maturity of the private placement market has led to improved standardization of documentation, visibility of pricing and terms, increased capacity for financings as well as overall increase of size and depth of the market ($10MM – $1B+). Thus, the private placement market fosters an environment that allows for quick execution of an investment, generally within 6-8 weeks (for the first transaction. Follow-on financings can be executed within a shorter time frame). Additionally, it is typically faster to issue a private placement versus a corporate bond in the public market because the issuer is not required to expend time and resources creating a prospectus and registering with the SEC. “Private Placements can complement existing bank debt versus compete with it.”

• Complement to Existing Financing: Private placements also help diversify a company’s sources of capital and capital structure. Since the terms can be customized, private placements can complement existing bank debt versus compete with it, and can allow a company to better manage its debt obligations. Diversification of funding sources is particularly important during market cycles when bank liquidity may be tight. Private placements enable privately-held, middle-market companies and public companies to access capital just as they would with an underwritten public debt offering, but without certain requirements, such as ratings, registrations, or minimum size. And for public companies, private placements can offer superior execution relative to the public bond market for small issuance sizes as well as greater structural flexibility.

• Privacy and Control: Private placement transactions are negotiated confidentially. Also, public disclosure requirements are limited, compared to those found in the public market. Companies would not be beholden to public shareholders.


Long-term capital is congruent with a company’s long-term investments. Thus, capital raised from issuing a private placement is most commonly used to support long-term initiatives versus short-term needs, such as working capital.

Companies, both public and private, use the capital raised from private placements in the following ways:

• Debt refinancing

• Debt diversification

• Expansion/Growth capital

• Acquisitions

• Stock buyback/Recapitalization

• Taking a public company private

• Employee Stock Ownership Plan (ESOP)

Pricing and Payment Structure

Private placement debt is predominantly a fixed-income note that pays a set coupon, on a negotiated schedule. Private placements are priced similarly to public securities, where pricing is determined by the U.S. Treasury rate, with the addition of a credit risk premium. Repayment of the principal can be accomplished in several ways, depending on the credit quality and needs of the issuer, such as sinking fund payments (amortization) or “bullets” as well as tailored/bespoke amortization. Interest is typically paid quarterly or semi-annually. A private placement allows for tailored terms and structures to meet the specific financing needs of the issuer.

Selecting a Private Placement Investor

There are important considerations for a company when determining whether to issue a private placement. When choosing a private placement investor or lender, some key characteristics to look for are:

• They are relationship-oriented rather than transaction-orientated. It’s important that they show interest in the businesses they finance as well as work to understand the needs of the business and how it functions.

• Because private placement debt is typically long-term, it is vital for the private placement investor to have the capacity to grow as a financial partner and have the knowledge and experience to help a company navigate during challenging times.

• They are fast-acting, responsive and have access to key decision-makers within their organization.

• The private placement investor demonstrates a constant appetite for private placement debt throughout market cycles and the calendar year.

• They follow through on their commitments.

Private Equity

Private equity generally involves the formation of an investment fund in which the capital of multiple investors is combined. The private equity firm then proceeds to make investments in individual assets or through buying out entire companies, which could include publicly-traded companies that are converted to the private sector. Much of the time, the businesses that private equity firms invest in are distressed, or financially troubled, and yet private equity is known for adding debt to its target companies to perform takeovers. The private equity firm seeks to improve the business and eventually sell those assets in some manner for a profit.

Evaluating Potential Risks

A primary risk in a private placement is the potential lack of liquidity in shares. If private placement investors want to sell their shares for cash sooner than planned, there’s no guarantee that there will be a buyer. In the public markets, investors have the support of market specialists matching buyers with sellers. A lack of liquidity is a risk that investors in private equity funds face because it usually takes several years before profits materialize.

Debt Vs Equity

Debt financings are the most common type of private placement, and they come in almost as many shapes and sizes as there are borrowers. At one end of the scale are fairly simple deals put together by small firms which finds itself handling many debt financings – some as small as $500,000 – that Texas banks once handled for local companies. Restructuring all the debt makes it a fix rather than a patch.” A more typical transaction for small and medium-sized businesses is mezzanine financing, so called because it is part debt and part equity.

A typical mezzanine deal combines subordinated debt plus some sort of equity, which may be warrants to buy stock at a certain price sometime in the future, or debt that is convertible to equity at some future date. Such combinations are popular with large investors because subordinated debt pays high interest, and the equity component offers the prospect of capital appreciation. “You get more risk, you’re farther down in the capital structure, you have a subordinated claim on a company, and in exchange for that, you get a higher return.” Despite investor demand for high returns, going into debt is still less expensive than selling equity and sharing profits. The advantages of equity are that there is no interest and the principal does not have to be paid back. The features that make a common stock offering attractive to companies make it unattractive to investors looking for high returns, so mezzanine financings with some equity involved are likely to include preferred rather than common stock.

One of the most important things an investment banker or private placement adviser does for a client is help make the decision about debt vs. equity. This is a crucial part of structuring any deal and is not something a company is expected to figure out. What a company does have to do for itself is prepare a business plan. This is the first thing an adviser wants to see. “You need to see the business’s financial history and the financial forecast, and then you want to understand what business they’re in.” “Once you have that, you can make an assessment as to what the prospects are of raising different kinds of money in private markets.” Structuring the deal includes deciding how much of the money should be debt, how much should be equity, what type and on what terms.

“Once the structure is established, we work out a ‘term sheet.” “This specifies what the terms should be for the interest rate, the payback period, final maturity, equity, warrants if appropriate, and so forth.” Using the information in the term sheet and the business plan, supplemented by “due diligence” personally investigating and verifying of the company’s data the adviser draws up a formal private placement memorandum to present to selected financial institutions or investment funds to see who is interested. “That institution then does its own due diligence, confirming the information in the memorandum, visiting the company’s physical facilities and getting a feeling for the management people.” If all goes well, the adviser gets a formal commitment from the financial institution, the deal goes to the lawyers and then to closing, and finally the company gets a check. Each step in this process may take a month or more, starting with preparing a business plan.

How Much Can You Get?

Cash flow is the most important consideration in determining how much debt a company can carry. “Obviously, if the cash flow available for debt service is less than what the debt service requires that’s not a good sign. Then you’ve got to liquidate the company to pay off debt, and that is not something you want to do. You want that ratio to be greater than one to one. It sounds like a silly statement, but a lot of people lose sight of these basic and important things.” A private placement is not a remedy for businesses with bad financials. It can be an alternative to a bank loan, or a supplement to bank loans, but not a replacement for loans no bank will make. With a small company, investors get worried if cash flow falls below two times or gets close to one-and-a-half times the firm’s fixed interest payments. The type of business and the stability of its revenues are also important in determining how much debt to carry. Once assets are pledged as collateral, cash flow becomes even more important

What It Costs

When it comes to a private placement, everything is negotiable, but the placement is also subject to what the market will bear. Debt is priced off treasuries of like maturity, just like commercial bank loans. Interest rates on straight debt are based on the risk involved. Venture capital may be even more expensive.

Private Placements of Debt and Equity Securities

In some cases, a company’s internally generated funds and available bank debt are not adequate to finance growth and an IPO is either not feasible or not desired by the shareholders. Under these circumstances, private sources of debt and/or equity may provide the needed financing. In many cases, privately placed debt is issued to the financing source with warrants or other equity features attached. Whether the financing vehicle is straight equity or debt with attached warrants, the company will be well served by an independent valuation. If the securities are sold at too low a price, the company will incur an excessive cost of equity capital and existing shares will be diluted to a greater extent than necessary. The variables most frequently negotiated in these situations are the company’s financial projections and the appropriate discount rate or cost of capital to apply to these projections. Both of these factors are carefully weighed in a comprehensive valuation.

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Michael R. Anderson, JD

Ascent Law LLC
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States

Telephone: (801) 676-5506

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