Business is all about money. While most businesses focus on making money, all business begins by spending money. Whether starting a business or growing and expanding, business owners need money -- better known as capital -- to get things moving. This provides an opportunity for investors who trade their money for potential future profit. Both private placements and initial public offerings, or IPOs, are methods of raising capital for a business.
When a business needs more capital than it generates, it has two choices: take out a loan or sell a stake in future profits. From an investment perspective, these are bonds and stocks. Bonds and preferred stocks are loans to the business in exchange for a known amount of interest over time. Stocks are shares of ownership in the business that offer an unknown growth potential. In either case the arrangement between business and investor is the same: the business gets the money it needs to grow and the investor gets a portion of the profit from the growth.
Any business can offer shares of stock or bonds to select investors as a private placement -- the equivalent of an exclusive club membership. This allows interested parties -- from friends and family to investment partners -- to support a business in the early and growth stages without opening investment to the general public. Private placement is less expensive than a public offering and is subject to less regulation with the Securities and Exchange Commission. Business owners may use private placement to raise capital while maintaining control over a company, or to allow support by a partner company without a merger or takeover.
Initial Public Offering
Sometimes a company choses to "go public" -- allow its stock to be traded by anyone in a public venue like the New York Stock Exchange or the NASDAQ. When it does this, it sells a particular number of shares that are available for the first time on a particular date. This is known as an initial public offering, or IPO. When a company goes public, it's financial data and corporate structure become public as well. Investors are partial owners, and the company is now responsible to shareholders for it's actions and the resulting profit.
Both private placements and IPOs offer opportunities and challenges for investors. Private placements allow an investor to get in on the ground floor of company growth. Initial investments may be lower for a portion of company profit than they would be for that same value on the public market. Private placements are less liquid than public offerings, however, and may leave investors with few options if they need to sell. IPOs offer a similar "I got there first" opportunity for investors -- short-term growth potential can be very high for any new stock as the market determines the value of a company over and above it's actual book value. Public offerings are more expensive for companies, so may cut into overall profit over time.
- The Motley Fool: Private Placement
- The Motley Fool: Initial Public Offering
- "Dictionary of Finance and Investment Terms": John Downes A.B. and Jordan Elliot Goodman, A.B., M.A.; 2010
- The Allied Companies: Private Placement Funding FAQs