Advantages and Disadvantages of Private Placement of Bonds

By Motley Fool

When most bonds are issued, they're made available to the public, registered with the Securities and Exchange Commission, and traded on a public exchange. When a bond isn't listed on a public exchange, it's called private placement. When bonds are placed privately, they're typically offered to a limited number of investors. Investors in privately placed bonds usually include large banks, mutual funds, or insurance companies.

Advantages of private placementOne major advantage of private placement is that the issuer isn't subject to the SEC's strict regulations for a typical public offering. With a private placement, the issuing company isn't subject to the same disclosure and reporting requirements as a publicly offered bond. Furthermore, privately placed bonds don't require credit-agency ratings.

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Another advantage of private placement is the cost and time-related savings involved. Issuing bonds publicly means incurring significant underwriter fees, while issuing them privately can save money. Similarly, the process can be expedited when done in a private manner. Furthermore, private placement deals can be custom-built to meet the financial needs of both the issuer and investors.

Disadvantages of private placementOne major disadvantage of private placement is that bond issuers will frequently have to pay higher interest rates to entice investors. Because privately placed bonds aren't assigned ratings, it can be trickier for investors to determine their risk. Issuers must therefore be prepared to pay investors a premium in exchange for taking on added risk.

In addition, private placement limits the number and variety of investors the issuing party can reach, so selling bonds privately could be more challenging than doing so publicly. In some situations, private placement may cause an issuer to spend more time and money finding and attracting investors than a public offering would require, thus negating one of the primary benefits of avoiding a public listing.

Finally, private-placement issuers could be forced to take extra steps to cater to their investors. For example, potential investors might demand additional equity from issuers or impose other such stipulations in exchange for their investment dollars.

Even if a company chooses to sell its bonds privately, it must still comply with certain SEC rules for private placement. These rules apply to aspects such as the number and monetary value of bonds being offered and the methods used to advertise them.

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