Instead of selling bonds to the public market through the capital markets, a borrower may decide to sell the bonds privately to a limited number of institutional investors buying for their own accounts, such as a pension fund.
In a private placement, the issuer only discloses its financial information to its investors, and its bonds are not made available in the secondary market.
The issuer hires a private placement agent to act as an underwriter. This agent finds and secures sophisticated institutional investors for the new issue. Issuers choose private placements because they can sell the bonds faster than either the negotiated or competitive methods of sale and there are fewer reporting requirements.
A private placement issuer is not obligated to publish an official statement. Instead, it circulates a private placement memorandum (PPM) or offering memorandum that states:
- The issuer’s objectives
- The new bond issue’s terms and associated risks
- The issuer’s financial statements
- The bond’s debt service requirements
The issuer also creates an investor letter, or private placement letter, that each investor must sign. This letter says that the investors:
- Affirm their status as sophisticated investors
- Attest they had sufficient information to make an investment decision
- Acknowledge they are able to evaluate the investment and bear the potential loss
- Agree to resale restrictions limiting their ability to market the securities
Resale restrictions may require that investors do not disclose the municipality’s finances without the issuer’s prior written consent.
Most private placement issuances include “traveling letters” which is a document that specifies the requirement that should the investor resell the securities, the new investor is required to sign an investor letter.
Like other underwriters, placement agents must register as broker-dealers with the SEC.
Example:
Unrated issuers or those with lower credit ratings may prefer private placements. Revenue bonds, especially industrial revenue bonds, are commonly issued through private placements.
What’s important here?
Private placements are a way for the borrower to sell bonds quickly and with less documentation than either negotiated or competitive bid processes. Private placements are usually executed when the borrower is seeking a faster sale and fewer disclosure requirements when compared to a public sale. . For this reason, private placements can be costly compared to the other methods of selling bonds. Private placements are never sold to retail investors because of their unique risks; the SEC has determined that only the most sophisticated individuals and institutions – usually based on investors’ finances – can invest in private placements.
