Private Placements: The Uncharted Funding Strategy

Published on 16th October 2007

Unlike in the case of an IPO, a private placement entails a firm inviting investors to buy shares or bonds privately. Before this, investors are vetted to ascertain if they fit into the company’s objectives. The capital market authority (CMA) does not regulate the placement; therefore, there are no mandatory requirements for initiating one. This is one way that small and medium firms use to get funds for expansion or operations. One company, Access Kenya, did a private placement in 2003 before it was listed on the NSE early this year. This helped it expand its business considerably.

Many Kenyan firms have not embraced private placements as a way of funding their businesses. As opposed to IPOs, private placements are not publicized. An issuing firm only informs those investors it deems fit for their business. In many cases, only large investors such as investment banks and insurance firms are involved in such placements. However, small companies that cannot attract the attention of large investors may invite small individual investors to participate in their private placements. Many investors don’t know how they can participate in private placements.

Consider a firm that cannot raise the minimum required amount of Ksh.20 million to list on the Nairobi Stock Exchange (NSE) and has been in operation for a year or two. For such a firm, private placement is a lucrative avenue of raising funds, especially if its growth prospects are good. Getting a loan from a bank may not be easy. It may call for provision of collateral besides other conditionalities. A private placement will not only give such a firm an unconditional  source of funds, but it will also act as a future funding scheme where investors can be asked to participate in other financing options like bonus shares (instead of giving them dividends) and rights issues.

Although the CMA has on several occasions hinted that it may open alternative avenues for smaller firms to list on the NSE, there is no progress in this direction to date. The recent directive by the Kenya government to make bank and insurance firms increase their capital base may oblige some of them to issue shares privately. Co-operative Insurance Company of Kenya (CIC) Ltd has already launched a private placement of shares aimed at raising Ksh.450 million. This will go towards increasing CIC capital base and help it comply with new capital regulations for insurance firms. Other companies and institutions that have followed suit include the Kenya School of Professional Studies and Family Finance bank. Such institutions can also raise capital through rights issues {e.g. NIC Bank} and mergers {e.g. CFC-Stanbic Bank}.

Benefits & requirements

Private placements have a high degree of flexibility in amount of financing ranging from combinations of debt, equity, or debt and equity capital. Investors are also more patient compared to getting bank loans. Often private investors seek a 10% to 20% return on their investments over a longer term of 5 to 10 years. For a steadily growing company, this condition is easy to fulfill. Apart from being a faster form of raising money, the costs of initiating a private placement are much lower than selling stocks to the public as an IPO.

Any small business wishing to raise money through a private placement needs to connect with bankers, attorneys, and accountants who, through their vast clientele, can network it with viable private investors. The business should have a sound business plan and develop a private placement memorandum (PPM) disclosing the full facts of the investment and business. The primary purpose of a PPM, which is sort of a prospectus, is to give the entrepreneur the opportunity to present all potential risks to the investor. Finally, the firm will need a law firm or lawyer experienced in private placements to help them with the legal jargons.

With the limitations of raising capital through the stock market, the private investors market offers an attractive alternative for small and medium businesses. Private placement is a viable form of business financing without the constraints of taking a company public or conceding its control.

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