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What is a private placement?

A private placement is a sale of securities by investment bankers or investment dealers to a small group of sophisticated investors, such as pension funds, life insurance companies, trust companies and venture capital companies at a negotiated price.

Generally, the amounts involved are more than $500,000. The entire issue is sold to a small number of institutional investors. Private placements are commonly used to issue corporate bonds.

If the value of the issue is more than $150,000, and only a small number of potential buyers are contacted, requirements for detailed disclosure, public notice and other rules may be waived by provincial securities regulators. A formal prospectus - a legal document used to disclose risks and other details when securities are issued - doesn't need to be prepared for a private placement. This significantly cuts the cost of floating an issue. Private placements are typically announced after the fact through ads in the financial newspapers.

Since the investors are often prohibited from selling the security for two years, this makes the investment illiquid: it can't quickly be turned into cash or traded for another investment. This lack of liquidity adds to the risk for the investors and helps to explain why many private placements are for bonds and other fixed-income investments.

If the company fails to make interest payments or to repay the bond's principal amount, the investors can recover at least some of their money by seizing company assets pledged as security for the bonds. There is greater risk for investors who buy company shares rather than bonds, because shareholders are entitled to assets of a failed company only after bondholders are paid. As a result, few shares are sold as private placements.

The interest rate paid on private placement bonds tends to be slightly higher than for comparable publicly issued bonds. This may encourage investors to buy the issue.

Bond and share issues are two of the main ways companies raise money. The money might be used to pay for new equipment or for other expenses.