Private Share Placement is one of the most popular processes of raising fresh capital, widely adopted by the private as well as public companies. Under the process, the companies issue its shares to private investors comprising of institutional investors, retail investors like High Net-worth Individuals, banks, mutual funds, insurance companies, at a fixed issue price.
The whole idea behind the concept is to raise funds through the fresh issue of securities to selected private individuals. But this method adversely impacts the ownership of existing shareholders in the company due to dilution. That means that after the company announces secondary issue via placement, the additional shares get added to the outstanding shares of the company which in turn brings down the ownership percentage of existing shareholders.
For instance, if the company had total of 10,000 outstanding shares and a shareholder is holding 1,000 shares of the company, then the private placement of say about 3,000 shares will reduce his ownership proportion 10% to 7.7%.
Prior to share placement
A shareholder owns = Number of shares held *100/ Total number of company’s outstanding share
= 10% of the total company’s equity.
Post Private Share Placement
That same shareholder will own = 1,000*100/ 13,000
= 7.7% of the total company’s equity
Consequently, many investors sell-off their shareholding leading to a decline in the share price of the company on the stock exchange. Recently, the pharmaceutical company Creso Pharma Limited (ASX: CPH) announced the placement of A$3.00 million pursuant to which it received A$2.725 million from sophisticated and institutional investors by 31st January 2019. And as the company issued 6,055,556 shares in settlement of placement, its stock price fell straight by 13.68% on ASX, to close at A$0.410 as at 31 January 2019.
But if the investors look at the bright side of the private placement, they can see the benefits emerging in long-run, provided the company invests additional capital in business expansion which boosts the revenue earning potential and financial health of the company.
Another advantage of the private placement is that it provides additional funding at the time the company needs the financial strength to get hold of the outstanding opportunity it comes across. Generally, a private placement is announced at a discounted price compared to its current market price with the view to attract institutional as well as retail investors. But the guidelines and issue price and size of the placement may vary for retail and institutional investors. It gives an opportunity to the company to raise funds from retail investors during sluggish market conditions.
Moreover, the private placement is governed by the minimum regulatory requirement. For public listed companies there are standards prescribed by security exchange to which the company needs to abide by.
The short-term dilution impact to the existing shareholders and share price fluctuation associated with share placement, needs to be carefully considered against the possible long-term benefits.
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