Wednesday, 28 August 2013

Placements: What are they, why do they exist and what are the downsides for investors?

This post will be all about placements, the ability for companies to issue shares to limited group of investors without offering them to all investors.  The description and the rules below are those on the Australian market as at the date of writing however similar ways of raising equity also exist in other financial markets around the world.

What are placements?

Placements are a way of raising capital.  They allow companies to raise capital quickly and cheaply from a select group of investors without offering these shares to all the investors in the company.

There are limits on how much capital companies can raise through this type of raising.  In Australia, companies cannot issue more than 15% of their issued capital in any 12 month period through a placement without shareholder approval (note that in Australia there is an extra 10% available to companies worth less than $300m which satisfy certain requirements).

Why do they exist?

As outlined above, placements are a quick and easy way for companies to raise capital.  Companies do not have to write and file a prospectus for all investors making it a much cheaper option than doing a pro rata rights issue to all investors.

They are also much quicker.  Placements can take place in an afternoon or over a one or two days rather than the weeks you typically need to give retail investors to make their decision.  It allows companies to access the cash they need much more quickly and this is especially important if the companies needs the cash in a hurry.

They are typically done at less of a discount.  Nearly all issues of secondary shares are done at a discount to the market value to encourage people to participate in the raising.  Companies that have a big shareholder or a shareholder that is looking to acquire a big stake without moving the market price may be able to raise capital at much less of a discount through a placement (thus being able to raise more money for the same amount of shares issued)

What are the downsides for investors?

The biggest downside for retail investors (who are the ones excluded from placements) is that the value of your shares decrease because the placement shares are issued at a discount to the current trading price.  Your parcel which was worth $10,000 may now only be worth $9,500 and you didn't have the chance to acquire shares cheaply even if you wanted to.

To see how the share price is affected by an issue at a discount see my post on how to calculate the theoretical ex-rights price of a share.

Further, your voting rights are also diminished.  Most retail shareholders don't value or exercise their voting rights anyway but it is definitely a problem if you get involved in the corporate governance of your investments or if you are a large shareholder but were not invited to participate.

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