To go public or remain private–that’s the perplexing question for many growing companies.
Private limited companies, simply put, are held by private individuals such as family, friends, relatives, or only you. Private ownership can have dual meanings; firstly that the ownership is in the hands of non-governmental organization and secondly few of the company’s shares are floated on the market but can neither be traded on the stock exchange nor can they be issued through an initial public offering. Private shareholders may not be able to sell their shares without approval from other shareholders. A private company can take the form of a sole proprietorship, a partnership, a corporation or a limited liability company as long as its shares are privately held and not traded publicly.
Private companies are not legally required to publicly disclose financial information. This allows them to focus on long-term growth rather than making sure shareholders are getting their quarterly dividends.
Furthermore, Private companies don’t need approval from shareholders regarding operational and growth strategy decisions (as long as that is stated in their corporate documents). Private owners usually get their initial investments from individuals and venture capital firms.
Private companies have several advantages:
- Limited Liability (for Private ‘Limited’ companies): Meaning that the personal assets of shareholders will not be at risk of being seized by creditors in case of financial distress.
- Continuity of existence: The business is not affected by the status of the owner; it continues after his/her death.
- Only 2 shareholders are needed to start the company.
- There is scope for raising capital as the maximum number of shareholders allowed is 50.
- The benefit of limited liability and the ease in procuring capital from financial institutions leads to a higher scope for expansion.
A public company, on the other hand, is one that has sold a portion of itself to the public via an initial public offering (IPO) of its shares of stocks. This basically means that shareholders now have a claim (to the degree of their investment) on the company’s assets and profits. A public company can, therefore, have hundreds or even thousands of co-owners.
Public companies are legally bound to inform shareholders and seek their approval for the company’s management actions, operations, financial performance and other decisions. Strict government regulation must be followed in this regard. Some examples of large private companies include Cargill, Mars, Ikea International, PricewaterhouseCoopers, Ernst & Young and Hallmark Cards.
As opposed to private companies, public companies are required by the Securities and Exchange Commission (SEC) of their respective country to file an annual report documenting their performance in detail. Setting up a public company requires a significant amount of documentation and incurs several large costs.
It is much easier for public companies to raise large amounts of capital by selling securities. Investors are also more likely to invest in a public company due to lower risk and potentially larger rewards. Public companies can issue shares on the stock market and raise more capital via secondary stock offerings or by issuing bonds. There is, however, unlimited liability for the shareholders which means the shareholders’ personal assets can be seized by creditors in case of bankruptcy.
Several advantages of enjoying public status include:
- Limited liability for the shareholders,
- A separate legal entity (meaning there is continuity in the event of any shareholders’ death)
- Limitless shareholders (enabling the business to raise large capital sums)
- Freely-transferable shares (which provides more liquidity to the shareholders)
Many companies start off as private companies. However, once a private company reaches a certain size and stage in its life, it has the option of ‘going public’, thus enabling it to open up its shares to the rest of the world. This has several advantages for the company;
The most distinct advantage of going public is the financial benefit of raising capital. This capital can then be used to fund R&D, fund capital expenditure or even used to pay off any existing debt. Another advantage is increased public awareness of the company as IPOs generate publicity by making the company’s products known to new, potential customers. This may be followed by an increase in market share for the company. Furthermore, an IPO also serves the purpose of an exit strategy.
Going Public Challenges
However, going public has posed its own challenges; it gives rise to the need for added disclosure for investors, requires detailed (and costly) periodic financial reporting and the added market pressure which may lead to short-term as opposed to long-term growth. The increased size may also give rise to management problems such as slow decision making and industrial relations problems.
Furthermore, as investors are constantly looking for rising profits, the management’s actions become increasingly scrutinized, which may lead management to perform questionable and/or unethical practices in order to boost earnings. The worst case scenario is that the original owners may lose control/ownership.
At the end of the day, a company must critically evaluate all of the potential advantages and disadvantages before deciding whether or not to ‘go public’. This usually happens during the ‘underwriting’ process whereby the company works with an investment bank to weigh the pros and cons of a public offering and determine its viability.