Some of the largest and most powerful companies in the world were created by raising capital in the public markets. Oil companies, utilities, food and beverage, and technology companies have all accessed the public market to fund their day-to-day operations and grow their businesses.
By selling all or part of a business in a public offering, companies that go public receive an immediate influx of capital. While this might appeal to some companies, others understand that public ownership comes at a price. By choosing to stay private, they do not have to report to a large group of shareholders and are able to keep their business plans and finances private.
Key Takeaways
- Many large companies choose to go public as a way to access an immediate influx of capital, better fund day-to-day operations and expand the businesses.
- But for some large companies, staying private is more advantageous, as it enables the firm to be accountable to a smaller group of shareholders, retain more control over the direction of the business, and keep finances private.
- While private companies have to practice accurate accounting policies, they are not subject to the rules of theSecurities and Exchange Commission (SEC), including required annual reporting and third-party auditing.
- Privately-held companies still have access to funding through bank financing and other sources. Such firms often havecommercial lines of credit and can use assets or inventory as collateral for any loan.
Going Public
Startups typically become established as private entities using capital from the owners or outside investors, cash generated from the business, and bank loans. When the company's growth or survival requires more capital than those sources can offer, it may decide to sell all or part of the business by offering its stock to the public. By doing so, companies become subject to greater scrutiny by regulators and shareholders.
Company founders or other major shareholders may be willing to sacrifice some control and privacy to access large amounts of capital they couldn't access otherwise. They can use publicly traded stock as a form of currency for purposes that would normally require large amounts of cash, such as purchasing other companies or compensating officers.
Staying Private
For some companies, the drawbacks of public ownership outweigh the lure of accessing large amounts of capital. One of the major reasons a company stays private is that there are few requirements for reporting. For example, a private company is not subject to Securities and Exchange Commission (SEC) rules, which require annual reporting and third-party auditing.
Anyone who has held shares in a publicly-traded company knows all about glossy annual reports that contain extensive information about a company's finances. Private companies do not need to produce such reports or disclose important information about their finances to the public. While they must practice accurate and current accounting, they do not need to meet the stringent and complex accounting rules and standards applied to public companies.
Although private companies cannot raise capital in the public markets, they do have access to it through other sources like bank financing. Private companies that have been in business for long time periods have established relationships with their banks and can tap into commercial lines of credit when needed. The companies can also use their assets or inventory as collateral for the loan.
Investing in a Private Company
Private companies can also raise capital by offering stock ownership to outside parties or to employees. The value of a private company's stock is determined by private valuation. Some companies carry the stock at cost on their books, while others may use a different valuation method. Investors who own stock in a privately held company must be prepared to accept the valuations and terms that companies dictate.
Offering stock to outside investors usually comes as a prelude to going public, and the purchasers are often venture capital sources. A company may go public more gradually by offering stock to employees as an incentive or as part of their compensation. This gives them anincentive to devote their efforts toward one goal and raises needed capital. United Parcel Service (NYSE:UPS) remained private from its founding in 1907 until it went public in 1999. Prior to going public, UPS regularly offered its private stock for employees to purchase or as compensation. While the majority of the first shareholders probably didn't fully recognize the value of their shares, they found out when the stock started trading on a public exchange, and its price was determined by public demand.
The Bottom Line
There are many reasons to take a company public; the most common one is to have instant access to large amounts of capital. However, that access also comes at a high price in the form of scrutiny by the SEC and shareholders. As a result, many private companies prefer to stay private and find alternate sources of capital.
Traditional lending institutions provide collateralized loans and stock that can be used as private currency or sold to employees to raise capital. This means that while it is possible to invest in private companies, it usually requires close ties to the company. While remaining private suits a family company like S.C. Johnson well, UPS chose to go public in 1999 after 92 years in business to raise the amount of capital necessary to compete in the global delivery marketplace. Both companies perceive their choices as the right ones.
