While the general public may not know the difference between public and private companies, this distinction is essential for navigating the world of business and investing. Public companies and private companies differ in ownership, access to capital and regulatory oversight. While both companies need to meet certain regulations, the manner in which they operate and the specific rules they must follow are different and so is their approach to issues of corporate
governance. Explore how a publicly traded company differs from a privately held company, both from a small business perspective and a shareholder perspective.
Public vs. Private Companies
Before we move into the public vs. private company distinctions, let's define these terms.
- A public company sells shares of its stock to the public through a stock exchange, such as the New York Stock Exchange. Members of the public who own shares thus own a piece of that company. Public companies must keep their shareholders happy, and this
can make them less flexible than private companies. Public companies also tend to face more regulations than private companies.
- A private company may be owned by an individual, a group of individuals (such as a
family business) or an entity, like a private equity firm. Because privately held companies are private, they tend to face fewer regulations and corporate disclosures. They can give them greater flexibility.
With these working definitions set, let's dive into the way these types of companies operate and the benefits and challenges of these business models.
Corporate Governance Models
Corporate governance refers to the rules and processes a company must follow. Public companies face more scrutiny from regulators and from the general public than private companies.
Public companies must run their business plans by their boards of directors, who get to weigh in on these plans. Boards of directors report to shareholders who own shares of company
stock. Shareholders periodically vote on issues of corporate governance, exercising a small measure of control over the business operations and direction.
Private companies tend to have a lot more leeway in how they operate. Owners of the company often make decisions on their own without needing to consult outside individuals. When a private company has a board, those board members make decisions. The general public knows little about how these companies operate because they have less scrutiny than public enterprises.
Regulatory Compliance Requirements
As mentioned above, public and private companies have to follow rules and regulations. If they do not, they risk fines, penalties and reputational consequences.
Key pieces of legislation public companies must adhere to include:
- The Securities Act of 1933, which outlines required disclosures around public offerings to investors
- The Securities Exchange Act of 1934, which focuses on financial reporting requirements
- The Sarbanes-Oxley Act of 2002, which sets standards for corporate governance and accountability
Public companies have to disclose information about their operations and business finances to the Securities and Exchange Commission (SEC). They must make SEC filings when they become public, such as after an IPO, and on an annual and quarterly basis. Other SEC forms must be filed when a qualifying event is triggered.
Public companies face more rules than private companies because of their reliance on investors and regulations that were developed in the wake of financial scandals to protect investors and ensure market transparency.
While there are exceptions, such as IPO solutions for a private company that plans to go public, private company financial reporting is far more limited in scope.
Shareholder Rights and Protections
Shareholders of a public company have six types of rights, namely the right to:
- Sue the company for wrongful acts
- Inspect corporate documents
- Receive dividends from the company
- Transfer ownership to another party
- Vote on matters of importance
- Own shares
Shareholders also have several measures of protection. If the company goes bankrupt, shareholders have a claim on business assets. The order in which shareholders are paid depends on the type of shares they own, such as preferred vs. common.
Shareholders may also possess other rights as outlined in the shareholder rights plan developed by the company. These rights vary by company but generally cover how shareholder interests can be protected if another entity tries to buy out the company.
Shareholders of a private company have fewer rights and protections than those of a public company. They tend to have the ability to vote on critical matters, to participate in important meetings and to receive dividends. While it is difficult to generalize, other specific rights granted to private shareholders can be found in investor relations materials furnished by the company.
Benefits and Challenges of Being a Public Company
The advantages of being on the public market include:
- Easier access to capital: Public companies can sell shares to investors and use the money to fund operations, perform research and develop new products or pay down debts.
While there are downsides to the visibility of being public, fundraising is easier.
- Greater market visibility: Often, public companies are household names. Their
operations make headline news. This translates into enhanced visibility in the market. The more consumers are aware of the company's name and product, the greater potential for market share.
As mentioned, companies that are public are scrutinized more than private companies. They also have a higher regulatory burden.
In practical terms, this means more financial reporting and oversight, including using SEC filing software to prepare and transmit financial reports.
For these reasons, some companies in the public sector may have an interest in taking a company private.
Shareholders of publicly traded companies have financial expectations around company performance. For example, shareholders may expect the stock price to go up or anticipate receiving a hefty dividend. They will be disappointed if shares fall. This places pressure on the company to reward its shareholders.
Taking a company public is expensive. Private companies that are considering whether to enter the public sector should carefully understand all the costs involved in these types of corporate transactions and assess whether doing so is in their best interest.
Investment and Financial Strategies
Investing in public companies is as simple as buying stock shares. These companies provide a range of investor-facing materials to help investors understand their financial standing, their past performance and future-facing financial projections.
Investors should do their own due diligence before buying shares. This includes:
- Understanding their risk tolerance
- Selecting diversified investments by purchasing a mix of asset classes or securities types
- Reviewing the company's finances compared with its competitors
- Following broad market terms to understand challenges or opportunities within the market
Private market investors play an important role in funding companies in the private sector. Investing is not as straightforward, however, as buying stock.
Common pathways to investing in private companies include venture capital firms, which provide capital for privately held businesses. There are also angel investors, who provide startups with an initial flush of capital, well before the initial public offering stage of taking a company public.
With privately held businesses, investors need to research the business, compare the risks and rewards and identify an exit strategy ahead of time. Just as investing in a private corporation isn't as simple as buying its shares, so too is closing out the position.
Public and private companies differ in how they operate, the regulations they must follow, governance and fundraising abilities. From an investment perspective, both types of corporations can be attractive in a portfolio, provided investors understand what they are investing in and have an overall investment strategy.
