There are many differences between private and public companies that investors should be aware of.
The biggest difference is that it is easier for individuals to invest in public companies because their stock is traded on exchanges. Anyone can buy a share from a brokerage and be a shareholder.
Investing in private companies can be done through family offices, venture capital firms and crowdsourcing, but usually requires a minimum investment.
Learning the difference between a private company and a public company can help make you a better investor and generate larger returns for your retirement and future.
What Is a Public Company?
Public companies are businesses who have completed an initial public offering that was approved by the U.S. Securities and Exchange Commission. Their shares are available for purchase through brokerages. Anyone, regardless of income or the value of his/her assets, can buy shares of the company, sell them and repurchase them again.
What Is a Private Company?
A private company is one that is owned by one or more individuals with a set number of shareholders. Shares in the company are not available through a brokerage for investors to purchase. Investing in a private company is accomplished by reaching out to the founders directly. These companies are either self-funded by the founders, friends, family members or venture capital firms.
Private vs. Public Companies - Key Differences
The key differences between a private and public company include access to capital, availability to investors, audited financials, valuations and risks.
Public companies tend to have greater access to raising capital to expand their business, buy additional companies or grow their business through a new venture. Companies that are public, like Tesla, (TSLA - Get Report) can raise money by issuing additional shares of their equity. They can also choose to raise capital by issuing various forms of debt such as bonds, bills or notes.
Private companies have fewer options to increase their capital. They can conduct a round of funding, known as Series A or Series B financing, where venture capitalists provide capital in exchange for equity in the company. Giving away too much equity can be problematic and dilute the percentage of control that the founders or management have of the company.
Investors often prefer to invest in public companies because their shares are readily available for purchase through brokerages or retirement investment plans. Selling shares of a company is also not an issue because it can be done the same day a decision is made. Investors can also trade the shares of companies through derivatives such as options and futures contract to take a position on the future profitability of the company.
Selling shares in a private company can be trickier because there needs to be a buyer. Unlike public companies where buyers and sellers are readily available to purchase and sell shares of a company, in a private company, it can be more complicated. Negotiating the price of the shares of the company can be lengthy if the two parties cannot agree on the value immediately.
Examining the financials of a company is key for both public and private companies. Although public companies must provide audited financials, investors should always be aware that auditors do not always find fraud, such as the case when Arthur Andersen, a former public accounting firm, failed to detect accounting fraud in the now-defunct energy company, Enron.
While public companies are also scrutinized by Wall Street analysts, be aware that their analysis can also be biased to persuade individuals to buy shares in companies.
"Many Wall Street analysts have conflicts of interest and as an investor, you need to be aware of them," said Alex Chalekian, CEO of Lake Avenue Financial, a financial services firm in Pasadena, Calif. "The analysts might be valuing the company on one end, but their firm might have a banking relationship on the other end."
Private companies face less scrutiny from shareholders because they do not have to release quarterly and annual reports like public companies do to remain in compliance with the SEC.
"Not having quarterly reports allows a private company to focus on the long term and not break down its business into 3-month snapshots," Chalekian said.
The valuation of a private company is based often on what venture capitalists value the business based on its future growth and what a buyer would be willing to pay. Public companies are valued by their market share or what shareholders deem the value of the business to be. Determining the valuation of either a private or public company can be tricky since many other factors have to be accounted for including liabilities, future earnings and free cash flow.
Investing in either public or private companies can be risky. Many factors can impact the future profitability of a company, such as a lack in demand in sales, geopolitics, macroeconomic factors, tariffs, trade disputes, a slowdown in the economy and higher interest rates.
"Knowing that with a click of a button, you can sell your ownership in a public company helps investors sleep better at night," Chalekian said. "Private companies can be hard to evaluate and the process to sell your shares can take a long time."
Advantages and Disadvantages of Private Companies and a Public Companies
There are advantages and disadvantages of investing in both public companies and private companies.
Advantages of public companies:
- Audited financials
- Shares available to buy, sell or trade from brokerages
- Analysis by Wall Street analysts
- Quarterly earnings and annual report
Disadvantages of public companies:
- Hedge funds and investment firms have more buying power
- Researching a company's 8-Ks and 10-Ks (SEC filings) can take up a lot of time
- Volatility in the stock market can dampen returns
Advantages of private companies:
- Earnings from the company can be paid directly to shareholders
- Potential to become public in the future, generating more return to investors and shareholders
- Potential to be acquired and for shareholders to receive a healthy return
- Option to work closely with management
Disadvantages of private companies:
- Finding a broker to invest in these businesses
- Capital may not be liquid
- Investment period can be lengthy
- Larger minimum investment
Introducing TheStreet Courses: Financial titans Jim Cramer and Robert Powell are bringing their market savvy and investing strategies to you. Learn how to create tax-efficient income, avoid mistakes, reduce risk and more. With our courses, you will have the tools and knowledge needed to achieve your financial goals. Learn more about TheStreet Courses on investing and personal finance here.