The Allure of Investing In A Private Company

A private company is a type of business that does not have its shares, bonds or other instruments traded on a public stock market. Like most rules in the investment world, there is at least one an exception to this rule. When a private company or issuer has exceeded a set number of shareholders, it may be considered public by its governing jurisdiction and may be subject to certain reporting requirements, benefits and other laws applicable to public companies.  If attempting to simply define a private company already seems a bit complicated, one can imagine the complexity of investing in a public one! This simple fact is now attributed to the growing allure of private equity investing.

 Shares of a Family Owned Business

Many privately held companies are simply family owned. This doesn’t necessarily mean that the business is “small.” Family owned businesses are frequently started by one member of the family and built from the ground up with the help of other members of the family. Ultimately, the business enterprise is tethered together through family connections.  If these companies are given the appropriate conditions to grow, they can see some incredible success! NASCAR is one of the better examples of a successful family owned business. Purchasing shares in a company of this type usually requires a personal or family connection to the business.

One drawback to investing in a company such as this is that there is a greater potential executive risk. It is not uncommon for the matriarchs and patriarchs of family businesses to hold trade secrets, fail-safe plans and influence over the company close to their heart when running their businesses. While this may have merit, it can also mean that certain vital information for the operation of the company is held securely in the vault of their minds, not so secure for the business, should something happen to any of these key figures. When investing in a family owned business, it is essential to evaluate whether the company could operate smoothly should it lose any of its key members. An important point to consider before investing in this type of company is that you may not be able to see a return on your investment for a longer period of time, nor will you be able to “cash in” your investment should you need your principal back on a moment’s notice. Business owners usually use your capital investment for operations and expansion, and will usually not have a plan to buy out shareholders for at least 12 months after an investment is made.

The benefits to investing in a family owned business include the ability to have direct influence over the actions of the company, provided that the shareholder has a large stake in the total percentage of the company; the ability to have a personal connection with the owner of the business and build a trusting relationship with him or her; and perks — family owned businesses usually don’t have a large amount of shareholders which means that you may have access to certain shareholder exclusive privileges depending on the type of company you invest in and the percentage of ownership you have in the company. Another benefit to consider is that these types of companies have a high potential for reward. Private companies often don’t rely on shareholders’ investments to run their businesses, and when they are ready to sell shares or equity in exchange for capital, it usually means they are ready for expansion or to launch a promising new idea that they simply can’t afford with the income from the business.

 Beware purchasing equity in a business which is struggling, and needs the capital to survive. This is often an indication that the market is no longer available for the product or service, that there may be an improper use of funds, or that there is inexperienced or unskilled management. In any of these cases, investors may eventually see a return on their principal, but will rarely ever see a good return.

 Generic Private Companies

 Once a business is incorporated, it is most often immediately considered a private company. Just about every business starts out in this category. Some may never change and will grow to be highly successful businesses; others may take the leap of going public. These types of companies are the most common type, but until recently have been less attractive to investors. These businesses occur in many types and sizes, ranging from your local landscaping company all the way to the number five largest company by revenue in the world, “Vitol Group,” a global energy and commodity trading company.

Private companies like these have historically been considered either second-rate or undesirable investments for smaller companies or they have been considered the “cream of the crop” for large investments. Private investments, when working with large sums of money, have a loyal following all their own, with exclusive deals and projects not offered to the public. These deals almost always involve high rates of return, which has led private investing to hold the title of the most lucrative method of investing for hundreds of years.

Private but Formerly Public

 Most companies can voluntarily change from public to private, and these types of businesses are extremely unique. A formerly public company will usually have lengthy internal histories, and are often owned by a limited number of individuals. Some companies become private through corporate restructuring which necessitates a downsize, while some go private through bankruptcy, which causes the company to delist from a public stock exchange and refocus their operations towards the effective running of their business. There are also some companies that de-list from exchanges voluntarily. These companies may have attempted an IPO only to find that there was not a public interest in its shares or that its shareholders were not yet prepared to sell; moreover, the cost of maintaining a public listing and the cost of public regulations no longer worked in the best interest of the company. This type of formerly public company is becoming more and more prevalent in the wake of the regulatory crack-down and uncertainty in the early 21st century.

Private with Pending IPO

An IPO is an Initial Public Offering, which is essentially the first time a private company or instrument offers its units (shares, bonds, etc.) to the public. Becoming a public company is a lengthy and arduous process which usually takes anywhere between one month and two years to complete, depending on the exchange and jurisdiction. Many businesses with public aspirations remain private until they are convinced that they are ready. It is not uncommon that a claim for public status is discarded or placed on a hiatus to await further documentation. A company that is “prepared” to offer its shares to the public will usually have a history of positive operating history, meet the capital requirements of the desired exchange, meet the age requirements of the desired exchange, is certain that there are investors who are willing to buy their shares, and will often have at least one “project” it is raising money for. Mining companies going public, for example, will usually have a location with extensive evaluations indicating a potentially lucrative place to start a mine, but are in need of the capital to launch the project.

Private Companies with Public Debt

Some companies choose to be private but issue debt in the form of bonds or other debt instruments to the public to help finance and promote internal growth for the business. Investors with access to the exchange these debt instruments are traded on can buy and sell units of the debt during the operating hours of the exchange. Private companies prefer this type of investment because it allows the company to raise money without having to give up equity in their company or comply with certain regulations that a public company must. Reduced reporting requirements also means that any investor looking to purchase debt instruments of this type should conduct cautious research on the history of the company involved and the investor should be aware of any and all risks involved.

Private Companies with Subsidiaries

Some companies prefer to stay private, but would still like to raise money for a project publicly. In this event, these companies can purchase or create a subsidiary of the private company, and take its shares public. One benefit for the private company is that it can hedge its liability for the subsidiary’s project and maintain its equity (ownership) while still funding the project.

A caution for potential investors is that the company would potentially have less to lose in the event that its public subsidiary fails, since its liability is hedged and may not be completely obliged to do all that is necessary to see the subsidiary succeed.

The benefit of investing in this type of company is that loyal investors of the private company and that those investors, for whatever reason, who were originally unable to invest in the private company, could then invest in the subsidiary through the public vehicle. This system also allows the company to carry forward effective policies, procedures and valuable experience from the primary private company to the new subsidiary and leave behind any of the rigid and inefficient policies and procedures, ultimately improving the company’s chance for success. This process may also allow necessary changes of jurisdiction, for example, a private drink company is looking to add a line of alcoholic beverages to its products; however, it is incorporated in a jurisdiction that restricts the sale and transport of alcohol. If this hypothetical company creates a public subsidiary incorporated in a jurisdiction without those restrictions, it can raise funds publicly and release its new line of alcoholic beverages in a jurisdiction where it has a better chance of thriving.

There are many benefits to a company going public. Investing in a private company that makes the transition from private to public can be immensely rewarding, as this process allows for the benefits of both a private company and a public one.