Private Vs. Public Companies

Advantages and Disadvantages of Private and Public Companies

Every investment contains risk. Private businesses hold some risks which have been eliminated with public companies, and public companies have risks that are foreign to the private companies. The growth potential is expansive for private companies and with offshore accounts gaining trust and accessibility, it is making offshore private investments more appealing and popular.

The chart below outlines the growth of private investing for the last two quarters of 2011 in the US. This chart outlines a significant increase in growth. In this short span of time, growth can be seen in almost all major facets of private companies.

The trends are clear. Private businesses are establishing a greater significance in American business culture. More investors are finding the strength of private investments overwhelming and desirable. This is a self-perpetuating mechanism of sorts. The greater the growth of private companies, the more promising the growth potential becomes. However, the private sector expansion isn’t rapidly maximizing; there is still potential for private investors to buy in and reap superior rewards

Private firms see considerable across-the-board growth in the latter half of 2011 with a business they trust and value. Private companies are quickly developing into the future of the securities industry.

Privately Owned, Operated and Invested

With a clearer picture of the attributes and differences between public and private companies now in mind, it is no secret that public offerings were less lucrative in 2007 and 2008 than they had been in the past. The turnover between public and private companies slowed to a crawl in those years. Initial Public Offering research firm Renaissance Capital reports that “during the latest 12 months (November 2007 to November 2008) only three private companies with revenues over $1 billion had public offerings, down from 15 over the same period a year earlier.”  The same research firm is anticipating the most IPOs since the year 2000 in the year 2012, about 200 on the major US exchanges; however, investors are still wary of public investing after the crash and the future of public offerings is still uncertain.

With such interesting changes going on in the public forum, this is a potentially lucrative and fascinating time for those who enter the market trends early and exist in an environment where others stay behind and stick to traditional methods.  This information is a blatant statement that private companies have grown in potential and that now is the time for smaller and larger investors alike to venture into the world of private equity and investment.

The transparency and accessibility of public companies makes the decision to invest easier. Google and the Internet have revolutionized the financial world by organizing and clearly labeling financial data to make exploring the markets easier. Years of historical stock trade prices dating back years are accessible at the click of a mouse, along with the ability to pick specific dates and measure trends, volume and prices against competitors; it essentially allows the user to find the perfect fit for his or her dollar. With all of the data available, investing has been made simple, for the most part. There are thousands of financial blogs and TV and radio personalities eager to “decipher” and analyze public companies for investors, though not all may have the investor’s best interest at heart.  While there are rules in place to keep public companies in check, that doesn’t necessarily mean that the rules are being followed or that every aspect of the public markets is completely transparent. Take the credit rating agencies, who labeled many of the 2008 failed investments “AAA”, (the best rating available, meaning that they were the least likely to fail) such as Freddie Mac and Fannie May. Had credit rating agencies appropriately rated those investments, many people, arguably, could have saved much of their life savings in the crash. The illusion of transparency has fooled many investors into trusting company statements for face-value, a critical mistake for investors of some companies such as Enron.

Investing in a private company is generally perceived as riskier, although that is not necessarily the case. Many people have lost millions in public offerings. The recent turbulence in the economy and stock market has taught investors many lessons, but perhaps the most important is that the “safety-net” of the stock market is no longer “safe”. Risk is present in any investment. Investing is all about assessing the risk, and the parameters of the situation surrounding that risk. In other words, anything is risky. The fact that a private company is not required to provide disclosure is often a cautionary sign to investors to conduct due diligence and research before investing and that leads to informed and successful investing. A public offering often creates a false sense of security for investors and leads investors to buy into companies and instruments that may be more risky than they expected.

In their 2012 research paper, Do Public Firms Invest Differently than Private Firms? Taking Cues from the Natural Gas Industry, noted economists Erik Gilje and Jérôme Taillard of the Boston College noted that “Looking at multi-year plant expansion decisions, it is shown that private firms anticipate future demand better than their public counterparts by expanding their capacity ahead of future positive demand shocks.” Of course, this future demand ideology applies to industries outside of manufacturing plants. The fact remains, most private companies expertly order and maintain their inventory and capacity on a manageable scale, and can have an informed opinion on demand. This usually makes private companies promising investment opportunities, given that the company has a reliable track record and other positive factors.

Private investments offer benefits that a public offering cannot. This includes greater control with less capital, virtually unlimited potential and the ability for investors to really be a part of a business if they so choose.

Private companies usually turn to those they can trust, and those who trust them in return, for their investment capital. For example, a man started a business where he sold toys made of all natural, organic materials. The toys promoted gardening, health and positive aspects of the organic food industry. He has had a successful two year run, but is grossly limited in terms of where he can take the business on his own and by his limited market. Unless he acquires greater capital, he knows that his growth will be constrained by periodic, albeit consistent sales and by he and his employees’ available time.

Seeking capital to grow and expand his market share, he builds a business plan with five year projections, as well as detailed records of his past revenue and finances. He has now put together much of what a large public offering does. Most public offerings go forward and build on what has been done and assess potential risks for the business, such as changes in market conditions, and have an independent auditor review the financials, tasks that investors can complete or have completed on their own before investing in a private company. Conducting this research on the company would allow potential investors to get to know the business they are investing in and the risks associated, two of the most important facts to know before an investor makes the final decision to invest. The only difference is that the investor conducted the research himself or herself or hired someone he or she trusts to conduct the research.

This is just an example, but one that rings true for many individuals in private firms. A business may have potential and a proven record of modest success, but be limited in scale due to external scenarios. Potential investors can see this opportunity, do their research and buy in, turning this man’s toy company into the next Mattel.

          Here are a few attributes that an investor should look for when considering such an investment:

  • The company has a track record and is willing to showcase it.
  • The owner has accurate and rational projections.
  • The company isn’t just one guy. There is a team of employees with trade knowledge and procedures in place.
  • The idea is solid in itself and there is a market for it.
  • The owner has bought back past investors or paid dividends.

As an investor, it is beneficial to follow and assess a company’s potential. As a family member, business associate or friend, you are more likely to know and trust this toy-maker both as a person as well as a business owner. It is not uncommon that family and friends will invest in projects of loved ones. Sometimes, these investments can be small, but they can mean the difference between success and failure for some companies.

When investing in a privately owned business, assess the details. Is the business solid, conceptually and financially? What do other investors have to say? Does the business have a successful history? Ask yourself: do I understand the business I am getting into? Is this business something I can get behind? Assess what you are looking for in an investment, and if your standards and levels of risk are in line, move forward. If not, that investment may not be for you.