Public or Private?

Businesses Making the Decision: Between Public and Private? 

Executive Summary

Private and Public companies are two classifications that businesses can undergo. Being a private company brings about more benefits then being traded publicly suggested through research and direct application from real life examples and situations. Privately traded companies have more control over business decisions through management’s ability to freely make decisions. This differs from public companies that often times will have investor’s impact a decision they make. Private companies can obtain capital from angel investors and/or venture capitalists; this is less volatile way to gain funds for a business. The volatility that comes with being a company that issues shares in the public market often times is not worth the risk. Cost is a large factor when analyzing the two options; private companies have little to no maintenance cost. Public companies have many fixed costs associated with reporting, the government mandates monitoring and regulating also that can cost a lot of money to businesses. The growth potential between the two is very similar but the volatility in the public market can cause businesses to progress and regress very quickly, which is a rare case in privately traded companies.

Private companies will allow businesses to stick to their business model and stay consistent with their goals and projected growth. There are very few outside influences that could negatively impact a private business. Investors are typically investing for a long-term purpose looking for an overall return as opposed to a rapid return with the risk of declining depending on the volatility of the market. When businesses are granted the privilege of internally managing themselves, it can allow for more creativity and expansion along with a clarified focus on the businesses mission. This mission will not be fogged with shareholder motives, regulators and an abundance of fixed expenses that a public company may undergo company.

Introduction

One of the biggest decisions in a business’s lifetime is whether or not to classify themselves as a private or publicly traded company. This is an important decision because of the financial impact this decision will have on the future of any company. The differences between the two is what makes the decision crucial to a business’s future. Some companies would rather function as a private company and some thrive on the benefits that come with being a publicly traded company. Any business owner should know the effects in which each status has on their company. It is important to analyze the type of company being assessed and base the decision on the company’s needs. Upper level managements interaction with shareholders is a huge factor when analyzing the potential benefits of either decision. 

Companies will make the decision based upon specific needs and analyzation of future projects and goals the companies have. Aside from the investment aspect there are more factors to making this decision, which may not be understood, to anyone unfamiliar with how a business is structured from the CEO and above. The trends that they consist of are based upon what each option will follow within. Privately traded companies will tend to follow their business model when publicly traded companies will tend to follow the market. These two factors being analyzed will be whether a business will benefit from being Publicly traded or Privately traded.

Through research information can be found about either path to take as a company. Primarily the focus will be on scholarly works, Interviews as well as real life examples of companies who have taken different ways to approach their business model.

Through scholarly research the procedures and process can be seen in a general sense of all companies. This is what will give a strong understanding of what private and public companies are. The differences can also be seen in many ways through scholarly research and analyzing the “definition” of the two options. Where the differences are highlighted will be through the other forms of research. Looking into business websites such as Forbes and Accounting.com can really show the differences from an Analytical, Financial, Managerial and Accounting perspective. This will transition into interviews and real applications which will bring about specific reasoning and benefits of each which will help to show what decision can benefit a company most when looking at the decision and factoring different variables.

Overview of Possible Actions/Options

When looking at a company it is difficult to identify whether or not it is private or publicly traded from an outside perspective. These two options were chosen based upon the decisions a business must make with how they are obtaining funds from investors. There are only two approaches to this and they are very important to not only today’s financial market but also how they interact with their stakeholders. The way companies deal with their stakeholders says a lot about their status as a company. The shareholders of companies can be active or not active and this is one of the main differences between being a publicly or privately traded company. 

The interaction amongst management and shareholders along with other stakeholders is very different when analyzing the model of the business. In private businesses managers will have more autonomy to freely make decisions. This changes when looking at publicly traded companies because many stakeholders influence management’s decisions. Aside from their shareholders: creditors, auditors and the financial market will influence the manager’s decision-making processes. Private and public companies will have the same common goal, which is to increase shareholder equity, but the process will be carried out in many different ways. Privately traded companies will be expected to do this and investors will invest in business models in which they believe in and trust to return their investment. Publicly traded companies investors are typically made up of upper level management and board members. This results in decisions to be made over the managers head and can be detrimental or influential depending on the goals and aspirations of the company. 

When analyzing the benefits and downfalls to the two options a company can undergo it is seen that each option will bring about different advantages. These advantages can be viewed in different ways depending on the size of a company. Something that may seem advantageous to a large company may actually be a downfall to a smaller company. As a quick example when looking at the benefits of a small business going public you have to factor in the variable of cost when making the transition. Some smaller companies may not be able to afford to enter the realm of publically traded companies because they do not have the capital to maintain the status. When analyzing all the factors the opportunity costs must be viewed in each specific case in each company that may want to make a change.

Privately Traded Companies

Being a privately traded company gives the business more control over the operations and allows them to carry out tasks and run their business without any major input from investors. Investors of private companies differ from those of public simply do to the fact that investments are obtained from people who support the ideals and goals of the business and are most likely looking for a long term return. This allows managers to make their own decisions and not be limited by motives from investors and or regulators. Without investors and regulators management will be given the opportunity to freely make decisions to improve their business and appease the investors through company performance and not carrying out investor ideas and inputs. 

Usually these private companies tend to be small simply because of capital. When keeping in mind those investors usually consist of angel investors and large contributors it is strenuous to raise capital. When raising money there is more of a presentation aspect upon request, the company must present the goals and projected future to obtain funds instead of hoping investors will put their money into the business. By showing investors the projections of the company they can analyze the information or project and see if the future value of their money is worth the present investment the company desires. The return rate and future value of the dollar is a bit harder to calculate than those who invest in publically traded companies due to the fact there are analytics that pertain to public investments as well as reports and financial statements that can be seen by the public. Financial Advisors will use this information to try and determine if the investment is worth it when privately traded companies will use their ideas and aspirations for a business as a backbone in the presentation to the investors. 

Internal Accountants are much more vital in a private company because of the fact there are no regulators so the information they produce is key when showing a return to investors due to the fact the information is not released to the public. Investors may also request certain information throughout the fiscal or calendar year whether it is quarterly or semi-annual reports of financials. Investors may request information to see if the company is staying in line with their business model and competent enough to attain profitability and in turn fulfill the return on the initial investment given. 

Some limitations include the difficulty to raise funds. Without venture capital investments and angel investors it is difficult to obtain funds for various purposes. A majority of the investors will be contributors of very large amounts investments will generally be given based upon percentage of company through shares. This is not always the case but with private companies investors will generally look to attain a certain percentage of ownership through purchase of shares. This works the same way in publicly traded companies but the only difference is private companies have complete discretion when it comes to amount of shares being distributed and the price for them. There is less regulation pertaining to share price, stock splits and distribution. 

Publicly Traded Companies

Publicly traded companies do have many privileges that privately traded companies may not have. These advantages do come with things that may be considered downfalls to some businesses. Being publicly traded allows for investors in the financial market to obtain portions of a company through the issuing of stock. Companies will issue out ownership (stock) of their company to obtain funds from investors in order to carry out business procedures, projects or strategies to maximize shareholder equity, which would give these shareholders a return on their initial investment. This is a big decision for companies that need to obtain capital because of the fact it costs a lot of money to classify a business on the public market. On top of the initial fixed costs there are many variable costs that come along with the transition as well as payment to regulators that must verify the numbers the business is recording for the public to view.

The benefit of being publicly traded is the issuance of shares to the public. This main advantage gives companies an opportunity to obtain shareholders by investor relations and gives them opportunities to strategize the distribution of ownership to obtain capital. Companies will pay out dividends to long-term shareholders as an incentive to keep the ownership and not sell it off. This aspect makes it difficult to obtain governance to meet the needs of the firm but allows for faster increase of capital and fundraising. The main concept behind obtaining funds deals with Initial Public Offerings or IPO, which are done through the help of investment banks. Initial Public Offerings is an easy way for businesses to obtain funds for growth, mergers and or acquisitions. [i]

Publicly traded companies also give managers indirect political power. Through the shares that are issued to the public managers will gain political power, this is something that can be often misinterpreted as a good thing when it is really good or bad depending on the situation. Managers of publicly traded companies must make the best possible decision for their business but these decisions are directly affecting the public who owns shares of the companies. This sense of political power is to assure that large financial institutions do not monopolize the market and gain complete control over a majority of the large publicly traded companies. The power managers are given and various regulations put in place over the years is what prevents the establishment of this coalition. This political power that is placed on individual companies brought about a lack of trust between Wall Street (New York) and Main Street (Washington D.C.) where these stakeholders do not correlate.

This idea brings about an important limitation that publicly traded companies incur. As mentioned earlier publicly traded companies must be regulated and monitored and are mandated to various forms of reporting. For the Government to regulate these public companies they must be audited as well as monitored. Auditing will assure that all reports are accurate that companies release to the public and monitoring will assure there is no fraudulent activity going on internally. There are many forms of monitoring that businesses may undergo. These forms of monitoring are Hierarchical, Collegial and Probastic; these are not always mandated and do not occur within all businesses. Hierarchical Monitoring consists of someone with industry expertise monitoring cash flows of the business to assure they are valid. Collegial Monitoring helps operating managers to inform owners on general information. Lastly, Probastic Monitoring will judge poor results and analyze manager’s performance to assure all decisions being made are valid and for the best interest of the company. Investors and/or government typically mandate these forms of monitoring. Companies apart of the public market must also report financials in many ways. They must come out with Quarterly Financial reports as well as 10-K, which is a yearly report. Companies will be required to use Auditors to assure validity of the statements and make sure the public has the correct information to make investment decisions check these. 

On top of regulations and reports, publicly traded companies obtain fixed costs when entering the public market. First off, it costs money to enter and then companies will be required to pay for these forms of security and documentation processes. Aside from having to pay companies to Audit and verify statements companies may need to advance their accounting department to assure fast and accurate reporting. This will require an increase of budget which may be difficult or out of the question for some companies. The decrease of autonomy is also something that is difficult to understand when analyzing the limitations. Publicly traded companies will have managers that have power, which is something that is not fully understood. When manager’s autonomy is lowered it is not limiting their power, what it is limiting is the capability of freely making decisions. Investors, internal and external, will be a large factor in decision-making processes and these factors could impact a manager’s decision to appease certain stakeholders in the company. This idea is known as corporate governance, which is essentially diffused ownership and control that is most typically allocated between managers and investors.[ii]

Criteria for Decision Making

This criteria was chosen based upon how a company functions depending on ownership. Both of the alternatives are very different in the sense of ownership and decision-making. Being a publicly or privately traded company is one of the most important classifications to know when thinking about investing in a company. Corporate governance differs in the two options also, which is one of the main factors in the decision of being public or private.

The factors in comparing the two options are not weighed but all even. When analyzing the benefits and limitations of the options, the factors that were generally assessed were Management Control, Obtaining Capital, Cost and Growth Potential. These factors are all equal in weight because they all heavily involved in the decision-making process when companies will choose to go public. Management Control deals with day to day and Growth Potential deals with the future. Cost deals with amount of money the company has and Obtaining Capital deals with how much money a company can get to grow financially. When using this concept to analyze each option the conclusion can be made that they all have a very significant impact in the present and future of any specific company. Each factor pertains to either short term or long-term desires of a business that are of equal significance at any point in a business’ life.

After interviewing the President of Fusion Recruiting Labs, a private company, I learned a lot about the functionality of the business. Being a privately traded company it is important to look at the benefits and limitations and find the opportunity cost of going public. The procedures and goals of business, short-term and long-term must be analyzed to see if the benefits of going public outweigh the benefits of staying private. This differs within all businesses, which is why considering the variables in each option is important. It is important to consider the control that management has in decisions. Although managers may have the same amount of power in either situation the question is who is factoring their decisions? As mentioned prior, managers in privately traded companies have more control over the decisions they make for the good of the business. How companies obtain funds or capital is another factor to consider. Private companies will obtain capital from angel investors and venture capitalists that believe in the business model or a vision the business will carry out. Often times upper level management will hold many shares as incentive for good return on equity. This gives management the opportunity to freely make decisions based on the needs of the business instead of shareholder profitability. Obtaining capital is usually a bit more difficult and goal oriented then doing so in the public market. The cost is much less and is a large factor in generally smaller businesses simply due to the fact they can not afford the cost of going public or the fixed costs that come with it including reporting, staffing and regulating. The last factor that must be assessed is growth potential; this factor is very similar in both cases and strictly will depend on the business. The potential for growth is based upon business strategy and how they can adapt to what they have regardless of the market they are in. 

To give a quick example of growth potential in a private market, a business can plan a project to build a new factory. If the business has an angel investor that is willing to put up large sums of money to support the growth of the business then that will give them room to grow. If this is not the case then the business would either have to find new investors, which is typically difficult or time consuming. This would hinder the growth of the business due to the fact that they could not obtain the funds to afford the project and the opportunity cost for the project would most likely outweigh the future return on the project at the time of the proposal.

Looking at the benefits and limitations of a publicly traded company it can be concluded that there are typically more stakeholders in the company, external and internal. Some businesses may find this as a benefit and others may not be able to manage a publicly traded business. To start considering the variables the example above for a publicly traded company will be continued. If that same scenario happened to a publicly traded company the following would occur. The company would release the idea to the public and from that they would strategically increase the volume of their shares and obtain funds from the purchasing of shares. After many approvals and regulations the company would undergo the project. The limitation to this is that if it is not done strategically it could affect the financial reports and overall profitability, which in return would decrease stockholder’s equity. This could hinder the long-term growth or amplify it depending on the research and or strategic planning preformed on that respective decision. This method of prospective growth is risky and not as concrete as immediately finding investors. 

When analyzing management control in a publicly traded company it must be considered that managers will make decisions to increase equity and also appease the stakeholders. Although a privately traded company does the same, in a publicly traded company this decision may not always be the best decision for the business. The decision may increase equity thus giving a return to the stakeholders but may not be consistent with the goals, morals and missions of a business. To gain capital public businesses will issue shares to obtain funds from the public and find investors through shares. Gaining capital in this way is much faster and more efficient but significantly less accurate. Share price can be suede by the performance of the market during any specific period of time. Building on the variable of funds, cost must be factored when considering the benefits of being a publicly traded company. Companies must have the funds as well as cash inflows to be able to afford the quarterly, yearly and other fixed costs that are associated with being public. Regulators and creditors are also stakeholders that must be paid out by publicly traded companies. Reading scholarly sources that deal with entrepreneurship and government regulation helped to put together the information needed when discussing the topic of publicly traded companies.  

Discussion/Recommendation

Being a privately traded company has greater benefits outweighing those of a publicly traded company. Having complete control in a business is what gives it an opportunity to carry out its mission and purpose, which will most likely turn a profit and increase overall equity. Management being able to make decisions freely with no influence from shareholders will help the business stay in line with projections and long-term goals. It can be difficult to obtain funds but with planning and preparation and access to angel investors it is less strenuous then issuing shares and dealing with the effects of the market. The cost is minimal compared to the abundance of liabilities a company obtains when going public, in private companies there is less regulation and reporting which directly affects the operating costs. The potential for growth is company specific, but with that being said privately traded companies that have good ideas and thought out goals will grow regardless of their status. Private companies tend to grow over time as opposed to the rapid growth and profit a public company may undergo. In these cases growth is typically volatile and subjected to decline.

A publicly traded company has many benefits that companies find advantageous in their business models. For most companies, the transition and maintenance is too much for a business to undergo. When analyzing management decisions it is seen in a public business that shareholders can have a say in decision-making processes for their own best interest. This could affect a company in the long-term or short-term, having a good relationship with investors is important and for a majority of publicly traded companies it is difficult to keep track of your shareholders. There is no saying as to whether investors will buy or sell shares which results in higher volatility in reported company performance. This can make obtaining funds simple but actually increasing capital and net worth of the business is inconsistent with the issuance of shares. The cost is a major downfall for companies entering the realm of the public market. These companies will pay large amounts of money to ensure accurate reporting, monitoring as well as regulating. These are some factors that must be kept in mind when analyzing costs of becoming public. The opportunity for growth as mentioned before depends on the business, overall volatility is a big factor and allows for growth to increase and decline based upon market performance for the fiscal time period being assessed.

Conclusion

Private companies present more benefits to business owners and internal stakeholders in the company. There is less room for error and less controls and fixed costs as well. Publicly traded companies are difficult to manage and appeasing all the stakeholders is often difficult and unrealistic. This allows for companies to be pressured into fraudulent activity to meet unrealistic standards set by shareholders. Privately traded companies give management the ability to make the decisions that affect the business. Shareholders will invest in business ideas for long-term return as opposed to trends that can result in rapid high return on investments.

Publicly traded companies could be a better option for very large companies that have a substantial impact in society. If a company is large enough and ready for enough growth they should look into the benefits of going public. Companies that are profitable Quarter after Quarter and constantly report net profits would thrive in the public market. For a majority of businesses this is not the case, which is what supports the decision of privately traded companies being superior to publicly traded in many variables including management control, gaining capital, cost and growth potential. 

Works Cited

[i]Boot, A. W., Gopalan, R., & Thakor, A. V. (2006). The entrepreneur's choice between private and public ownership. The Journal of Finance, 61(2), 803-836.

[ii]Roe, Mark J., Political and Legal Restraints on Ownership and Control of Public Companies (May 1990). Journal of Financial Economics (JFE), Vol. 27, 1990.