A stock represents part ownership in a company, which gives the stockholder the right to receive dividends from the company and entitles him to the proceeds from the company’s assets in the event of a liquidation. But do all companies have stocks?
Not all companies have stocks — while all publicly traded companies have stocks, a privately held company may or may not have stock, depending on the type of private company. In addition, not-for-profit corporations are structured not to have stocks.
You may want to know more about private companies, the types, and how they differ from publicly traded companies. Continue reading to find out more.
The Difference Between Public and Private Companies
Private companies differ from public companies in so many ways, and these are some of them:
As you would expect, private companies are held under private ownership. Most of the time, a private company is owned by its founders. However, in some cases, a private company may be owned by a group of private investors.
On the other hand, a public company is owned by all the investors who are currently holding the stock of the company. So the ownership of public companies can change frequently, and any investor can become part of the ownership of any publicly traded company at any time by buying the stock of that company.
2. Type of Corporation
Private companies vary in scope and organizational structure, and in fact, there are five main types of private companies:
- Sole proprietorship: This type of company is owned by one person, and the company does not have a separate legal status from the owner. So the owner has complete control of the company and bears all the liabilities and financial obligations.
- Partnership: Companies in this group are owned by at least two individuals, and just like the sole proprietorship, the owners bear unlimited liability.
- Limited liability companies (LLCs): In this type, the company has multiple owners, and the liability is shared by the owners in a limited way.
- S Corporations: Also with limited liability, this type of company can have shareholders up to a maximum of 100. The company is not directly taxed on its profits, but the shareholders pay taxes on their shares of the profits. Thus, there’s no double taxation.
- C Corporations: With this structure, a private company can have unlimited shareholders, but both the company and its shareholders are subject to taxation on their earnings — double taxation.
Public companies, on the other hand, maintain only the C corporation structure, so the companies and their shareholders are taxed as separate entities.
3. Issuing stocks
Under Regulation D, a private company can sell a limited number of its shares to qualified investors without registering with the Security and Exchange Commission (SEC). However, a private company cannot sell its shares or bonds on the stock exchanges.
On the other hand, once a company has gone public by listing its stock on the stock exchange, investors can freely buy or sell the stock on the exchange. The company can always go to the capital market to raise money by issuing bonds or more equity.
A private company does not need to disclose its earnings and other information about its operations to the SEC or the public, because it is not publicly traded on the stock exchange.
Public companies, on the other hand, are required to report their quarterly and yearly earnings and major events to the SEC and the investing public.
Why Some Companies Stay Private
Although going public is a natural final step for a private company, there are many reasons a private company may choose to remain private, and these are some of them:
1. Disclosing Financial Information
Going public would mean that the company must regularly release its financial statements to its shareholder and the investing public. The SEC requires every publicly trading company to submit, on a regular schedule, its quarterly earnings, annual reports, major events, and proxy statements.
A company that is not ready to always release its financial information to the public may choose to stay private.
2. Cost of Listing
The cost of undertaking an initial public offering (IPO) can be quite high. To list on a stock exchange, a company has to pay the SEC registration fee, the Financial Industry Regulation Authority (FINRA) filing fee, and the stock exchange listing fee.
In addition, the company will also pay the investment bank that will underwrite the offering. So the cost can be a reason for a small company to prefer staying private.
3. Family Ownership
Many privately held companies are run as a family business, and these include some of the largest private companies, such as Koch Industries, which has been held by the Koch family since 1940 when it was founded. By staying private, the company has no public shareholders to answer to, and the family can have full control of the company for generations.
The Benefits of Going Public
Trading publicly on the stock exchange comes with the a lot of benefits:
The most important benefit a company gets from listing on the stock exchanges is the ability to raise funds, from the capital market, to pay off debts, develop new products, and expand its business. Equity funding needs no servicing and has no payback option.
2. Risk Distribution
Because publicly traded companies are owned by a large number of people, the risks associated with running the companies are distributed to a large pool of investors. In other words, no one person is bearing the risk alone.
3. More Visibility
Trading on the stock exchanges gives a company more visibility in the consumer market. As analysts and investors talk about the stock on the TV and other media, consumers get to hear about the company and its products.
4. Easier Methods of Transaction
When a publicly traded company is negotiating a serious transaction (an acquisition, for example), it may be able to use its shares to pay for the deal.
5. Attracting Better Talents
A publicly traded company can attract more talented employees. For instance, every other thing being equal, a smart employee is more likely to choose a company that has employee stock option plans.
Can a Retail Investor Invest in Private Companies?
A retail investor can invest in a private company, but there are some inherent risks associated with investing in a private firm. First, private companies are not required to release their financial reports to the public, so it may be difficult to assess a company’s financial worth.
Also, the stocks of private companies are generally illiquid, so the investors often need liquidity events, such as going public, shares buyback, or a corporate takeover, to sell their shares.
Limitations for Retail Investors
Because of the risks, the SEC placed some restrictions on who can buy private stocks. Generally, to be able to buy a private stock, you must be an accredited or sophisticated investor. An accredited investor is someone whose annual income exceeded $200,000 ($300,000 for a couple) in each of the previous two years or has a net worth of $1 million, excluding his primary residence.
A sophisticated investor is one who has sufficient knowledge and experience in financial and business matters. For these types of investors, private stocks can be negotiated directly with the corporation through private placement. They can also buy from current owners of the private shares through their registered broker-dealers.
However, if you don’t meet the accredited or sophisticated standard, you may still be able to buy private common shares, depending on the registration exemption used by the company. Furthermore, there are equity crowdfunding websites through which an individual investor can invest a limited amount of his income on startup companies. Popular equity crowdfunding portals include Kickstarter, Crowdfunder, RocketHub, and Indiegogo.
You will have to register with the portals to see the private firms that are raising funds at that moment. After reviewing them, you can choose the company to invest in. Remember that there’s a limit to the amount you can invest, based on your income.
It’s not all companies that have stocks. All publicly traded companies have stocks, but depending on the type of company structure, a private company may not have stock. While trading on the exchanges helps companies to raise money faster, some companies may choose to stay private for other reasons.
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