The distinction between public and private companies is important in the world of business and investing.
Each differs in ownership, access to capital and regulatory insight, but still both need to meet certain regulations.
So what are the main differences between the two, and how do they operate?
How do each operate?
Public companies sell shares and operate on the public stock exchanges, such as the NYSE, NASDAQ or ASX.
These kinds of companies are normally beholden to keeping shareholders happy and consulting them in their decisions.
University of Melbourne Professor in Management and Marketing Daniel Samson suggests that public companies' duty to their shareholders is both an advantage and a drawback.
“Public companies that are listed on stock exchanges have the great benefit of being able to raise capital, for example, by publicly issuing shares and bonds,” Samson tells Azzet.
“They also have to spend quite a lot of time and resources on their disclosure processes, knowing that what they do and how well they do will be scrutinised in detail by analysts in the market.
“Their activities are examined not only by those who are interested in their financial performance from an investment perspective, but also by a range of special interest groups.”
On the other hand, private companies are typically owned by an individual, a group of individuals or an entity like a private equity firm.
They usually face fewer regulations and corporate disclosures, which Samson says can be an advantage.
“Private companies have much lower requirements on disclosing the detailed activities, decisions and performance metrics, and they are under much lower levels of scrutiny by analysts and journalists,” he says.
“Private companies can typically make decisions more quickly, and hence be more flexible and agile.”
However, Samson says a disadvantage of private companies can be funding availability and governance.
“Private companies might have limitations on funding availability because their shares may be closely held, such as in a family,” he says.
“It may also be the case that they have not set up their board of directors and governance processes with the same quality that is mandated and required of public companies, which can sometimes be a disadvantage.”
Switching between models
According to Samson, private companies are typically smaller.
“They tend to exist and be sustained where there are lower requirements for capital, in other words, in less capital-intensive industries, such as the service sector,” he says.
However, some larger industries where they may exist include legal services, engineering services, medical services and architectural services, which are often structured in one form or another as partnerships.
Samson says it would be unusual to find a private company operating in industries where large amounts of capital are required like mining, steel, oil and automotive.
Most companies start out private to begin with and go public on the stock exchange as they grow.
“For those that are successful, their growth requirements and opportunities may exceed their ability to fund that growth through simply retained profits, and they may wish to grow faster, which can be done by launching and listing on the Stock Exchange, raising capital,” Samson says.
“In order to list on any reputable Stock Exchange, a lot has to be disclosed about the company.”
While it's less common for companies to become private, there are some exceptions to the rule.
A recent example of this is the owner of games like Madden NFL, Battlefield and The Sims, Electronic Arts, being acquired by private equity firm Silver Lake Partners and Affinity Partners for US$52.5 billion.
Samson said private equity companies are a fairly recent phenomenon.
“They’ve reached prominence in the last 40 years and they acquire the shares of companies that are often public, significantly restructure those companies, which may include changing their strategies, assets, leadership etc, then after a few years they can't switch back to relaunching them as public companies,” he says.
“Private equity companies usually seek companies that they deem to be underperforming or undervalued, where they see a path to significant value creation.”
Research from Columbia Business School found that the number of companies traded on the U.S. stock exchanges has halved from more than 8,000 in the 1990s to around 4,000 today.
The research found that this was likely due to costly regulations keeping companies from going public.
Samson also said that when a company switches models, it can greatly shift how it functions.
“When a company goes from public to private, decision making and leadership often change very substantially: the new owners will want to make substantial changes in order to lift performance and hence asset values,” he says.
He says typically there are substantial cost reduction strategies implemented as part of this, and can commonly be seen in U.S. healthcare.
“In the U.S., a substantial proportion of hospitals have been acquired by private equity companies in recent years, that has led to significant cuts in healthcare costs and service levels provided to patients in some cases,” he says.
