What is a Private Company?
A private company is owned by either a small number of shareholders, company members, or a non-governmental organization, and it does not offer its stocks for sale to the general public. Instead, its stock is offered, owned, or exchanged privately among a small number of shareholders – or even held by a single individual. Private companies are also referred to as privately-held companies, limited companies, limited liability companies, or private corporations, depending on the country where they’re incorporated and how they are structured.
Private companies may include family-owned businesses, sole proprietorships, partnerships, and small to medium-sized enterprises (SME). Since such companies lack access to the public exchange market, they can only raise funds through private investments, company profits, or loans from lenders.
- A private company is formed by a small number of shareholders who come together for a social cause or profit motive.
- The shares of a private company are not traded on a public stock exchange.
- The common types of private companies include sole proprietorships, partnerships, and limited liability companies.
Types of Private Companies
1. Sole proprietorship
A sole proprietorship is a business owned and managed by one person, and the owner bears unlimited personal liability on the debts incurred by the business. All of its assets, liabilities, and obligations are the responsibility of the business owner.
If the business goes into debt, the owner may be required to sell personal assets to settle the debt. The owner can decide to either run the business on his/her own or employ other people to help run the business.
A partnership has a lot of similarities to a sole proprietorship, except the partnership is owned and managed by two or more people who come together with the goal of making a profit. The partners bear unlimited personal liabilities on any debts incurred by the business. The main types of partnerships include general partnerships, limited partnerships, and limited liability partnerships.
A corporation is a for-profit or not-for-profit business entity that exists as a separate legal entity from its owners. A corporation possesses the rights and privileges of an individual, as it can enter into contracts, sue or be sued, own assets, and pay taxes. Corporations are owned by shareholders or individual investors who provide capital to the business through the purchase of the corporation’s stock.
The shareholders are required to elect a board of directors, which is required to oversee the overall operation of the business. The board appoints the managerial officers, such as the Chief Executive Officer (CEO), who supervise, direct, and manage the core business activities of the corporation.
Why Do Private Companies Stay Private?
1. To avoid regulatory and government scrutiny
Public companies are under high scrutiny from their shareholders, regulators, and the government, and they are required to publicly release their financial statements by filing the quarterly reports, annual reports, and other major events with the Securities and Exchange Commission in the United States, or with a similar government entity in other countries.
In contrast, private companies can choose to keep their financial status and operations to themselves, avoiding government scrutiny and all the regulations that apply to publicly-traded companies. There are no legal obligations for private companies to make their financial statements public. Privately held companies must, however, keep their accounting records in order and make financial statements available to their shareholders.
2. To keep ownership within the family
Companies sometimes opt to stay private to retain their family ownership. Some of the biggest US companies are family-owned, and they’ve been passed on from one generation to another. Going public would mean that the company would be answerable to a large number of shareholders, and might be required to choose different members for the board of directors other than the members of the founding family.
Remaining private means that the company alone can decide who sits in the board of directors, and it is only answerable to a small number of shareholders or private investors. Private companies self-finance their projects and acquisitions without selling large equity stakes to investors through an Initial Public Offering (IPO).
Changing from a Private Company to a Public Company
A majority of public companies start as private entities, either as a family-owned business, partnership, or limited liability company with a few shareholders and advisors. As the business expands, it typically requires additional funds to finance its operations, expansion, or acquisition of other smaller companies beyond what it can raise from internal revenue sources and a small circle of investors.
Transitioning from a private to a public company gives the company access to a large pool of funds in the public exchange market. The process of becoming a public company involves offering stock to the investing public through an IPO.
The private company planning to go public is required to select an underwriter, usually an investment bank, to provide guidance on the IPO process. The underwriter acts as a broker between the issuing company and the public and is responsible for conducting due diligence and helping the issuer navigate all government regulatory requirements for public companies.
When the company goes public, all the privately-held shares are converted to public ownership, and existing shares are assigned a new value equivalent to the public trading price. The original shareholders can choose to hold on to their shares when the company goes public or sell them to new investors for a profit.
CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.
In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional CFI resources will be very helpful: