A private company is a business that is owned by a private group of individuals that does not sell shares of stock in the stock market. Stock within a private company can be owned by either a single individual or by a small group of shareholders who may own or exchange shares amongst each other. Private companies can also be referred to as a privately held company or a close corporation.
What Makes a Company Private?
One major contributing factor that makes a company private is that the company does not offer shares to trade in public stock markets. For this reason, they do not have to follow the strict filing requirements of the U.S Securities and Exchange Commission (SEC).
How Does a Private Company Work?
Private companies are held under private ownership and usually consist of a small number of board members. However, they don’t necessarily have to be small businesses to be considered private.
There are many large corporations that have remained private companies despite bringing in billions of dollars in revenue. Somes of these large private companies include Koch Industries, Ernst & Young, Cargill, and Mars.
While almost all companies in the United States begin as a privately held company, they may choose to go public to help gain funding. Once a company offers their shares of stock to the public, they become a public company and will have new rules and regulations to follow set forth by the SEC.
Types of Private Companies
There are four main types of private companies. These include sole proprietorships, limited liability corporations (LLCs), S-corporations, and C-corporations. Let’s review the different types of private companies below.
Sole Proprietorship
Sole proprietorship is a type of business that is most often owned by one person with the name of the business typically being the owner’s name. The owner’s of a sole proprietorship are the ones that will receive the profits of the business. However, this also means that any liabilities are going to fall back on the owner, as well, which can be a disadvantage of starting a sole proprietorship.
Example of Sole Proprietorship
There are many examples of sole proprietorships. Some examples include:
- Home healthcare companies
- Financial planners
- Landscaping companies
- Catering companies
- Housecleaning services
Limited Liability Corporations (LLCs)
Understanding what a limited liability corporation (LLC) is makes sense once you understand what liabilities are. An LLC is a type of business where the owners are not liable for the company’s debts or liabilities. In the United States, regulations for an LLC vary from state to state. LLCs are not required to pay taxes; however, their owners have to claim profits and losses on their tax returns.
Example of LLCs
Some examples of LLCs include:
- Pepsi Cola Decatur
- Sony
- Nike
- eBay
- Amazon
S-Corporations
S-corporations, also referred to as S-subchapter, are corporations that can choose to pass along income, losses, deductions, and credits to their shareholders. This can allow S-corporations to avoid double taxes on corporate income. There are specific requirements that must be met in order to qualify as an S-corporation. These requirements include:
- Must be a domestic corporation within the United States
- Must have no more than 100 shareholders
- May only have one class of stock
- Must meet certain corporation requirements
- Shareholders must be individuals, certain trusts, or certain estates and cannot be partnerships, corporations, or non-resident shareholders.
Example of S-Corps
Examples of S-corporations can include:
- Financial advisors
- Physicians
- Surgeons
- Anesthesiologists
- Insurance agents
- Real estate agents
C-Corporations
C-corporations are some of the most common types of corporations. They differ from S-corporations in that they tax their shareholders, as well as the corporation itself, causing them to endure double taxation.
In other words, a C-corporation’s profit is taxed as it is earned and then taxed again when it is distributed to its shareholders. They are also required to hold shareholder or board meetings and keep detailed records of the meetings.
Example of C-Corps
Common examples of C-corporations include:
- Coca-Cola
- Apple
- Microsoft Corporation
- IBM
Why Do Companies Stay Private?
You may ask why a company would choose to remain private, even though going public would bring in additional revenue. However, many companies choose to stay private for several reasons. These reasons can include avoiding regulation, keeping a business in the family, no minimum capital requirements, limited liability, and maintaining a separate legal entity.
To Avoid Regulation
As mentioned above, private companies do not need to follow the strict filing requirements with the SEC. This can allow them to keep their financial statements more private than a public company, which is required to disclose their information on a regular basis.
However, just because a private company does not have to file with the SEC does not mean they avoid all regulations. Many are still regulated at the state level and are still required to keep records available for shareholders.
To Keep Family Ownership
Another reason that a company may choose to remain private is to keep the business within the family. Many of the largest private corporations that still exist today have remained in one family for many generations. A good example of this is Cargill, Incorporated, which is owned by the Cargill family.
There Is No Minimum Capital
Simply stated, there is no minimum capital requirement for a private company in the United States. This is partly due to the fact that private companies are not as regulated as public companies, and therefore, do not need to disclose a minimum amount of capital. Some of the largest and most profitable companies in the world are in fact, private companies.
Limited Liability
Remaining private for LLCs, in particular, can remain an advantage due to the limited liability they face. This means that should a company fail or report losses, the owners and investors are not held responsible for the company’s liabilities.
Separate Legal Entity
Registering your business as a corporation allows the business to remain a separate legal entity from those that own it. It allows for a sense of autonomy and the ability to maintain proprietary rights over whatever products the business owns. This can also help save on taxes and liabilities.
Disadvantages of Private Companies
Of course, there are also disadvantages to remaining a private company. By staying private, the number of shareholders will be restricted, private companies cannot issue prospectus, and their shares cannot be quoted. Let’s examine each of these situations.
Restricts Number of Shareholders
Private companies are limited in the number of shareholders they are allowed to have. Originally, in the United States, the SEC had a 500 shareholder threshold in place for private companies, meaning they could have up to 499 shareholders without needing to disclose their financial information.
However, with more recent companies growing at much faster rates, the threshold was increased to 2,000. Therefore, private companies today can have up to 1,999 shareholders without having to file an initial public offering (IPO) to go public.
Cannot Issue Prospectus
Since a private company does not offer its shares to the public, they do not or cannot issue prospectus. Prospectus is a financial document required by the Securities and Exchange Commission to be filed by companies that are offering stocks, bonds, and funds to the public. It essentially informs investors of information about the company of which they are looking to invest in.
Shares Cannot Be Quoted
Since a private company does not trade on public markets, their shares cannot be quoted. This can be a disadvantage when a company is trying to gain funding, because even though a company is private, they can still issue shares. However, since their company information is not listed publicly, it can be difficult to find investors willing to take that risk.
Differences Between Private and Public Companies
While there may be some similarities between a private company and a public company, there are some key differences between the two. Private companies do not have to meet the strict filing requirements with the SEC; however, public companies must comply with the regulations set forth by the SEC.
Public companies must be corporations, while private companies can be any type of business. There is typically only one owner or a small amount of shareholders responsible for private companies. Inversely, a public company will have many shareholders responsible for the big decisions within a company.
Is There a Way to Invest in Private Companies?
While it may be more difficult to invest in private companies, there are still opportunities to do so. Since private companies are typically owned and started by one person, they can receive capital from people they know, such as family or friends. This is typically known as angel investing. If a company continues to grow past this stage, they can expand to receive venture capital from a larger group of investors.
Typically, there is more risk involved with investing in a private company early on in their business development. However, as private companies continue to grow and become more profitable, the risk decreases.
Using a Financial Advisor to Invest in Private Companies
Majority of businesses within the United States are private companies. There are many advantages to remaining private versus going public with shares. It is easier for a company to go from private to public, although it can be costly and time consuming to do so. Also it’s possible to invest in private companies, although it may be riskier and more difficult depending on how established the company is.
Consulting with a financial advisor can help you determine whether investing in a private company is worth it for you. Not only can a financial advisor explain the differences between private and public companies, they can also help you to understand the best way to begin your business ventures.