Private company

What Is a Private Company?

A private company is a business entity that is not publicly traded on a stock exchange. Its shares or ownership stakes are held by a relatively small number of individuals, often including founders, management, employees, or private investors. These entities fall under the broader financial category of business structure and are characterized by their private ownership and typically fewer regulatory obligations compared to public companies. A private company prioritizes generating profits for its private shareholders rather than for a broad public investor base.

History and Origin

The concept of privately held enterprises predates modern corporations, with early forms of business associations, like partnerships, existing since ancient times. The evolution of the corporate form gained significant momentum with the advent of limited liability in the 17th century. This legal innovation allowed investors to contribute capital to a venture without risking their personal assets beyond their initial investment, encouraging greater participation in commercial undertakings.⁸ As legal frameworks developed, the distinction between private and public forms became clearer. Private companies, often referred to historically as "closely-held corporations" or "private corporations," continued to thrive as a preferred structure for family-owned businesses, small business ventures, and enterprises that wished to retain tight control over their operations without the public scrutiny and extensive reporting requirements associated with publicly traded entities.

Key Takeaways

A private company does not trade its shares on public stock exchanges, with ownership typically concentrated among a limited group of individuals or entities.
They generally face fewer regulatory and public disclosure requirements than public companies, offering greater operational flexibility.
Raising capital for a private company often involves private placements, venture capital, or private equity funding, rather than public stock offerings.
Key challenges include limited liquidity for investors and potential difficulties in establishing a clear market valuation.
Private companies are a significant engine of economic growth, contributing substantially to employment and gross domestic product (GDP).

Formula and Calculation

Unlike public companies, a private company does not have a publicly traded share price that can be directly used in common financial formulas like market capitalization. However, private companies still undergo valuation to determine their worth for purposes such as mergers and acquisitions, internal planning, or raising capital.

Common valuation methodologies for private companies include:

Discounted Cash Flow (DCF): This method projects a company's future cash flow and discounts them back to a present value. The formula involves:
$V = \sum_{t=1}^{n} \frac{CF_t}{(1+r)^t} + \frac{TV}{(1+r)^n}$
Where:
- (V) = Value of the company
- (CF_t) = Cash flow in year (t)
- (r) = Discount rate (often the Weighted Average Cost of Capital, WACC)
- (n) = Projection period
- (TV) = Terminal Value (value of the company beyond the projection period)
Asset-Based Valuation: This method assesses the fair market value of a company's total assets after deducting its liabilityies.
Market Multiples (Comparable Company Analysis): This approach compares the private company to similar publicly traded companies or recent private transactions, using metrics like enterprise value-to-EBITDA or price-to-earnings ratios. Adjustments are often made for differences in size, growth prospects, and most notably, the lack of liquidity.

These calculations are complex and typically performed by financial professionals.

Interpreting the Private Company

Interpreting a private company involves looking beyond publicly available financial metrics. Since private companies are not required to disclose extensive financial information, assessing their performance often relies on internal financial statements and direct engagement with management. Key indicators include consistent profitability, strong revenue growth, effective corporate governance practices, and a clear path to future expansion.

Investors in private companies, such as venture capital or private equity firms, often focus on operational improvements and strategic initiatives that can enhance the company's long-term value, rather than short-term fluctuations in a stock price. The lack of public trading means that changes in valuation are typically less frequent and often tied to specific events like funding rounds or a potential mergers and acquisitions (M&A) event.

Hypothetical Example

Imagine "GreenTech Innovations Inc." is a private company developing sustainable energy solutions. It was founded by Sarah and David, who initially self-funded and then brought in a few angel investors. GreenTech Innovations is focused on research and development for a new type of solar panel. They do not publish quarterly earnings reports or have their shares traded on an exchange. Instead, their "shareholders" are Sarah, David, and the angel investors.

When GreenTech Innovations needs additional capital to build a prototype factory, they approach a venture capital firm. The venture capital firm performs extensive due diligence, reviewing the company's internal financial statements, intellectual property, and management team. After negotiations, the venture capital firm invests $10 million in exchange for a significant minority stake. This investment increases GreenTech Innovations's operational capacity without forcing it to go public, allowing Sarah and David to maintain substantial control over their vision and product development.

Practical Applications

Private companies are foundational to global economies, driving innovation, creating jobs, and contributing significantly to national GDPs. In the United States, for example, small businesses—which are predominantly private—account for a substantial percentage of employment and economic activity. The⁷y operate across virtually every industry, from local service providers and family-owned manufacturing firms to large technology startups and established privately held corporations.

Key practical applications and roles of private companies include:

Entrepreneurship and Innovation: Private companies provide a flexible environment for entrepreneurs to develop new ideas, products, and services without the pressures of public market scrutiny.
Specialized Markets: Many private companies cater to niche markets or offer highly specialized services where broad public investment might not be necessary or suitable.
Private Equity and Venture Capital Investment: The growth of the private markets has enabled a significant flow of capital into private companies through private equity and venture capital funds. These funds often invest in private companies to drive growth, improve operations, and eventually seek an exit strategy through an initial public offering (IPO) or sale. For example, private equity firms are increasingly involved in mergers and acquisitions (M&A) within emerging sectors like the "creator economy," acquiring companies to leverage their growth potential.

##⁶ Limitations and Criticisms

While private companies offer distinct advantages, they also face limitations and criticisms, primarily centered around transparency and liquidity.

Limited Transparency: A significant drawback for private companies is their limited obligation for public disclosure. Unlike publicly traded entities, they are not typically required to release regular financial statements or detailed operational information to the public. Thi⁵s lack of transparency can create challenges for external investors seeking comprehensive data for analysis and can lead to concerns about corporate governance and accountability.
⁴ Illiquidity: Shares in a private company are not easily bought or sold on an open market. This illiquidity can make it difficult for investors to exit their positions or for employees with equity stakes to monetize their ownership. The process of selling shares often requires finding a willing buyer privately, which can be time-consuming and may result in a lower valuation than a publicly traded company of comparable size.
³ Access to Capital: While private companies can raise capital through private placements, venture capital, and private equity, their access to large-scale funding from the general public is restricted without undergoing an initial public offering (IPO). This can limit their ability to fund rapid expansion or major strategic initiatives.
Regulatory Scrutiny (Indirect): Although private companies generally avoid the direct regulatory burdens of public markets, they are not entirely exempt from oversight. For instance, the U.S. Securities and Exchange Commission (SEC) regulates the offer and sale of all securities, including those issued by private companies under specific exemptions like Regulation D. Inc²reasing amounts of capital in private markets have led to discussions about potential risks associated with this lack of transparency, particularly as more institutional funds with everyday investors' savings are exposed to these markets.

##¹ Private Company vs. Public Company

The fundamental distinction between a private company and a public company lies in their ownership structure and regulatory obligations.

Feature	Private Company	Public Company
Ownership	Held by a small group of founders, management, or private investors.	Shares are publicly traded on stock exchanges and owned by a wide range of investors.
Share Transferability	Restricted; often requires internal approval.	Freely transferable through public markets.
Access to Capital	Primarily through private placements, venture capital, private equity, or debt.	Can raise significant capital by selling shares or bonds to the public.
Regulation & Disclosure	Generally fewer requirements; financial information is often private.	Subject to extensive government regulation (e.g., SEC in the U.S.) and mandatory public disclosure of financial statements and other reports.
Liquidity	Low; difficult to sell shares quickly.	High; shares can be bought and sold easily on exchanges.
Control	Founders and original owners typically retain more control.	Control can be dispersed among many shareholders and influenced by market pressures.

While a public company gains significant access to capital and increased liquidity, it sacrifices a degree of control and privacy. A private company, conversely, maintains greater control and privacy but faces limitations in raising broad public funds and providing liquidity to its investors.

FAQs

Are all small businesses private companies?

Most small businesses are indeed private companies. This includes sole proprietorships, partnerships, and privately held corporations. They are typically owned by a small number of individuals and do not issue shares to the public.

How does a private company raise money?

A private company raises money through various channels, including self-funding from founders, loans from banks or other financial institutions (debt financing), investments from friends and family, angel investors, venture capital firms, and private equity firms. They can also conduct private placements, offering securities to a limited number of investors without public registration.

Can a private company become a public company?

Yes, a private company can become a public company through an initial public offering (IPO). This process involves selling shares to the general public for the first time, after which the company's shares are listed and traded on a stock exchange. This is often a major exit strategy for founders and early investors.

Are private companies regulated?

While not subject to the same extensive public market regulations as publicly traded companies, private companies are still subject to various laws and regulations. These include general business laws, labor laws, tax laws, and industry-specific regulations. Additionally, certain types of private offerings of securities are regulated by bodies like the SEC to protect investors.