02/05/2023 | News release | Distributed by Public on 02/05/2023 05:31
Published: February 05, 2023
There's a lot to think about when starting a business - how will you structure it? Where will it be located? What industry will you enter? How will you market your offerings?
And if your products and services are a hit, will you keep your company private or take it public one day?
Remaining private is the most common choice: There are 33m+ small businesses in America. Going public typically requires more scale and growth, while staying private gives the founders more control.
If you're thinking of starting a private business, then learn the ins and outs of private company structures, valuations, and legal requirements.
A privately held company is a business that's entirely owned by one or more founders, managers, private investors, and/or families.
It's not publicly traded on a stock exchange and doesn't receive investments or capital from the public. It also excludes government-owned companies.
Examples of privately held companies include family businesses and most SMBs (small and medium businesses). However, large corporations can be privately owned as well.
The primary difference between private and publicly traded companies is how they raise capital. Public companies use the stock exchange to raise funds, while private businesses build capital using investments from venture capitalist (VC) firms, banks, and angel investors.
Another distinction is their public disclosure requirements. Public companies must disclose their financial information, such as quarterly earnings reports and executive compensation, to the Securities and Exchange Commission (SEC).
The documents are publicly available, which helps protect investors and keeps the market fair and transparent.
Private companies generally have fewer owners and aren't required to disclose financial data to the public. However, private companies must still share key information, such as their income statements and balance sheets, with the IRS and other government agencies.
Note that businesses can sell limited private shares without reporting to the SEC. Regulation D of the SEC states private companies can sell to up to 35 non-accredited investors and remain private.
A non-accredited investor is an individual that earns less than $200k annually and has a net worth under $1m (excluding primary residences).
Owners of private businesses typically enjoy several advantages, such as:
But there are things to watch for when accepting investments for your privately held company.
"Sometimes venture capitalists can get too involved in the day-to-day operations, which can positively or negatively impact the direction of the company," says Michael Aswad, CEO of VoM, a cloud accounting software firm.
"VCs tend to favor growth over profitability, which may cause a bit of a challenge down the lifeline of the business."
So make sure to lay out the roles and responsibilities of VCs in your agreement to avoid bumping heads down the road.
There are other disadvantages of being a private business:
The most common types of privately held businesses are:
Yes, LLCs (limited liability companies) are privately held businesses. An LLC is a legal entity formed to protect the personal assets of its owners, also known as members, while engaging in business activities.
These members have the freedom to run their business as they see fit, but must comply with state laws, like registration and licensing requirements.
If an LLC elects to be taxed as a partnership and has a publicly traded partnership structure, then it can sell its stocks in a public securities exchange.
To value privately held companies, you could run a comparable company analysis (CCA). This involves comparing the private business's financial metrics and performance to similar publicly traded companies in their industry.
For instance, you can run a valuation using the price-to-earnings (P/E) ratio. You could get a public company's P/E ratio by dividing its market capitalization by its annual net income, then apply it to the private company's metrics.
For example, if the average P/E ratio of four publicly traded lumber companies is 10, and the net income of a private lumber company is $10m, the private lumber business would be worth $100m ($10m x 10).
Another method to value a private company is the discounted cash flow (DCF) model, which estimates the company's future cash flows then discounts them to get present value.
Private company stock is an equity stake in a private business. It can be sold to investors, such as venture capitalists, angel investors, and family offices. Unlike publicly traded stocks, private stocks don't have to abide by SEC regulations.
Private companies may also offer employee stock options or grants as an incentive for employees to remain with the company.
Privately held companies are more common than publicly traded companies because most companies are small businesses that operate as sole proprietorships or LLCs.
But it's not just small companies - some household names are privately owned businesses, such as:
The largest privately held company in the US is an agribusiness called Cargill, with an annual revenue of $165B. Other giants include:
Big corporations remain private for various reasons - some owners may like autonomy and control. For example, Kohler is a family-owned business that's remained private. Its previous owner, Herbert Kohler Jr., was a revolutionary who liked to experiment, which is perfect when you're a privately held company that doesn't need permission from public stakeholders.
Koch Industries chose to stay private so "employees can remain firmly focused on long-term success, which is created by efficiently delivering real, long-term value to customers." The company also reinvests up to 90% of its earnings back into Koch companies.