Public Equity vs. Private Equity
KEY POINTS
Public equities and private equities share many attributes, but may present very different risk profiles to your investment portfolio
You will need to consider many investment risks including liquidity, information, funding, concentration, and more
Public Equity
Public equities refer to shares that are traded on a public stock exchange (e.g., New York Stock Exchange , London Stock Exchange , Toronto Stock Exchange ). Typically, a private company becomes a public company by undergoing an initial public offering (“IPO”) whereby the company offers a portion of its shares for sale to the public.
Public shares are available to all investors whereas IPOs are typically only accessible by wealthy individuals and institutional investors.
Public companies occasionally decide to go private. Such may be done through a management buyout or acquisition by a private equity company and would result in the delisting of the company from the respective stock exchange(s).
Private Equity
Private equities are not traded on a public stock exchange and are typically held by a finite number of individuals or entities. Such ownership may be comprised of the founding shareholders, key employees, wealthy individuals, family offices, endowments, pension plans, venture capitalists, and private equity firms.
Private Equity Investment Options
Individual investors may find it difficult to invest directly in the private equity market due to the high minimum investment required for participation.
Indirect investment options exist including private equity funds and private equity exchange traded funds.
Another option is to invest in a special purpose acquisition company (“SPAC”). A SPAC is a publicly listed shell corporation. Its sole purpose is to purchase a private company. The private company would thus become public without going through the IPO process.
Attributes of Public and Private Equities
Each type of security has its own attributes and related risks. Individual investors may weigh some of the risks differently.
For example, one investor may accept the liquidity constraints associated with a private equity fund with a 7-year lock-up period whereas another investor may prefer public equities as they are unable to accommodate the private equity liquidity constraint.
We have highlighted the following key attributes investors should consider when making allocations to public and private companies. Many attributes are shared and the comments are general in nature.
Liquidity Risk
Public equities typically have low liquidity risk as they can be traded on an exchange and settled in 1-2 business days. However, periods of increased market volatility may increase liquidity risk. Thinly traded stocks may also exhibit higher liquidity risk than stocks with larger market capitalizations and higher average trading volumes.
A direct investment in private equities has a high degree of liquidity risk as it is not traded on a stock exchange and the transaction must be negotiated with a finite number of potential investors. An investment in a private equity fund will often have lock-up periods (noted above) covering several years.
Funding Risk
Some private equity investments (e.g., private equity funds) require the investor to commit to future funding requirements that may extend over several years. These commitments are contractually binding, and the amount and timing of the related capital calls are unpredictable.
There is always a risk that an investor will default on their funding obligations. Such default has a negative impact on the investor and the private equity fund.
Access to Capital
Public companies can raise capital through an additional share offering. The capital raised can be used for expansion plans, research and development, acquisitions, growth opportunities, and more.
Private companies can raise capital from various sources including wealthy individuals, family offices, endowments, pension plans, venture capitalists, and private equity firms. They can also raise capital by listing their shares on a public stock exchange via an IPO.
Strategic Partnerships
Private companies are subject to less regulatory and compliance requirements. This provides the ability to pursue strategic partnerships and alliances without making public disclosures and waiting for regulatory approval. This fosters greater collaboration and optimal utilization of shared resources.
Acquisition Currency
As noted above, a public company can issue shares on the open market to raise capital. Such newly raised capital can be utilized for acquisitions.
Alternatively, a public company can use their stock as currency for acquisitions. In this scenario, the company issues stock in exchange for equity ownership of the company being acquired.
Attract and Retain Employees
Public and private companies can both offer stock-based compensation to attract and retain employees. The resulting increase in the number of shares issued will have a dilutive effect on existing shareholders.
Such compensation may consist of stock options, employee stock ownership plans, warrants, and other stock-based compensation. Private company stock compensation is less liquid than that issued by a public company as the private stock can usually only be converted during a recapitalization, sale of the company, or initial public offering.
There is no definitive rule regarding whether stock-based compensation is more attractive to an employee when offered by a public or private company. Each opportunity will have its own risk/reward profile.
Concentration Risk
Private companies typically rely on a handful of individuals to develop and implement the company’s strategic vision. Any disruption to this group can have a noticeably adverse effect on the company. The company may obtain key person insurance on such individuals to offset the financial impact related to the loss of such an individual.
Visibility and Credibility
Public companies are regulated by financial regulatory bodies in one or more jurisdictions. Such requires adherence to strict rules regarding the type and timing of disseminating financial reporting to the public.
For example, an annual report will be required which will often include a letter from the CEO, letter from the directors, management discussion & analysis, audited financial statements, and commentary regarding the company’s strategic vision and related financial and non-financial initiatives.
Private companies are not required to make public financial disclosures like those noted above.
A public company’s visibility, transparency, and credibility provide it substantial advantages compared to private company’s when raising capital.
Information Risk
In theory, stock prices reflect all available information. However, the degree of available information can vary considerably between public and private companies.
Information risk generally increases as an investment becomes less widely held.
For example, your financial advisor should have access to a broad information spectrum for publicly listed companies. Whereas there may be limited information available pertaining to a prospective private equity investment.
Regulatory / Compliance Burden
Public companies face an increased burden related to regulatory and compliance requirements. Such require a costly human resources infrastructure and can impede a company’s ability to implement its strategic plan in an optimal manner.
Private companies experience less regulatory and compliance impediments. Such may facilitate greater flexibility and the ability to pivot with faster decision making. However, in some unfortunate circumstances, it may lead to an increase in unethical behavior.
Private companies also enjoy greater privacy. This allows them to refrain from providing sensitive information to competitors and risking their competitive advantage.
Performance Pressure
Public companies are accountable to a greater number of shareholders and are measured by their stock’s performance. The stock price can impact management retention, ability to attract new talent, ability to raise additional capital, and the ability to execute stock-based mergers and acquisitions.
Any mandate tied to a stock’s performance may lead to making decisions based on achieving short-term results while sacrificing better long-term options.
Private companies do not face the same dilemma. They may be better positioned to invest their resources in long-term endeavors such as research and development, strategic investments, branding initiatives, and more.
BOTTOM LINE
Public companies and private companies share many attributes; however, their differences are substantial. Investors should work with their financial advisors to determine if either or both may fit their risk profile while supporting their long-term and short-term financial goals.
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