Michael Zagari

Investing in Public & Private Companies

Since Elon Musk announced his plans to buy Twitter and return the company to a private ownership structure, it seems many are now wondering about what could come next from such a tactical move.

Although public markets are cost effective means to raise capital for companies and provide liquidity for investors, the decision-making process under a public structure is much more democratic.

That might come across as a positive for investors, however in the case of Twitter, it seems years of mismanagement by the company’s executives and board of directors might have been a major contributor in holding back Twitter’s true growth potential.

Could returning back to a private ownership model be the answer for many publicly traded companies including Twitter?

Could this latest move ignite a trend in hostile takeovers by other billionaires with similar means?

The Private Market

You might not know this but there are actually many more privately held companies than public companies in existence. 

While extremely large businesses tend to become publicly traded at some point, there are many well-known private companies operating today that we may think, are publicly traded. Take for example brand names such as Ikea, Fidelity Investments and Lego.

Before we get into these details, let’s first discuss the differences between a public and private company.

A private company is typically owned by the company’s founders, management, or a group of private investors. Less owners of the business, means more control which means faster adoption of ideas.

However, shares of a private company are less liquid and are more difficult to trade or convert to cash. It’s also more difficult to value a private company compared to those of public companies.

There are four main types of private companies:

  • Sole proprietorship
  • General partnership
  • Limited partnership
  • Corporation

The Public Markets

A public company is a company that has sold all or a portion of itself to the public via an initial public offering. With a public company, access to capital is typically more cost effective and easier to access however by having millions of shareholders from all over the world, there are trades offs to consider.

For example, certain investors may simply trade the stock for short term profit generation and might not be aligned with the long-term future of the company.

Other shareholders may simply buy and hold for many years while forming an attachment to the company. Similar to being part of a community or cause.

From a disclosure perspective, one of the biggest differences between the two types of ownership model is how they deal with public disclosure and transparency.

In the case of publicly traded companies that trade on a public stock exchange, take for example in the United States, quarterly earnings reports are required to be filed with the Securities and Exchange Commission.

Financial information of the public companies are made available to the public and can be found on the company’s investors relations website.

Unlike public companies, private companies have a choice in how they prepare their financial statements. While public companies must use International Financial Reporting Standards (IFRS), private companies can choose between IFRS or the Accounting Standards for Private Enterprises (ASPE).

Risks & Rewards

So why would investors consider investing in a less transparency ownership model and what are the risks involved?

Owning shares in a private company poses many risks.  While all investments are risky, owning shares in a private business entails some unique risks. Here are just few to consider:

We already touched upon this point, but one main reason is lack of liquidity. When you own shares of a private company there are no markets or exchanges to convert your investment back to cash.

Typically, investors need to wait for a liquidity event where the company is either bought out or the company decides the timing to go public is ideal. There are many other reason liquidity events that could take place however these 2 examples are the most popular.

Another consideration is the challenge of valuation since information about the company is less readily available.

With private companies, proper governance may also be a challenge since many private businesses lack the corporate governance structures that are in place in public companies.

And finally, personal liability. This is where owners of private companies typically need to pledge personal assets as collateral to get financing from banks. In the case of limited partnerships, investors can only lose what they invest – nothing more.

We now know some of the risks of privately held companies so let’s discuss several notable benefits.

First, flexible decision-making. Private companies do not have to answer to a board of directors or groups of shareholders. This feature provides company executives the ability to make key decisions on their own and with far less friction.

Simplicity and taxes. With private companies, they are not legally obligated to prepare and disseminate financial information the way that public companies are. Private companies also have simpler tax structures.

And finally, consistency of vision.

Public companies must adjust course depending on the will of their shareholders. Private companies can stay true to the founder’s vision without interference from a variety of different channels including activist type investors.

Remember, Bill Ackman, the activist investor with Pershing Square Capital Management, who attempted to take down Herbalife?

From his perspective and research, he believed Herbalife was a pyramid scheme that preyed on low-income people and minority groups. It has been reported that his company invested over $1 billion dollars betting against Herbalife although, Bill Ackman’s accusations were never proven.

That battle lasted over 5 years by the way.

On a final note, it is worth pointing out that many world class money managers, hedge funds, pension plans and endowment funds all including private equity investing into their personalized investment strategies.

Have a great weekend!

Talk soon,

Michael Zagari, FCSI, CIM, CIWM

Investment Advisor with Mandeville Private Client Inc.

Financial Security Advisor with Zagari + Simpson

Disclaimer: Nothing on the website shall be construed as an offer to buy or a solicitation of an offer to buy any services or products. Commissions, trailing commissions, management fees and expenses may be associated with investments. Products are not guaranteed, their values change frequently and past performance may not be repeated. Mandeville Private Client Inc. is a member of the Investment Industry Regulatory Organization of Canada and a member of the Canadian Investor Protection Fund.

This publication contains the opinion of the writer. The information contained herein was obtained from sources believed to be reliable, but no representation or warranty, express or implied, is made by the writer, Mandeville or any other person as to its accuracy, completeness or correctness. This publication is not an offer to sell or a solicitation of an offer to buy any securities. The information in this publication is intended for informational purposes only and is not intended to constitute investment, financial, legal, tax or accounting advice.

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