Out of 18 million businesses in the United States, fewer than 4,000 are publicly listed on a stock exchange. Private companies remain the default model of conducting business, so what are they and how do they differ from public companies?
What Is a Private Company?
The term “private company” refers to a corporation whose stock is not publicly traded on an exchange. Individuals or groups may own private companies.
Private Company Examples
Many popular and well-known companies are private companies. These include service companies such as Deloitte and PriceWaterhouseCoopers, chemical companies such as Cargill (the largest private company), and even supermarket chains like Publix.
Private Company vs. Public Company: Which Is Better?
Neither is better nor worse. Companies may choose to become public companies later if they need additional capital. If a private company wishes to sell shares of stock to raise funds, this begins the process of becoming a public company. The process is called an initial public offering or IPO.
An IPO is an expensive and time-consuming process, and often the last resort after private companies exhaust other potential funding sources such as loans, angel investors, and venture capitalists. Once companies complete their IPO and register with the SEC, their stock trades on a public exchange. They are then called a public company or publicly-traded company instead of a private company.
Types of Private Companies
When a person starts a company, he or she must choose from one of the following five legal business structures.
A sole proprietorship
A limited liability corporation (LLC)
Each business structure offers different protection of an owner’s assets (as well as various tax ramifications).
Sole proprietorships are the most common type of business structure. A sole proprietor is the only owner of the business and pays taxes on business income. This owner is also personally liable for the debts of their company.
A business partnership is an agreement between two individuals who share ownership and responsibility for the business. Partnerships have two owners. Each owner passes the partnership income through to their tax returns, paying taxes on the business’ profits. Partners are legally responsible for the business’ debts and any issues arising from their business activities.
A limited liability corporation (LLC) combines elements of a sole proprietorship/partnership and the legal benefits of corporations, all without the encumbrance of some of the filing requirements of an S or C corporation. Like a corporation, owners are not usually held personally responsible for the LLC's debts or legal judgments if the LLC is sued, though in certain situations a court can hold the owner personally liable. This is referred to as 'piercing the corporate veil' and is more common with smaller LLCs where the owners business and personal assets and interests are intertwined. An LLC is a “pass-through entity” like a sole proprietorship, with all profits and losses from the business passing directly to the owner’s personal income tax return.
Corporations: S Corporations and C Corporations
S and C corporations may be private or public companies. All start as private companies and may choose to transition to a public company through the IPO process.
Both S and C corporations issue stock, vote on officers and directors, hold annual shareholder meetings, and conduct business as a separate legal entity from their owners. Contracts and legal proceedings are in the name of the corporation, not the name of the owner.
C corporations are the default when filing incorporation papers (unless the business completes IRS Form 2553 to elect to become an S corporation).
S corporations and C corporations differ in two areas: ownership and taxation. S corporations are limited to 100 owners (shareholders) and may not be owned by non-resident aliens. An S corporation reports its income to the IRS on Form 1120-S, but the shareholders report profits or losses on their personal income taxes.
C corporations have no limitations on the number or nationalities of owners. They must pay taxes on their corporate income and file separate tax documents annually with the IRS. The owners must also pay taxes on the income received from the company. In effect, this taxes the C corporation income twice: once as a company, the second time through the owner’s income.
Advantages and Disadvantages of Private Companies
One of the biggest advantages of private companies is that they don’t have to disclose their revenues and profits to the general public. This ensures that information is kept secret from everyone, including their competitors. In addition, private companies are not subject to the pressure from investors associated with meeting quarterly earnings expectations, which can sometimes conflict with decisions to reinvest back into the business. This is in contrast to public companies which face these pressures and requirements.
Corporate officers do not have to disclose their salaries or benefits to the public. They do not answer to external shareholders either. Shareholders of private companies are usually owners, officers, and directors. Because they don’t answer to external shareholders, there is more freedom to experiment, explore, and take risks than in a publicly-traded company.
Disadvantages of Private Companies
Private companies are limited in the shares of stock they can issue (and the stock is also illiquid). Borrowing or debt are the only methods of raising additional capital. It may be difficult to attract top talent without the added incentive of stock options available at public companies.
Learn More About Public and Private Companies
For more information about the types of business structures in America, see:
Personalized Financial Plans for an Uncertain Market
In today’s uncertain market, investors are looking for answers to help them grow and protect their savings. So we partnered with Vanguard Advisers -- one of the most trusted names in finance -- to offer you a financial plan built to withstand a variety of market and economic conditions. A Vanguard advisor will craft your customized plan and then manage your savings, giving you more confidence to help you meet your goals. Click here to get started.