Why do Companies Stay Private?

Courtyard of the Amsterdam Stock Exchange (Beurs van Hendrick de Keyser [nl]) by Emanuel de Witte, 1653.

Why do Companies Stay Private? 2021 was a huge year for Initial Public Offerings (IPOs), topping the record with 1033 new listings, with about 59% of them being Special Purpose Acquisition Companies (SPACs). However, about 80% of these IPOs lacked positive earnings and had yet to mature. IPOs are now 2 years older on average than in the 1980s because of a greater difficulty to reach scale and provide profit.

This creates an issue because valuing IPOs requires projection of future growth targets, which remain uncertain. Thus, companies are starting to stay private longer to focus on the growth of their business, instead of short term returns and investors that reap the benefits if the company decides to go public. 

Pros of Staying Private

While IPOs allow companies to gain access to an enormous amount of capital, they are risky and can devastate a company if unsuccessful. Private equity can reduce this risk while providing sufficient capital in the early stage ; in 2021 alone, PE invested more than $1 trillion into companies. This is the kind of risk that follows when the deal becomes overthrown or when the market overpriced or underpriced the IPO.

However, staying private can spur entrepreneurship by attracting investors ranging from VC to nontraditional investors, such as sovereign wealth funds. As a result, startups can reach higher valuations by having earlier access to funding. Staying private also allows shareholders to focus on growing the business instead of diverting attention to the stock’s performance, which could become a distraction for employees worrying about their finances.

Furthermore, going public subjects companies to SEC regulation and requires them to release financial reports, which may lead to shareholder scrutiny.  There are many companies taking advantage of the benefits of staying private, as there are 1,000 ‘Unicorns’ around the world. ‘Unicorns’ refer to private companies with valuations of over $1 billion, and currently most of them are related to tech. 

Cons of Staying Private

While private companies can reach extraordinarily high valuations, it is difficult to provide stock options for compensation, which hinders the attraction of top talent employees. Thus, employees may be incentivized to work for companies with solid growth outlooks such as Apple, Google, and Microsoft. 

Another issue resides in that private companies are unable to acquire other companies using public stock and thus must leverage debt or use cash to do so. Additionally, private investors may not be able to raise the required funding for a company. Or the company has difficulty finding investors willing to take the risk. Furthermore, private companies are illiquid. So investors may have a hard time finding a buyer for their stake in the company. However, investors acknowledge that there is high risk and high return in their investments. 

Why do Companies Stay Private?

Written by Martin Min & Edited by Lauren Kauppila, Philip Kim & Avhan Misra

Sources:

https://www.forbes.com/sites/forbesfinancecouncil/2020/02/26/why-more-businesses-are-choosing-to-stay-private/?sh=47195f3a6400

https://www.livewiremarkets.com/wires/staying-private-for-longer-the-benefits-of-early-stage-investing

https://www.wsj.com/articles/tech-startup-financing-hits-records-as-giant-funds-dwarf-venture-capitalists-11627822800