What is a Privately Held Company?
Privately held company refers to the separate legal entity which is registered with SEC having limited number of outstanding share capital and hence limited number of shareowners whereas the owner shall also be held by either non-governmental organizations or private individuals and these shares are not traded on stock exchanges for general public hence such companies are closely held companies.
Being a private company has its benefits as well as disadvantages.
- One of the most important benefits of being a privately held company is that it doesn’t need to adhere to any SOX or SEC regulation. Since preparing documents for SOXSOXThe Sarbanes-Oxley Act (Sox) of 2002 was enacted by the US Federal Law for increased corporate governance, strengthening the financial and capital markets at its core and boost the confidence of general users of financial reporting information and protect investors from scandals like that of Enron, WorldCom, and Tyco. and SEC Regulation is pretty expensive, being a privately held company helps the owners save a lot of money.
- One of the disadvantages of being a privately held company is that selling shares in the private market is pretty difficult. If you’re one of the owners of a privately held company and you want to sell off your shares in the private market; you need to wait months to sell-off. As the private shares are highly illiquid, it’s tougher to sell these shares.
However, being a private company does give its owners a lot of autonomy and freedom. Since adhering to regulations is an afterthought, they can always think about the long-term future of the company rather than worrying about the next quarter’s profit figure.
Types of Privately Held Companies
- Sole Proprietorship: The first type of private company is the sole proprietorship. A sole proprietorship company doesn’t have a separate entity. It’s the same as the entity of the person. As a result, the owner of the company gets unlimited freedom to make her own decisions. But at the same time, the risk is huge, and raising money becomes way too difficult.
- Partnership: Partnership is an extension of a sole In partnership companies, the only difference is the number of owners is more than one (or at least two). The owners have the same unlimited liabilityUnlimited LiabilityUnlimited liability refers to the legal commitment of business owners to be accountable for all business debts if the firm's assets cannot meet its debts or liabilities. In other words, the owners' liability to the business is unlimited. and at the same unlimited autonomy to make decisions.
- Limited Liabilities Companies (LLC): This is another type of privately held companies. LLCs have more than multiple owners and share the responsibilities. LLCs provide the benefits of both partnerships and corporations. Two of the most important advantages of LLC are first, it can have pass-through income taxation and second, it has limited liability without having to incorporate.
As you already know to own a privately held company has its advantages. Here are the topmost advantages that a privately held company has –
- Control & Autonomy: The first and the most significant aspect of owning a privately held company is having complete autonomy over operational decisions. Since you don’t need to worry about the regulations and what you need to adhere to, you can think long-term and concentrate on the things that would be good for the company in the future rather than worrying about the next year’s profits.
- Non-disclosure rights: Owning a privately held company has its benefits. One of the most crucial is your non-disclosure rights. As an owner of a privately held company, you don’t need to adhere to any SOX or SEC regulations (other than in few cases). As a result, first, you would be able to focus on better things and second, the company doesn’t need to incur a huge cost of preparing the documents for SEC Regulation.
- The structure of taxation: In privately held companies, the owners can decide how they would structure the company. They can structure the company as a limited liability company or any structure that best serves the interest of the company. As a result, they can escape from paying double taxes and pay the amount lowest taxes possible (as per the statute).
- Confidentiality can be maintained: The public companies can’t keep their secrets. They need to disclose everything to the public because they’re bound by the SEC Regulation. But privately held companies can keep their confidentiality and don’t need to disclose legal settlements, employee compensation, and other confidential information.
- Almost no issues regarding litigation: Public companies disclose all. As a result, they’re more vulnerable to lawsuits. On the other hand, privately-held companies don’t need to disclose their legal matters or any sensitive information; as a result, they can skip the issues regarding litigation by all means.
There are not many disadvantages to private companies. But it has a couple of demerits.
- Limited Capital: It’s not easy to source share capitalShare CapitalShare capital refers to the funds raised by an organization by issuing the company's initial public offerings, common shares or preference stocks to the public. It appears as the owner's or shareholders' equity on the corporate balance sheet's liability side. for a privately held company. If you’re a sole proprietorship company or a limited liability partnership company, your chances of sourcing capital are You can find out some private backers (if they’re interested) and then source capital via private placementsPrivate PlacementsPrivate placement of shares refers to the sale of shares of the company to the investors and institutions selected by the company, which generally includes banks, mutual fund companies, wealthy individual investors, insurance companies..
- Unlimited responsibility/liability: As you know there’s no separate entity for a sole proprietorship business and the sole proprietor. That’s why as a privately held business owner you have all the responsibility/liability for If there are any law-suit and the court’s verdict is against you; the court may take your personal assets beyond the assets of your business.
When does a Private Company need to Adhere to SOX/SEC Regulation?
We just mentioned that a privately held company doesn’t need to adhere to any SOX/SEC regulation. But that’s not always true.
In some cases, even a privately held company needs to adhere to a few regulations. When a privately held company does business with a public company, then the privately held company needs to adhere to SOX regulations. However, the regulations that a public company needs to adhere to is always much more than a private company. That’s why often, few private investors can delist a public company and turn it into a privately held company for more freedom, autonomy, and fewer regulatory barriers.
Why Private Companies Remain Private?
We can see giant companies like Dell and Mars remaining private. Why then remain private when they can easily become public and raising money becomes easier? It’s because to conduct an IPO, a corporation needs to invest huge money which a privately held company may not want to invest. At the same time, privately held companies can align its business objectives around its mission which is always an afterthought for a public company.
This has been a guide to Privately held companies. Here we discuss types of private companies, its advantages, and disadvantages & when they have to adhere to regulations. You may also have a look at the following articles to learn more about Corporate Finance –