Securities: Privately Held Firms

Privately Held Firms

Overview

A privately held company is owned by a relatively small number of shareholders. Privately held firms have fewer obligations to release financial statements and other information to the public. This saves money and frees the firm from disclosing information that might be helpful to its competitors. Some firms also believe that eliminating requirements for quarterly earnings announcements gives them more flexibility to pursue long-term goals free of shareholder pressure.

Shareholder Limitations

At the moment, privately held firms may have only up to 499 shareholders. This limits their ability to raise large amounts of capital from a wide base of investors. Thus, almost all of the largest companies in the U.S. are public corporations.

Fundraising and Securities Trading

When private firms wish to raise funds, they sell shares directly to a small number of institutional or wealthy investors in a private placement. Rule 144A of the SEC allows them to make these placements without preparing the extensive and costly registration statements required of a public company. While this is attractive, shares in privately held firms do not trade in secondary markets such as a stock exchange, and this greatly reduces their liquidity and presumably reduces the prices that investors will pay for them. Liquidity has many specific meanings, but generally speaking, it refers to the ability to buy or sell an asset at a fair price on short notice. Investors demand price concessions to buy illiquid securities.

Regulatory Considerations

As firms increasingly chafe against the informational requirements of going public, federal regulators have come under pressure to loosen the constraints entailed by private ownership, and they are currently reconsidering some of the restrictions on private companies. They may raise beyond 499 the number of shareholders that private firms can have before they are required to disclose financial information, and they may make it easier to publicize share offerings.

Trading in Private Corporations

Trading in private corporations has also evolved in recent years. To get around the 499-investor restriction, middlemen have formed partnerships to buy shares in private companies; the partnership counts as only one investor, even though many individuals may participate in it.

Computer Networks

Very recently, some firms have set up computer networks to enable holders of private-company stock to trade among themselves. However, unlike the public stock markets regulated by the SEC, these networks require little disclosure of financial information and provide correspondingly little oversight of the operations of the market. For example, in the run-up to its 2012 IPO, Facebook enjoyed huge valuations in these markets, but skeptics worried that investors in these markets could not obtain a clear view of the firm, the interest among other investors in the firm, or the process by which trades in the firm’s shares were executed.

This article takes inspiration from a lesson found in FIN 4504 at the University of Florida.