There are two types of privately held companies: those that are in the early stages of funding (using venture capital or working on the second or third round of funding) and those that are past initial funding stages and still prefer to stay private. This can occur because of scale issues, the company’s profitability trajectory, or the fact that the owners don’t want to sell out just yet because there is still a lot of value in the company and the capital isn’t needed at this point.
Private ownership allows managers to make difficult choices away from the public limelight.
Often, private equity investors are able to take a company that is underperforming or perhaps lacks resources and help add value by augmenting management, right-sizing its cost base, identifying growth initiatives and/or pursuing add-on acquisitions. These longer-term decisions can made more efficiently when they aren’t subject to the scrutiny and immediate reaction of the public markets.
Let’s not forget another big reason that there are fewer publicly held companies than there were in years past: merger-and-acquisition (M&A) activity has skyrocketed. This is especially true for the banking sector, where it can be challenging to be a small-scale bank dealing with the additional costs brought about by the Dodd-Frank Act and other regulatory requirements. A larger company can gain efficiencies by acquiring a smaller company and leveraging across a wider cost base. M&A activity continues to be a popular strategy because it’s currently supported by cheap debt stemming from low interest rates. Under these circumstances, acquiring companies can pay a healthy multiple for their targets, and the acquisition will still be accretive to earnings.
When deciding whether to invest in public or private companies—or to have a mixture of both—investors must be mindful of their circumstances. Private equity investments have restrictions on when investors are able to withdraw their money, and this period of time typically lasts for a number of years. This allows private equity funds to make long-term decisions, but may pose challenges to investors who need immediate access to their money. On the other hand, publicly traded companies allow investors to add or subtract from their positions at will. With the advantage of liquidity, they can use periods of volatility to capitalize on market distortions.
Ultimately, both private and public equities are needed within a healthy market. They serve different purposes and different types of investment objectives. But our approach to identifying attractive opportunities stays the same regardless of whether the company is publicly or privately owned. We look at the quality of a company’s business model and whether or not it is using its balance sheet wisely. This emphasis on fundamentals continues to be our long-term focus.