Public Companies

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Last Updated:September 20, 2023

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What Is a Public Company?

A public company is a business owned by shareholders in public markets. They are responsible for properly following special regulations to inform investors and the general public.

Public companies are responsible for vast growth in the American economy and countries' economies globally. They comprise the vast majority of many mutual and index funds purchased by the general public.

Owning public company shares gives you a partial claim of their total assets. This is known as equity.

Shares may be purchased on stock exchanges such as the NYSE or NASDAQ but can also be purchased in the OTC (Over-The-Counter) markets.

The Securities and Exchange Commission considers public companies to possess one of two traits. These are:

The company trades on public markets and/or;
The Company discloses certain business and financial information regularly to the public

The SEC officially defines a public company as a business with public reporting obligations. Public reporting obligations require disclosure by the company of financial data and analysis of potential opportunities, weaknesses, and threats.

Companies must follow these requirements if they participate in certain business activities. These are:

Issuing stock or bond securities in an initial public offering (IPO)
Their investor base reaches a size (defined by the SEC as 500+ accredited investors or 2000+ shareholders)
Voluntarily register with the SEC

Key Takeaways

A public company is a corporation whose shares and debt securities are traded publicly on a stock exchange.
Public companies allow the public to easily access investment exposure to various sectors while also protecting them from inaccurate information or deceit through regulation by the SEC.
Companies become publicly traded through the issuance of debt or stock to the public, known as an IPO.
Public companies may go private through a take-private transaction facilitated by a private equity firm, known as a leveraged buyout (LBO).

Advantages of Public Companies

Public companies enjoy many privileges not available to private corporations.

The advantages are:

1. Access to Capital

Public companies have much more access to retail and institutional investor capital, thus allowing for larger offerings and owners to liquidate equity for use elsewhere. This is due to the vast accessibility of stock exchanges compared to private offerings.

Many private companies in the growing phase issue private placements and work up to a public offering only when it is necessary to obtain the capital needed to continue expanding the business.

An example of this is Airbnb (NASDAQ: ABNB), which recently began trading publicly in 2020. The company completed several private placements valued at several billion from 2015 to 2020 before completing an IPO at a $3.5 billion valuation.

Although going public has vast benefits for corporations, it is worth noting that the process has vast amounts of legal, accounting, and regulatory fees that can eat away at potential profits. The underwriting fees of large investment banks can range from 4-7% of net IPO proceeds.

The top underwriting firms that include full-service investment banking services are:

2. Public Perception

Becoming a public company puts an increased reliance on corporate governance to please shareholders and maintain a solid company reputation to serve the interests of employees, management, and board members.

Although being a public company often requires more work on behalf of management, it can also lead to better brand recognition and customer/investor loyalty; otherwise, it is not often formed as a private company.

Corporate governance allows public companies to:

Build and maintain trust with local communities, investors, and legal officials
Create a clear long-term picture of the company for shareholders
Facilitate investor confidence and a consistently rising share price
Set the groundwork for long-term success

Having shares listed on a public exchange allows a business to achieve a much higher market cap, as shares traded on exchanges have much higher volume and liquidity compared to private placements.

Note

Public investment comes with many benefits, but failure to satisfy investors through corporate governance can cause shareholders to be at odds with company leadership, creating an undesirable brand image that could lead to a decline in the company’s share price.

A low share price can cause a drop in investor confidence and impede a company’s ability to raise capital and further grow its operations. Even worse, enough of a decline in the share price can make a company vulnerable to hostile takeovers from outside sources.

Listening to shareholders and ensuring expectations are met is just as important as maintaining the goals of upper management.

Disadvantages of Public Companies

Although public corporations open up a lot of doors for a growing company, other corporate actions may require more effort and time dedicated to the public.

The disadvantages include:

1. Public Regulation

Companies registered with the SEC must file an initial registration statement and continue to file important disclosures thereafter. These include:

Annual Reports on Form 10-K
Quarterly Reports on Form 10-Q
Current Reports on Form 8-K
Proxy Statements
Additional Disclosures

While dedicating resources to necessary filings can be a disadvantage for corporations, requiring the disclosure of important company information to investors allows the public to be aware of all available information before investing.

2. Reduced Operational Efficiency

While increasing the number of shareholders has many benefits for public companies, it also affects the decisions a company may or may not be able to make. When a company becomes public, a Board of Directors is formed to serve the desires of investors.

When a public company wants to change a corporation's structure or engage in mergers and acquisitions (M&A) activities, the corporation must obtain approval from shareholders to proceed.

Many changes that would otherwise be approved instantly as a private company may take months of going through the voting process or may even be rejected by shareholders entirely. Companies must ensure corporate decisions benefit ownership and shareholders equally.

Note

More advanced information on the structure of M&A activities can be found in the Wall Street Oasis M&A Modelling Course.

3. Wall Street Expectations

Another negative of becoming a public company is the time and cost associated with meeting analyst expectations, specifically in quarterly earnings forecasting and year-over-year growth.

Meeting these numbers can be a very time-consuming expenditure for public companies. It can cause a lot of a firm’s operational expenses to be dedicated toward financial engineering, lowering funds available for capital expenditures and research and development.

Public companies must manage earnings expectations, corporate governance, and growth prospects to ensure all crowds are pleased. Wall Street’s expectations are noteworthy for businesses to consider in budgeting processes and the long-term trajectory of the corporation.

How Companies Become Public

Companies mainly go public through an IPO. The necessity of an IPO for a company often depends on how much money is needed to continue to grow operations.

No concrete number exists for every business, but many larger companies seek to have $100-250 million in annual revenue before going public. If you can raise the necessary capital from private placements, it may not be worth the fees to do an IPO at present.

The process of becoming a publicly traded company follows three key steps:

1. Due Diligence

The first step of the IPO process is to hire an investment bank to conduct due diligence on the overall company. The due diligence process relies on various aspects to determine the current value, projected value, risks, and potential strengths and weaknesses.

2. Legal Disclosures

Every public company must register with the SEC.

Before fully registering, companies often issue a preliminary prospectus, otherwise known as a “red herring.” This allows investors to learn about the company and understand the growth expectations for the company held by executive leadership.

After the waiting period is over, the final prospectus is filed officially with the SEC.

SEC Staff reviews this document to ensure the information is legitimate and includes the number of shares that will be sold. It helps prospective investors make a more informed decision.

3. Approval and Agreement

Once the SEC makes the documents effective, the underwriter (investment bank) and the issuing company agree to an offer price.

This price can greatly vary based on the type of company and general investor sentiment, although they tend to be underpriced to ensure that every share is sold to the public.

Investment banks can sell the shares on a firm or best efforts agreement during the process. If the bank is underwriting on a firm agreement, it must retain any unsold shares after the IPO. The unsold shares are returned to the issuer on a best efforts agreement.

Public Company Regulations

To bring a company to the public markets, businesses must follow certain securities laws set in place by the government to protect investors and avoid catastrophic events.

Economic collapses typically precede the enforcement of new regulations. Failures typically occur before rules are created, and legal action typically lags behind failures in the financial markets.

The most notable laws pertaining to public companies are:

Securities Act of 1933
Securities Exchange Act of 1934
Sarbanes-Oxley Act of 2002

The Securities Act of 1933 is responsible for rules governing how securities are displayed to the general public. The law established the registration process for public companies, requiring the disclosure of financial information, management, and the company’s business model.

The Securities Exchange Act of 1934 governs the disclosure of information for public companies listed on stock exchanges. Companies with over $10 million in assets must issue quarterly and annual reports to investors.

Companies are also required to file 8-K reports to announce significant events relevant to shareholders or for major changes inside the company.

The Sarbanes-Oxley Act was formed in response to the Enron Scandal of 2001 and created reforms to hold corporations responsible for fraud and increase the validity of company disclosures and accounting activities.

The act also created the Public Company Accounting Oversight Board (PCAOB) to ensure investor safety and prevent misinformation. All accounting firms are required to register, and those that do will be monitored for compliance with these regulations.

Note

Private companies are not beholden to the same reporting requirements. Founders and management own them, or private investors may own them. Investment in private companies is often restricted to accredited investors or qualified institutional buyers (QIB).

How Do Companies Go Private?

Public companies may take steps to change the structure of the business through M&A deals facilitated by private equity firms. A “take-private” transaction involves a public company being purchased by an acquirer at a premium to the current stock price (usually 20 - 40%).

Going private is often a long-term process considered for a substantial amount of time through relationships built between private equity firms and executives. The premium gained through such a transaction can benefit CEOs and managers with large equity positions.

Due to most retail and institutional holders of companies being short-term oriented, shareholders typically vote in favor of take-private transactions. Taking a company private is typically a low-risk way to secure returns that benefit shareholders and insiders.

A company can do this through a leveraged buyout (LBO) transaction. LBOs allow a firm to take out a large amount of debt with collateral backed by the acquired company's assets and acquire a private equity firm.

An LBO is typically done with companies with stable cash flows and a bright outlook, allowing the company to repay its debts over a specified time. When entering an LBO transaction, the company needs to ensure several factors before proceeding:

Are cash flows sufficient to meet interest payments over the time of the loan?
Are growth projections realistic to ensure company obligations will be met?
Has the acquirer been vetted to ensure executives can retain control over operations?

If these factors are not considered before proceeding with an LBO transaction, taking on such high amounts of debt can be a death sentence for the acquired company.

In 2005, Toys “R” Us was involved in a $6.6 billion leveraged buyout that left the company with more than $5 billion in debt to pay off over time. Due to stagnating growth and the rise of e-commerce, more than 97% of retained earnings had to be put toward interest payments.

The company could not innovate and remodel existing stores and ultimately filed for bankruptcy in 2017. It serves as a reminder of the potentially harsh consequences of entering a take-private deal without necessary due diligence.