What is a private company?
A private company, also referred to as a private limited company in some cases, is formed by a small group of shareholders who come together either for a social cause or to make a profit. The shares of a private company are not sold on a public stock exchange. Common types of private companies include sole proprietorships, partnerships, and limited liability companies.
How do private companies work?
Private companies operate with a focus on confidentiality and control. They do not have to disclose their financial performance to the public, which allows them to keep sensitive information private. Management decisions are typically made by a small group of shareholders or directors, providing agility and swift decision-making. Private companies often reinvest profits back into the business rather than distributing them to shareholders. They can raise capital through private investments, loans, or by issuing shares to a limited number of investors. Additionally, private companies have more control over their operations and strategic direction without the pressure of public market scrutiny.
Types of private company
Sole Proprietorship: A sole proprietorship is an unincorporated business where ownership lies with one individual. It is not a separate legal entity, so the owner is personally responsible for all the business's assets, liabilities, and financial obligations. While the owner has full control over the business decisions, they also bear all the risk. In India, the owner does not file corporate taxes but reports the business’s income and expenses on their personal income tax return.
Partnerships: A partnership involves two or more individuals who share ownership of the business. Like a sole proprietorship, partners in a partnership have unlimited liability, meaning they are personally responsible for the debts and obligations of the business.
Limited Liability Partnership (LLP): An LLP is a business structure where the owners share ownership and liability, but with limited personal liability. It combines the flexibility of a partnership with the benefits of limited liability. In India, an LLP protects its partners from personal responsibility for the company's debts, unlike in a partnership. The business is taxed separately, and income is passed through to the partners.
Private Limited Company: A private limited company is a popular business structure in India. It can have multiple owners, known as shareholders, who have limited liability. The company’s ownership is divided into shares, which are not freely transferable. It provides protection to owners from personal liability and allows the company to raise capital through private investment. The company pays taxes on its income, and the owners do not report business income on their personal tax returns.
Public Limited Companies: These companies can be similar to private limited companies in structure but are open to the public for buying shares. Unlike private limited companies, public companies are required to submit quarterly and annual financial reports. In India, public limited companies are also subject to more stringent regulations and disclosure norms, ensuring transparency to shareholders.
Why Do Private Companies Choose to Remain Private?
1. To avoid regulatory and government scrutiny
Public companies face a lot of attention from shareholders, regulators, and the government. They are required to share their financial information publicly by filing quarterly reports, annual reports, and other important updates with government bodies like the Securities and Exchange Commission in the US or similar authorities in other countries.
On the other hand, private companies have the freedom to keep their financial details and operations private, avoiding the strict regulations and government oversight that public companies must follow. Private companies are not legally required to make their financial statements public, although they still need to maintain proper accounting records and provide financial statements to their shareholders.
2. To keep ownership within the family
Some companies choose to remain private to keep ownership within the family. Many large companies in the US, for example, are family-owned and passed down through generations. Going public would mean answering to a large group of shareholders and possibly having to appoint board members who are not part of the founding family.
By staying private, the company has full control over who sits on the board of directors and is only accountable to a small group of shareholders or private investors. Private companies finance their own projects and acquisitions without selling large shares to the public through an Initial Public Offering (IPO).
Features of private company
- Limited liability: Shareholders' personal assets are protected from business debts.
- Restricted share transfer: Shares are not freely transferable, ensuring control remains within a select group.
- No public disclosure: Financial statements and operational details are not required to be published.
- Flexibility in management: Fewer regulatory requirements allow for more agile decision-making.
- Ownership concentration: Control is maintained by a small group of shareholders or investors.
Transitioning from a Private Company to a Public Company
Most public companies begin their journey as private entities, such as family-owned businesses, partnerships, or limited liability companies with a small group of shareholders and advisors. As the business grows, it often needs more money to fund its operations, expand, or acquire smaller companies. This funding typically goes beyond what the company can generate from its own revenue or its close circle of investors.
To meet these financial needs, many private companies decide to become public. This means the company will sell shares of itself to the public through a process known as an IPO. Going public gives the company access to a large pool of capital (money) from investors in the stock market, which can be used for growth and expansion.
Before the company can go public, it must choose an underwriter, usually an investment bank. The underwriter plays an important role in guiding the company through the IPO process. They act as an intermediary between the company and the public investors, making sure the company complies with all government regulations and carries out proper checks (due diligence) to ensure the process is transparent and legal.
Once the company goes public, its privately-held shares are converted into publicly traded shares. The value of these shares is now determined by the market, based on supply and demand. Shareholders who owned the company before it went public can decide whether to keep their shares or sell them to new investors. If they choose to sell, they may make a profit, as the public trading price of the shares could be higher than what they originally paid.
In summary, going public allows a company to raise substantial funds, but it also involves careful planning, regulatory requirements, and decisions about ownership. While it can be a great way to finance further growth, it also comes with new responsibilities, as the company is now answerable to a large number of public shareholders.
Formation process of private companies
- Name reservation: Choose and reserve a unique name for the company.
- Drafting MOA: Prepare the Memorandum of Association (MOA) outlining the company’s objectives and structure.
- Registration: File the necessary documents, including the MOA, with the relevant government authority.
- Obtaining PAN and TAN: Acquire a Permanent Account Number (PAN) and Tax Deduction and Collection Account Number (TAN) for tax purposes.
- Issuing shares: Allocate shares to the initial shareholders as per the company’s share structure.
Advantages and disadvantages of private company
Advantages:
- Limited liability: Shareholders’ liability is limited to their investment.
- Control: Owners retain control and decision-making power.
- Flexibility: Fewer regulatory requirements and more operational flexibility.
- Confidentiality: Financial and operational information remains private.
Disadvantages:
- Limited capital: Raising capital may be more challenging compared to public companies.
- Share liquidity: Shares are not easily transferable, which may affect liquidity.
- Growth constraints: Limited access to public markets can constrain growth opportunities.
- Management pressure: Increased pressure on a small group of investors or managers.
What is the average size of a private company?
The average size of a private company can vary widely depending on the industry and location. In India, private companies range from small startups with just a few employees to large firms with hundreds of employees. Typically, small to medium-sized private companies have fewer than 200 employees and generate moderate revenue compared to large public corporations. The size of a private company often reflects its growth stage, market focus, and operational scale.
Private vs. Public companies
The difference between a private and a public company is given in the table below:
| Aspect | Private Companies | Public Companies |
| Share Trading | Shares are not traded publicly. | Shares are traded on public stock exchanges. |
| Disclosure | Less financial disclosure required. | Must adhere to strict disclosure requirements. |
| Ownership | Limited to a small group of investors. | Ownership is distributed among public shareholders. |
| Regulation | Fewer regulatory requirements. | Subject to extensive regulatory oversight. |
| Capital Raising | More challenging, relies on private sources. | Easier through public markets. |
The main difference between a private and public company lies in the trading of shares and regulatory requirements. Private companies enjoy greater control and flexibility but face challenges in raising capital. Public companies benefit from wider access to capital but must comply with rigorous regulations. For businesses considering growth, Bajaj Finserv Business Loan can be a viable option to support expansion and operational needs.
