So what does the “Private” in Private Equity mean? In essence, it means that the companies that PE funds (buyout, venture capital and growth equity funds) invest in and/or acquire are privately-held companies. To understand this, first we'll explore what public companies are, and then we'll take a deeper dive into what private companies are, and we'll finish with a discussion of the types of companies that buyout funds acquire..
Generally speaking, a “public company” is a company that has its stock listed and traded on a public stock exchange, such as New York Stock Exchange or NASDAQ. These exchanges act as a middle-man, and very efficiently connect buyers and sellers of a stock. This is what is meant when it is said there is a “public market” for the stock. The generic term “stock market” includes all exchanges that trade stocks of public companies.
The primary way companies enable their stock to be traded on these exchanges is through the company’s “initial public offering” or “IPO” and subsequent “follow-on” offerings. I have discussed IPOs in many posts, but key posts are “IPO 101: An Overview of the Initial Public Offering Process” and “LP Corner: What LPs Need to Know About IPOs.” Once a company has its IPO, it must file periodic reports (such as quarterly and annual reports) with the US Securities and Exchange Commission (“SEC”), which are publicly available on the SEC’s website (https://www.sec.gov/edgar/searchedgar/companysearch.html).
For example, the stock of Apple, Inc., the maker of Mac computers, iPhones and iPads, is traded on NASDAQ under the ticker symbol AAPL. Apple’s stock price is available on any finance or stock broker website, and is constantly updated throughout normal trading hours (usually 9:30 am to 4:00 pm ET weekdays). This means that during trading hours you can place an order with a stock broker (or brokerage app) and buy Apple stock almost instantaneously. It also means that you can sell your Apple stock almost instantaneously.
How many public companies are there? According to the World Bank, there were 4,336 publicly-traded companies in the US at the end of 2017. This number has declined since 1996, when the number of publicly-traded companies in the US peaked at 8,090. The number of publicly-traded companies fell to 4,102 in 2012. The reasons for this decline are manifold, and beyond the scope of this blog post.
As a nuance, there’s also a type of company called a “public reporting company.” A public reporting company means a company that is required to file periodic reports with the SEC. Companies with stock traded on an exchange are public reporting companies, but other companies are required to file reports with the SEC. For example, privately-held companies that have bonds (high yield bonds) or debt that are publicly traded are required to file periodic reports with the SEC. Also, privately-held companies with over 2,000 stockholders and a minimum of $10 million in assets are also required to file periodic reports with the SEC. These types of privately-held companies that are required to file periodic reports with the SEC are not what are meant by “publicly-traded” companies.
Now that we know what a public company is and that there are roughly 4,300 publicly traded companies in the US, let’s turn to private companies.
A private company generally means a privately-held company. A privately held company is a company whose equity (stock) is owned by a limited number of people, and the stock is not traded on a public stock exchange such as the New York Stock Exchange or NASDAQ.
How many private companies are there? According to the US Census Bureau’s 2017 data (latest available data), there were 6.0 million companies in the US that had one or more employees. In addition to this number, the US Census Bureau reports that in 2017 there are 25.7 million companies that had no employees. Most of these companies are sole proprietorships (generally mom-and-pop shops, such as a corner market). That’s a lot of companies. But Private Equity isn’t generally interested in these very small companies.
What is the target universe of privately-held companies for PE funds? It’s hard to come up with a precise metric, but let’s assume that for buyout and growth equity funds, the universe would be companies with 20 or more employees. The Census Bureau data indicates that there were 5.3 million companies in the US with under 20 employees. This would put the target universe for buyout and growth PE firms at roughly 700,000 privately-held companies in the US. This means that the investment opportunity for PE funds dwarfs the investment opportunity for public market investors, in terms of number of companies. This is one reason why private equity is able to generate returns that exceed that of the public markets over time.
But what about venture capital? The same methodology doesn’t really work with venture capital, because venture capital may fund an idea that one or more people have, even before a company has been formed. In addition, venture capital also invests in companies as they grow from just an idea to having hundreds of employees. This means that the target universe of private companies for venture capital is much harder to identify, but it is also very large when compared to investment opportunities in public companies.
Types of Companies Acquired by Buyout Funds
Now that we've explored private companies and public companies, let's explore the types of companies do buyout funds acquire. Based upon the numbers of private vs public companies we've discussed above, it should be no surprise that the vast majority of buyout deals involve private companies. However, a buyout firm may also acquire a public company in what is known as a "take private" transaction, where the buyout firm makes a "tender offer" for the publicly-traded company's shares, and when it has acquired a sufficient stake in the company, the buyout firm will de-list the company from the stock exchange upon which its shares trade (take the company private). A third type of company that a buyout fund will acquire is a "spin-out" of a division, product line or technology from an existing public or private company.
The “private” in Private Equity refers to companies that (1) are typically owned by a limited number of people, (2) don’t have any stock traded on a public stock exchange, and (3) don’t file periodic reports with the SEC. In contrast, public companies (a) can be owned by thousands of people and investment funds, (2) have their stock traded on a public stock exchange, such as NYSE or NASDAQ, and (4) file periodic reports with the SEC.
There are only around 4,300 public companies in the US, compared to 6 million private companies that have at least one employee. Private Equity funds will generally target companies that have 20 or more employees, or roughly 700,000 companies, which means the target universe for private equity investors dwarfs the target universe for publicly-traded company investors.
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