Companies may choose to raise equity capital publicly or through private placements. Companies in different financial and business situations and of different sizes must balance between the cost and benefit of using public placement vs. private placement in financial equity. While it may be easier and cheaper to raise capital through public offerings, being a public company may have certain negative effects. For some companies, private placements of equity may be a more viable choice, but can be positive at the same time.
Costs
The costs of using public vs. private placement may include both issuing costs and financing costs. Public offerings involve substantial issuing costs such as those used to pay for underwriters and in dealing with regulatory requirements. On the other hand, private placements require only direct negotiations between companies and their targeted investors, incurring much lower issuing costs. However, private equity shares are often sold at a deeper discount, a higher financing cost to issuing companies, compared with public stocks, given the difference in the availability of potential capital in the public market vs. the private market.
Size
Large and more established companies often find it easier to raise capital through public offerings, partly because of the companies and their management's credibility with public investors. Public investors tend to be skeptical with their investments as a result of the perceived information asymmetry between corporate managers and themselves. Therefore, small and less-known companies may have a harder time to convey investment ideas in the public market. More sophisticated private investors can better understand the potential investment opportunities presented by smaller companies that often have higher debt and are more cash-constrained while still in their developing phases.
Flexibility
In general, public offerings and being public provide companies more financial flexibility than private placements and remaining private. Compared with the availability of all possible public investors, sources of private capital can be restricted and difficult to obtain, thus reducing the flexibility in arriving at more preferable financing terms. In public offerings, such flexibility is often visible as underwriters may price offered shares upward or downward depending on public demand. Private placements may also limit future financing choices. Ownership concentration resulting from having only a small number of private investors may force companies to seek equity replacement if some investors decide to exit. Publicly traded shares present no direct challenge to company financing.
Effects
Public vs. private placements have different effects on companies, in operations and financially. As a publicly traded company, management faces various regulatory compliance issues such as filing periodic financial reports with appropriate government agencies. Public companies must also undertake enormous efforts in dealing with investor relations like holding annual shareholder meetings and reporting earnings every quarter. Financially, new issues of public shares can negatively affect the price of existing shares as companies would like to sell new shares at a higher price only if management believes that their shares are currently overvalued. On the other hand, private equity issues often are perceived as a positive signal when private investors believe that the companies have growth potential, but are likely undervalued by the public market.
Tags: public offerings, issuing costs, private investors, private placements, public market, being public