Public Companies – Everything you must know
In this article, we will discuss the basic framework of public companies, including detailed characteristics and requirements.
You might have heard the term “public company” often in regard to the stock market. Public companies are listed on stock exchanges, and their shares are traded publicly. But, did you know that they are more than just the stock trading that you see in the news? Public companies are legal entities that must operate by a set of rules and regulations. They must also be managed responsibly that aligns the interests of their shareholders and those of all other stakeholders, including employees, government agencies, customers, vendors and the community. In this article, we will discuss the basic framework of public companies, including detailed characteristics and requirements.
Public companies and IPO
Before the late 1980s, there were very few companies in the market. Today’s high-tech world is characterized by a plethora of public companies that are constantly raising and diluting capital through IPOs. But, what is an IPO? Well, IPO or Initial Public Offering is the process of selling shares of a company to the public for the first time. In order to conduct an IPO, a company must meet certain requirements under the Securities and Exchange Act Commission (SEC). While public companies in this regard refer to companies wherein the public has access to their shares, or in other words, the company that is listed on stock exchanges.
What are public companies?
In brief, public companies are ventures in which the ownership is widely distributed to the public via stock exchanges. The Securities and Exchange Commission (SEC) of the US regulates public companies that trade their shares on the stock exchange. Regulated public companies, by law, must provide potential investors with a multitude of information including annual reports, financial data, etc.
As such, public companies are transparent, and their operations are subject to the scrutiny of the SEC. Therefore, public companies generally have a diversified number of shareholders due to the fact that the shares can be bought or sold by anyone through the stock exchange. So, what are the pros and cons of public companies?
Pros of public companies
Public companies, especially those that have a huge number of shareholders, tend to offer greater potential for long-term investor returns. However, from the perspective of a company, here are a few advantages of being a public company:
- Access to capital – Public companies have a wide pool of potential investors, which means they will have access to capital more easily. In fact, a huge amount of initial capital can be collected with the help of an IPO.
- Low risk – Funds can be raised without the costs of debt or constraints of private equity investors such as venture capitalists or angel investors. By raising funds through an IPO, several companies have been able to offset their low cash flows resulting in improved performance.
- Wider opportunities – Being a public company, the publicity and media coverage that they receive can help the company better promote itself, its products and services, and brand awareness. As a result, companies can potentially expand their customer base.
- Attract top talent – In addition to raising capital and expanding operations, public companies can potentially attract top talent in the form of highly skilled employees. After all, public companies typically offer higher salaries and better benefits.
Cons of public companies
Public companies are, however, not without their fair share of disadvantages. The following are some disadvantages of being a public company:
- High cost for IPO – The cost of an IPO is high, to begin with. Costs associated with the process include legal expenses, accounting fees, filing fees and other charges. Additionally, companies must pay for initial public offering registration and ongoing compliance costs such as SEC filings every year.
- Stringent financial reporting – The financial reporting of public companies is typically more complicated. This is because, unlike private companies, public companies are obliged to report their financial information in a standardized format. While they are subject to the SEC’s regulatory guidelines, public companies are required to report more data than private companies.
- Dilution of ownership – Public companies have a huge number of investors, which can lead to a dilution of ownership for existing shareholders. This dilution is due to the fact that for every additional share that is issued, existing shareholders are diluted by the number of new shares. Thus, the percentage of ownership for existing shareholders reduces.
- The lack of control over corporate direction – As public companies are publicly listed, the management must respond to the interests of all of its shareholders. Since the shareholders and the boards of directors are differently incentivized, it is difficult for management to maintain a strongly aligned interest between the two.
Main Difference between Public Companies vs. Private Companies
Now that you are familiar with the basic framework of public companies, let’s discuss some of the main aspects that make public companies distinct from private companies. You already know that public companies are publicly listed, whereas private companies are not. However, here are a few more differences between public companies and private companies:
- The shares of public companies can be bought, sold and traded on stock exchanges, which means it has greater liquidity in the markets. In contrast, private companies restrict access to their shares, which limits the liquidity of these shares. Hence, public companies have greater liquidity than private companies.
- Public companies are owned by a large number of shareholders. In fact, public companies are owned by the general public and not just a select group of investors. On the other hand, private companies are owned exclusively by a limited number of shareholders or investors,
- Public companies are regulated by the SEC, which is a government agency that oversees the operations of listed companies. In comparison, private companies are subject to fewer and less stringent regulations. Therefore, private companies tend to have fewer restrictions and are not subject to the same level of scrutiny as public companies.
Example – To better understand the difference between public and private companies, let’s take a look at an example. Twitter, a social networking and micro-blogging website that was founded in 2006 and went public in November 2013. As you might know, recently, Twitter was acquired by Elon Musk on October 27, 2022, for $44 billion. Now, Elon Musk is planning to delist Twitter from the New York Stock Exchange and make Twitter a private company. Musk will soon reverse the IPO of Twitter and convert it into a private company. But, why would Musk want to convert Twitter into a private company?
Well, with no SEC regulation, better ownership rules, fewer reporting requirements, and less scrutiny, he might be able to achieve more of his business goals for Twitter. Additionally, private companies have greater flexibility and control over the direction of the company’s operations. As a result, it is likely that Elon Musk will be able to achieve a lot more in terms of value creation with Twitter as a private company, compared to when it was a public company.
Characteristics of public companies
Well, after all that we’ve discussed so far, you might be wondering what the characteristics of public companies are. Below mentioned are some of the main characteristics of public companies:
- Board of directors – This is an elected body of the owners of a company. The board of directors has different roles which include setting strategy, approving the annual budget, appointing project teams and monitoring the performance of the management team. Many public companies have boards that are composed of independent directors and thus, they are generally elected by the shareholders.
- Stockholder ownership – In publicly traded companies, the shares are owned by a large number of shareholders. Since these shareholders are spread all over the world, they have a wider geographical diversity than privately held companies. As a matter of fact, the shares of public companies are priced on the basis of the market, while a 409A valuation is used to determine the price of shares in privately held companies.
- Corporate leadership – In a public company, the CEO is responsible for running the company. Even though the board of directors are present, the CEO and his team have significant decision-making authority regarding corporate operations and their performance evaluation. It is therefore important for the CEO to deliver excellent results and act in accordance with the best interests of shareholders.
- Public financial information – Corporate information, namely financial statements of the company, is made public by the SEC. The Securities Exchange Act of 193 mandates that all public companies must disclose their financial information. Public companies are obliged to report, disclose, and publicly discuss their financial information. Thus, the SEC is a primary regulator of public companies and it regulates the market activities of all publicly traded companies.
Transparency and Continuing Disclosures of Public Companies
From the initial registration of a publicly traded company until the dissolution of such a company, the SEC requires public companies to make a number of disclosures. The transparency and continuing disclosures are as follows:
- Annual Reports on Form 10-K – The SEC requires public companies to prepare and submit an audited annual financial report on Form 10-K. The financial report must be prepared in accordance with Generally Accepted Accounting Principles (GAAP). It is basically a comprehensive review of the company’s financial performance during the preceding fiscal year.
- Quarterly Reports on Form 10-Q – As the name suggests, the quarterly reports on Form 10-Q are submitted by publicly traded companies every three months. The SEC requires public companies to disclose their financial and other performance results, including unaudited financial statements, along with the management’s discussion and analysis, in a quarterly report.
- Current Reports on Form 8-K – These reports are required by publicly traded companies to disclose material events that occur after the close of regular trading. The reports are made available for the public and investors to get a better idea of the company’s important developments. It includes major events such as a change in the corporate structure, bankruptcy proceedings, or the acquisition of the company.
- Proxy Statements – One of the most important rights of shareholders is the right to vote. They can vote to choose the board of directors, accept or reject proposed mergers and acquisitions, and other important issues. As such, proxy statements are issued by publicly traded companies and allow the shareholders to vote. It is basically a formal notice of the shareholders’ meeting, which is distributed to all shareholders.
- Additional Disclosures – Since public companies are subject to regulations by SEC and federal securities laws, they must disclose additional information about their business. Some of the additional disclosures include events such as tender offers, mergers, stock splits, dividend payments, and acquisitions.
Requirements for public companies
You might wonder what if the company goes bankrupt, How to deal with the SEC in this case? What is the exact procedure? Well, before we get into the details of this matter, it is important to know what bankruptcy is? Bankruptcy is a legal proceeding that is initiated by a company due to financial difficulties and debts. If a company is unable to pay its obligations, it can file for bankruptcy and dissolve its existing business. The following are the main legal requirements that must be filed with SEC before a public company files for bankruptcy:
- 8-K Reporting Obligations – A public company must file an 8-K report with the SEC when it files for bankruptcy. Within four days after the petition for relief is filed, the 8-K report must be filed. The report must contain information about the company and its request for bankruptcy, along with financial statements.
- Requirements for Stock Exchange Listing – If a public company is listed on a stock exchange, its corporate charter must be terminated by the exchange upon filing for bankruptcy. NYSE and Nasdaq require that a company must announce its intention to file for bankruptcy, and thus it is at the discretion of whether the company will be delisted or not.
- Ongoing Exchange Act Reporting Obligations – The requirement for ongoing exchange reporting is set by the SEC. The company must include Form 10-K, the quarterly reports in Form 10-Q and current reports on Form 8-K. These forms must be filed after the bankruptcy petition is filed.
- Stockholder Action – Stockholders have the right to be notified of the bankruptcy filing and they can take action to protect their interests during and after a bankruptcy case. For example, compensation and management information must be made available to shareholders in order to allow them to make the appropriate decisions.
- Termination of Exchange Act Reporting Obligations – A public company must terminate its reporting obligations if the bankruptcy proceedings are completed. This can be done in three simple steps including delisting from the exchange, deregistering under Section 12(b) and Section 12(g) under the Exchange Act and suspending the obligations under Section 15(d).
- Confirmation of Plan of Reorganization and Section 363 Sales – When a public company files for bankruptcy, it is important to know about the reorganization plan. A mandatory Form 8-K filing is brought about by an order approving a plan of reorganization. Additionally, an exhibit containing the reorganization plan needs to be filed. Lastly, a Section 363 asset sale by an issuer must be submitted in Form 8-K.
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