raising capital private vs. public

Raising Capital: Public vs. Private Markets

raising capital private vs. public

Raising capital in the public and private markets is a complicated and expensive process and there are pros and cons to both. It is expensive to raise capital in the public markets due to regulatory and compliance costs. Oftentimes it is difficult to raise capital in the private markets because of a lack of transparency, a limited investor base, risk, and regulatory oversight.

The Process of Going Public

In order to raise funds on a publicly traded exchange, a company will often hire an investment bank to help construct an investment package, strategize on an initial public offering (IPO) price, find buyers, and go on a roadshow to pitch prospective investors. This is an expensive process. The expertise needed in the build up to become a public company necessitates the need for experienced professionals in accounting, legal, finance, and operations. The company will have to develop a compelling story around its future and current financials, the strategy to capture market share, and its ability to comply with the regulatory environment and market competition. As the company strategizes around an IPO, it must first draft a prospectus and registration statements which the SEC will review. The SEC will comment on all aspects of the documents including items pertaining to legal, business, accounting, and financial reporting. These items must be addressed and approved before the company can go on a roadshow and pitch the opportunity to investors.

Investors will have transparent access to information about the company, including annual and quarterly financials, and will be provided updates on material events within the organization. All of this reporting and auditing can be costly and burdensome, but usually worth the cost to reap the benefits of being publicly traded. The initial capital injection of an IPO can provide a company with a clear path to expansion and profitability. Barriers to raising additional capital after going public are significantly lower because a company can issue more outstanding shares and take both institutional and retail investor capital, enhancing the firms’ total liquidity profile.

However, there are tradeoffs to being public. These include a certain lack of operational flexibility. For example, executive business decisions that have a material effect on the business have to be reported and will have a reaction from shareholders. With many shareholders come many opinions and opposing ideas about the business. Public companies have to fend with activist investors, and potential hostile takeovers. Any mistakes or misrepresentations of the business, while detrimental to private companies, can spell the end of a publicly traded company.


Raising Capital in the Private Markets

Raising funds in the private markets is generally a more restricted process. Many of the same processes occur when raising private capital. The private firm will also have to develop a compelling story around the business, furnishing potential investors with marketing materials, financials, and a professionally prepared business plan or Private Placement Memorandum (PPM). By complying with SEC registration exemptions, issuers may raise capital from the private placement of securities by only accepting investments from accredited investors. This is much more restrictive then the public markets in which firms can sell to the general public. As such, the investor pool for private capital raises is restricted.

Private companies have only a few select options in raising capital. The firm can hire an investment bank or placement agent whose goal is to market the opportunity and acquire qualified investors. Another source of capital is provided by private equity firms, whose main goal is to invest in promising private companies with the goal to realize gains in an exit opportunity. Many startups rely on venture funding to fuel growth and propel business to the next level. In exchange for an equity position, venture firms provide guidance and capital to the startup with the goal of capitalizing on that equity in a future IPO or M&A event.

To be sure, there are significant costs in raising capital in either the private or public markets. Private market dynamics are changing with recent regulatory changes implemented by The JOBS Act. With the lifting of the ban on general solicitation and less restrictive registration requirements, private firms can advertise their offerings to a bigger market of potential investors. Market dynamics will shift, enhancing transparency and the availability of information in the private markets. In some respects, the private markets and public markets will converge to resemble each other more closely as the pricing and valuation of private firms begin to take on greater efficiencies.


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