Public Equity Vs. Private Equity: Key Differences Every Entrepreneur & Investor Should Know

Public equity vs. private equity–what’s the difference? That question may not particularly concern an early-stage startup owner. Your focus is likely on private equity sources for your fledgling company. However, it is crucial to understand how investors view these investment channels.

You should take the time to explore their viewpoints on earning returns, protecting their investment, and gaining decision-making rights. These insights will help you craft compelling pitch decks that resonate with investor requirements. That’s how you can raise your chances of attracting capital.

While the company is still in the early-stage growth phases, you’ll approach private equity firms for funding. Public equity comes into play when the company goes to IPO and becomes publicly-traded. Here’s a quick overview of how public equity vs. private equity works.

For starters, understand that “equity” refers to the stock or shares a company issues to investors. It provides these shares as an ownership stake in lieu of the capital investors give the company. This capital investment is subject to specific terms and conditions.

You’ll draw up the legal agreement with the guidance of an expert fundraising consultant. This term sheet will include clauses that describe the returns investors expect and the company’s obligations toward them.

Public Equity vs. Private Equity – Some Basic Factors

Public equity and private equity have their upsides and downsides for company owners and investors. Regardless of their size and growth stage, companies show equity in their balance sheets in the shareholders’ equity section.

This equity is the key metric that demonstrates the company’s net worth, which you’ll calculate by deducting liabilities from assets. Companies offer equity to investors to attract capital, structuring the cap table in different ways.

Each share category assigns different returns, voting rights, and exit channels. For instance, if the company issues preferred shares, investors get preferential treatment during dividend distributions. If the company goes bankrupt, they get back their capital on priority with the accumulated interest.

If it enters into an M&A transaction, investors owning preferred shares will have first claim on the company’s assets. Investors purchasing this asset class can expect higher returns, more dividends, and assurance that their investment is secure.

Common stock, on the other hand, is structured differently and a company lists both common and preferred stock in its balance sheet. As a rule, the latter option offers more liquidity.

Understanding Private Equity

When you first set up the company, you will create it as a private entity. At this time, you’ll reach out to private sources of capital, depending on the company’s growth stage. For instance, at the pre-seed and seed stage, you may start by bootstrapping, personal loans, and friends and family loans.

You’ll also reach out to angel investors or participate in programs like incubators and accelerators. These investors offer assistance not just in terms of capital, but also technical and industry-specific expertise and networking opportunities.

You’ll also get help with creating the minimum viable product or MVP. As the company grows, you’ll approach private equity (PE) firms with substantial capital to invest in promising startups. These firms have private investors participating and pooling capital as limited partners.

The PE firms typically maintain their holdings for 3 to 6 years, within which they hope to earn rich returns. Depending on individual PE firms, they may also remain invested for up to 10 years. Their objective is to ensure that the startup’s growth accelerates exponentially with ready capital infusions.

Comparing public equity vs. private equity, none of these benefits apply to public equity. The company’s stock is traded in a stock exchange, and any individual or institution can purchase shares.

Here’s some added information you’ll find helpful:

• Private equity firms have accredited investors as members. These members must qualify with minimum net worth requirements and typically commit to contributing a fixed capital amount to the firm.
• Members may include venture capitalists, angels, family offices, high-net-worth individuals, and endowments. Pension funds, banks, and insurance companies may also invest in PE firms.
• Private equity investors earn returns by way of dividend distributions, and these earnings continue throughout the investment’s lifetime. In this way, the investment is geared more toward earnings than stock accumulation.
• When sourcing private equity, you’ll draw up a private placement memorandum (PPM) with the help of your expert fundraising consultant. This document is much like the prospectus for public equity and outlines the terms of the funding deal. For instance, the equity structure, distributions, and other terms and conditions.
• Since private equity is typically geared toward nascent companies, it is not subject to extensive regulatory guidelines and restrictions. However, this factor raises the risk factors for investors, which is why PE firms prefer to work with accredited investors.
• Most private equity investors prefer to delegate the company’s management to the founders. They may also give them complete autonomy in managing the equity and making distributions. However, some firms may prefer to purchase a controlling stake in your startup as a portfolio company.
• An expert fundraising consultant can help you get the capital you need. However, founders may also work with investment banks who help structure the value of private shares or paid-in capital.
• It is not unusual for companies to enter long-term partnerships with private equity providers. You could consider soliciting their support when you’re ready to raise further funding rounds. As long as the company is stable, shows growth potential, and delivers returns on schedule, you’ll count on PE support.

Why Private Equity

Private equity is suitable for small and mid-sized companies not traded in public markets. These startups demonstrate viability and profit-generating capabilities thanks to certain markers. For instance, a unique product with the potential to disrupt the industry or a strong customer base.

All these startups need is a significant capital injection to propel them into the accelerated growth stage. They also benefit from in-house management assistance and expertise to help them achieve their next milestones.

Approaching private equity firms can give you access to this assistance. You can also benefit from the option of partnering with other startups within your vertical by entering into horizontal mergers. PE firms facilitate these partnerships by offering roll-ups or add-ons.

Their ultimate goal is to stabilize and grow your company to the point where they can exit their investment. This exit can happen as a strategic sale to another PE firm or taking the company to IPO.

Thus, private equity has effectively become an economic engine that drives the small and mid-sized startup ecosystem. Their support opens up opportunities for mergers and acquisitions and the option to penetrate markets in unexplored geographical locations.

Keep in mind that storytelling is everything in fundraising. In this regard, for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.

Remember to unlock the pitch deck template that founders worldwide are using to raise millions below.

Understanding Public Equity

You’re ready to go public once your company achieves accelerated growth and demonstrates the necessary markers. For instance:

• You have a large addressable market and robust metrics from the last six quarters.
• Your company has excellent financial projections and is ready to test public markets with an IPO.
• Its financial reporting is consistent and audit-ready and you’re ready for a significant capital investment.
• When the company reaches its unicorn status with a billion-dollar valuation.
• Interestingly, experts suggest that a company is ready for an IPO when it is not reliant on public capital. It has alternative sources of capital lined up even if the IPO is unsuccessful.

Most entrepreneurs consider an initial public offering when the company. To make that happen, you’ll approach an investment bank to act as an underwriter and prepare the listing.

As mentioned in the foregoing sections, investment bankers assist with raising private and public equity. They’ll help advertise the IPO and are typically the lead entities managing the pricing and cap structure.

You can entrust them with documenting, filing, and issuing stock to investors on the public stock exchange. The underwriting entity receives compensation for their time and effort. This consideration can be in the form of a predetermined percentage of the total funds you raise with the IPO.

In addition, investment banks earn a commission for selling shares to investors. This commission is calculated as a percentage of the total value of shares purchased. But the payment depends on the banker fulfilling certain conditions and requirements.

It is crucial to understand that public equity is subject to certain regulations. These rules include the Securities Exchange Act of 1934, and the Investment Company Act of 1940.

Here’s some added information you’ll find helpful:

• Public equity investments carry a lower risk as compared to private equity. Although public equity relies on the vagaries of the stock exchange, a well-diversified portfolio of companies can lower the risk.
• Accredited investors invest capital in both–private equity and public equity. In the case of private equity, they entrust the task of screening companies for viability to the General Partner. However, when investing in public equity, they carefully study monthly or quarterly industry reports from credible sources before making investment decisions.
• Public equity does offer the opportunity to earn dividends and distributions. But most investors earn returns by purchasing and selling stocks or growing their stake. Like, for instance, when the company splits its shares.
• Public equity is not restricted to accredited investors with substantial capital and net personal worth. Anyone, including small individual investors and larger mutual funds, can invest in public equity by opening a brokerage account. Investing through mutual funds and exchange-traded funds (ETFs) is also an option.
• Comparing public equity vs. private equity–understand that private equity investors expect to lock in their holdings for at least 10 years. However, public equity is more liquid. Investors can purchase and sell shares within a short time. Intra-day trading is also an option.
• Investors in public equity need not worry about a fee structure or the membership dues they must pay. Private equity firms carry membership fees calculated in percentages of the returns.

Regardless of your growth stage or the type of investors you’re approaching, you should know how to come up with an investor worthy business. Not sure how to do that? Check out this video I have created.

Transitioning from Private Equity to Public Equity and Vice Versa

When you’re ready to take your company to IPO, you’ll issue shares to the general public. Most small companies have private equity on their cap table. In that case, the existing shareholders convert their shares into public shares. The public trading price determines their value.

Private equity investors may be subject to lock-up periods depending on certain conditions. This condition prevents them from liquidating their shares right after the IPO.

Although private equity firms may invest in startups with an IPO exit plan, they may have to deal with dilution. Their ownership stake could get diluted when you issue new shares in the public market.

Yet another option you have is to acquire a publicly-traded company through a reverse merger. This strategy will allow you to bypass the complex procedures and costs associated with an IPO. You’ll purchase a shell company and quickly start trading shares on the stock exchange.

On the flip side, publicly-traded companies can become private again. When that happens, a private equity firm or a group of private equity firms purchase the stock. They may also use debt financing for the purchase.

As a result, the company’s stock is delisted from the stock exchange and it becomes private again. The general public can no longer purchase shares from the open market.

Public Equity vs. Private Equity – The Investor Perspective

Whether investors participate in public equity or private equity, they can make assured returns. Using the private equity firm channel allows them to be passive investors and trust general partners to make strategic investments.

This solution is beneficial for investors who lack the time, inclination, and expertise to screen viable startups. They are assured of returns since the PE firm invests in a basket of small companies with promising MVPs and growth potential. However, the fee structure can be a concern.

Investing in public equity by purchasing stock on the open market has advantages. Investors can pick the companies that demonstrate excellent reports. Or, they can invest in an index mutual fund or an ETF–which again gives them instant access to a portfolio of companies.

Ultimately, the key is diversification. Investors choose depending on the potential for returns and the risk factor. Other considerations are liquidity and the time frame for which they want to lock in their capital. Both options–private equity and public equity have their pros and cons.

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