What Kind of Financial Statements Do Private Companies Have to File?
Private companies don’t sell stock to the general public, so they don’t have to report their finances to the government (except for filing their tax returns, of course) or answer to the public. No matter how big or small these companies are, they can operate behind closed doors.
A private company gives owners the freedom to make choices for the firm without having to worry about outside investors’ opinions. Of course, to maintain that freedom, the company must be able to raise the funds necessary for the business to grow.
Private companies maintain absolute control over business operations. With absolute control, owners don’t have to worry about what the public thinks of its operations, nor do they have to worry about the quarterly race to meet the numbers to satisfy Wall Street’s profit watch. The company’s owners are the only ones who worry about profit levels and whether the company is meeting its goals. Further advantages include
Confidentiality: Private companies can keep their records under wraps, unlike public companies, which must file quarterly financial statements with the Securities and Exchange Commission (SEC) and various state agencies. Competitors can take advantage of the information that public companies disclose, whereas private companies can leave their competitors guessing and even hide a short-term problem.
Owners of private companies also like the secrecy they can keep about their personal net worth. Although public companies must disclose the number of shares their officers, directors, and major shareholders hold, private companies have no obligation to release these ownership details.
Flexibility: In private companies, family members can easily decide how much to pay one another, whether to allow private loans to one another, and whether to award lucrative fringe benefits or other financial incentives, all without having to worry about shareholder scrutiny. Public companies must answer to their shareholders for any bonuses or other incentives they give to top executives.
Greater financial freedom: Private companies can carefully select how to raise money for the business and with whom to make financial arrangements. After public companies offer their stock in the public markets, they have no control over who buys their shares and becomes a future owner.
If a private company receives funding from experienced investors, it doesn’t face the same scrutiny that a public company does. Publicly disclosed financial statements are required only when stock is sold to the general public.
The biggest disadvantage a private company faces is its limited ability to raise large sums of cash. Because a private company doesn’t sell stock to the general public, it spends a lot more time finding investors or creditors who are willing to risk their funds. Many investors don’t want to invest in a company that’s controlled by a small group of people and that lacks the oversight of public scrutiny.
If a private company needs cash, it must perform one or more of the following tasks:
Arrange for a loan with a financial institution
Sell additional shares of stock to existing owners
Ask for help from an angel, a private investor willing to help a small business get started with some upfront cash
Get funds from a venture capitalist, someone who invests in start-up businesses, providing the necessary cash in exchange for some portion of ownership
These options for raising money may present a problem for a private company because
A company’s borrowing capability is limited and based on how much capital the owners have invested in the company. A financial institution requires that a certain portion of the capital needed to operate the business — sometimes as much as 50 percent — come from the owners.
Persuading outside investors to put up a significant amount of cash if the owners want to maintain control of the business is no easy feat. Often major outside investors seek a greater role in company operations by acquiring a significant share of the ownership.
When private-company owners seek outside investors, they must ensure that the potential investors have the same vision and goals for the business that they do.
Another major disadvantage that a private company faces is that the owners’ net worth is likely tied almost completely to the value of the company. If a business fails, the owners may lose everything. If owners take their company public, however, they can sell some of their stock and diversify their portfolios, thereby reducing their portfolios’ risk.
Reporting requirements for a private company vary based on its agreements with stakeholders. Outside investors in a private company usually establish reporting requirements as part of the agreement to invest funds in the business. A private company circulates its reports among its closed group of stakeholders and doesn’t have to share them with the public.
A private company must file financial reports with the SEC when it has more than 500 common shareholders and $10 million in assets, as set by the Securities and Exchange Act of 1934. Congress passed this act so that private companies that reach the size of public companies and acquire a certain mass of outside ownership have the same reporting obligations as public companies.
When a private company’s stock ownership and assets exceed the limits set by the Securities and Exchange Act of 1934, the company must file a Form 10, which includes a description of the business and its officers, similar to an initial public offering. After the company files Form 10, the SEC requires it to file quarterly and annual reports.
In some cases, private companies buy back stock from their current shareholders to keep the number of individuals who own stock under the 500 limit. But generally, when a company deals with the financial expenses of publicly reporting its earnings and can no longer keep its veil of secrecy, the pressure builds to go public and gain greater access to the funds needed to grow even larger.