Private Companies

- Private Firm → private non quoted on official markets: unrestricted right to issue equity and debt.

- Public Firm → quoted on official market, with unrestricted right to issue equity and debt on listed
mrkt.

Private firms constitute the majority of companies around the world, but we got fewer data for them.

Private Firms’ Financing

Generally, Private firms have fewer choices for raising equity (no IPOs, SEOs, preferred, warrants):

- Owners’ equity → earnings retention as a source of financing.

- External equity → Venture Capitals’ and Private Equities’ financing.

On the other hand Public firms issue stock with IPOs, SEOs, warranties, preferred stocks…

In terms of Debt the situation is the same, as Private firms don’t issue bonds and don’t have a rating:

- Banks Debt → as private firms don’t have a rating, specialized actors like banks have to issue debt.

- Trade Credit → represented by account payables given by firms in a business relationship with us.

On the other hand Public firms are usually rated, accessing the large bond market and bank debt too.

Capital Structure

The capital structure for private firms is mainly determined by 2 effects:

- Sensitivity effect, consequences arising from the higher costs of accessing external
capital markets (debt & equity) for private firms, due to more passive financial policies.
For these reason private firms will tend to go less on the market looking for financing opportunities,
hence, the leverage ratio is gonna be more dependent on operating performance.

- Level Effect, consequences arising from the private firms’ higher k e vs k d relatively to public firms,
due to the lack of info on private (equity more sensible to asymmetry), and ownership concentrated
(duluting families firm control). For that reason private firms are more likely to choose debt versus
equity financing. On the other hand, public firms, will prefer issueing more equity than debt.

This means that we’ll observe higher D/E for private firms than for public firms.
Going Public and Leverage

- Public firms tend to issue much more equity and debt side for the cited effects

- The activity for Private firms is much more oriented to debt rather than equity.

Therefore the leverage ratio of private companies is higher than the one of public ones.

- After going Public, private firms increase their equity issuance, as predicted theoretically.
As a consequeence their leverage decreases over time (dilute ownership + transparency).

- After going Private, public firms decrease their equity issuance by a great percentage.
As a consequeence their leverage increases over time (concentrate ownership + opacity)

Leverage Determinants

- Profitability (ROA) → negative relation Lev-ROA. For pecking order, larger for private (retained earns).

- Tangibility → positive relationship between Lev-Tangibility. No big difference for private and public.

- Size →positive relationship between Lev-Size.No big difference between private and public companies.

- Growth →negative relationship Lev-Growth for public companies, being finance through equity.
But positive coefficient for private ones, as growth opportunities tend being financed with debt.

- Growth →

- Profitability and Cash → positive relation for present profitability, negative for past profitability:
private firms had troubles accessing external finance, profitable private firms will need to keep
a larger amount of cash in house to finance investment projects (smaller coefficient for public firms).

- CAPEX and Cash → negative relation for present profitability, positive for past profitability:
To the extent that private firms have troubles accessing external finance, an increase in
profitability does not immediately translate in an increase in investment. Actually, it first
leads to a decline in CAPEX and only after one year CAPEX increases. This evidence is consistent
with the notion that private firms need to build up cash reserves before making investments.

An increase in profitability for public firms translate almost immediately in an increase in CAPEX.
This is consistent with the idea that public firms are not as financially constrained as private firms.
An incresase in profits can be seen by outside investors as good news about the firm, making them
willing to offer finance almost immediately (positive-positive)