Level 1 CFA® Exam:
Private & Public Corporations

Last updated: December 09, 2022

Defining Private & Public Corporations for CFA Exam

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Let’s have a few definitions that you should know after this lesson:

  • Generally, a public company is a company whose shares are traded on a stock exchange. However, in some countries also companies with a large number of shareholders (e.g., more than 50) are treated like public companies, even if the company is not listed.
  • Private company is a company that is not public.
  • An initial public offering (IPO) is the first time when a company's shares are offered for sale to the public. We say that the company is going public.
  • An exchange listing is when a company's shares are listed on a stock exchange.
  • A share ownership transfer is when the ownership of a company's shares is transferred from one person or entity to another.
  • The secondary market is the market where the previously issued shares of a company are bought and sold.
  • The market capitalization of a company is the total value of all its outstanding shares.
  • The enterprise value of a company is the sum of its market capitalization and its debt less cash.
  • Share issuance is when a company issues new shares.
  • A private placement is when a private company sells its shares to a limited number of investors.
  • A private placement memorandum is a document that contains information about a private company's business, shares, and risks that is provided to potential investors.
  • Accredited investors are individuals who meet certain criteria set by the SEC (e.g., high income, working in the financial industry, etc.) and are allowed to invest in more risky assets on less regulated markets. For example, accredited investors are allowed to invest in shares of private companies.
  • A direct listing is when a company lists its shares on a stock exchange without going through an investment bank.
  • An acquisition is when one company buys another company.
  • A special purpose acquisition company (SPAC) is a company that is formed to buy another company.

CFA Exam: Differences Between Private & Public Corporations

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Exchange Listing & Share Ownership Transfer

One of the differences between a public company and a private company is that in the case of a public company it is easier to transfer ownership because shares can be easily bought or sold on the stock exchange. Investors can sell or buy shares by placing sell or buy orders on the stock exchange.

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Enterprise Value (EV)
Click to show formula

\(EV=MC+MD-C\)

  • \(EV\) - enterprise value
  • \(MC\) - market capitalization (market value of shares/equity)
  • \(MD\) - market value of debt
  • \(C\) - cash

Share Issuance, Registration & Disclosure Requirements

Usually, public companies can more easily raise funds than private companies. After a public company issues new shares, investors can trade them on the stock exchange.

To sell shares to the public, a company must first register with the SEC (or any other regulatory authority in its country).

In the case of public companies, we are dealing with more demanding regulatory and disclosure requirements. For example, a public company has to publish financial statements on a regular basis. This is usually not required from private companies.

To issue new shares to investors, private companies use private placement which is a proposal to buy shares of the company presented to a limited number of (usually accredited) investors. A private placement memorandum contains information about the private company's business, shares, and risks and is provided to potential investors.

The disclosure requirements for private companies are usually much less strict than for public companies.

CFA Exam: Leverage Buyout & Management Buyout

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Above, we discussed how a private company becomes a public company. However, sometimes the reverse process takes place.

This process takes the form of leveraged buyout (LBO) or management buyout (MBO).

Leveraged buyout is when investors not directly related to a public company buy all the shares of this public company and delist the shares from the stock exchange, which makes the company private.

Management buyout is when managers of a public company buy all the shares of this public company and delist the shares from the stock exchange, which makes the company private.

Generally, in both cases, the purchase of shares of the target public company is financed through bank loans or high-yield bonds. Sometimes, a financial institution (e.g., a bank) assumes a part of the risk in return for a share in profit (such instruments as bonds convertible to stocks or bonds with warranties are used). This kind of strategy is called mezzanine financing.

What is the purpose of leverage or management buyout?

When investors realize that a public company has potential but it’s not well managed or there are other obstacles against the company’s growth, they may decide to buy out the company shares, delist the company, improve it using debt financing, and then sell it to other investors or make it public once again.

Level 1 CFA Exam Takeaways: Private & Public Corporations

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  1. Generally, a public company is a company whose shares are traded on a stock exchange.
  2. Private company is a company that is not public.
  3. An initial public offering (IPO) is the first time when a company's shares are offered for sale to the public. We say that the company is going public.
  4. The secondary market is the market where the previously issued shares of a company are bought and sold.
  5. A private placement is when a private company sells its shares to a limited number of investors.
  6. Accredited investors are individuals who meet certain criteria set by the SEC (e.g., high income, working in the financial industry, etc.) and are allowed to invest in more risky assets on less regulated markets.
  7. A public company is easier to value than a private company because a public company has an observable stock price.
  8. In the case of a private company, it is a lot harder to transfer ownership because there is no easy way to sell/buy shares.
  9. A company may become public in 3 ways: (a) initial public offering (IPO), (b) direct listing, and (c) acquisition (including SPAC and reverse merger process).
  10. Leveraged buyout is when investors not directly related to a public company buy all the shares of this public company and delist the shares from the stock exchange, which makes the company private.
  11. Management buyout is when managers of a public company buy all the shares of this public company and delist the shares from the stock exchange, which makes the company private.
  12. The 4 main stages of the corporation lifecycle are: start-up, growth, maturity, and decline.