One of the most common ways for a business to raise money is to offer equity, or shares in the ownership of its company in exchange for funds. The equity issued to shareholders represents the amount of money that they would receive if the assets were liquidated, after debt was paid. Investors buy these shares because they anticipate a return on their investment when the value of the company—and the value of their shares—rises. 

When companies are startups or in the early phases of development, the equity they offer is private since shares aren’t traded on a public exchange. Thus the term “private equity.” By comparison, public equity is the exchange of shares for ownership of companies whose stocks are traded on public exchanges.

What is private equity? 

Private equity is the equity held by investors and funds in private companies that is not traded on a public exchange. Shareholders may be investors who furnish startup capital, employees that receive shares as part of their compensation packages, or institutional investors who invest individually (or in groups as firms) or operate as venture capital companies.

A private equity (PE) firm is an investment management company that offers capital through its limited partners to private companies, and may invest in a company by using strategies such as venture capital, growth capital, or leveraged buyout. A PE firm might also buy a public company and take it private or buy an established private company and ready it for an initial public offering, or IPO. In any case, the goal among private equity investors is to grow the company and take a profit when they exit the investment. The way private equity works:

• A private company seeks investors to raise capital or reorganize, or a private equity firm finds a company to invest in or buy through its research on target companies.
• The fund’s investors either invest in or buy the company. If the company is publicly traded, they take it private. 
• The PE firm uses its management expertise to overhaul the company’s organization and invests capital to help it grow. During that holding period, the firm’s general partners manage the investment and collect management fees.
• The firm exits the investment by taking the company public via an IPO or selling the company and distributing the profits to shareholders.

Private equity is not available to just any investor. Those who want to invest in unregistered securities (equity in privately-held companies) must be accredited, meaning they must meet annual income and net worth requirements, and are generally experienced investors.

What is public equity?

Public equity is when investors own shares in public companies, which are traded on a financial exchange. They offer equity, or an ownership interest, in these public companies. A company’s common stock, or shares or stock, is the ownership interest in the company divided into equal shares. The way public equity works:

• Shares are listed on a financial exchange, where anyone can buy them. 
• A public company’s stocks are liquid, in that shareholders can sell them whenever they want or need to. 
• Employees of public companies may also be offered equity as part of their compensation package. Typically, there is a “vesting period,” or a set period an employee must stay with the company to take full ownership of their shares.

What are the main differences between public and private equity?

Aside from the marketplace in which they’re exchanged, there are several key differences between public and private equity.

Privacy

Private companies typically do not disclose financial information, including information about stocks, to the public. Public companies, on the other hand, are obligated to release their financial information to the public based on the public reporting requirements of the Securities and Exchange Commission (SEC).

Since the information about public companies is so visible, stocks that are traded publicly can be influenced by public sentiment. For example, a weak earnings report from a company can cause investors to sell en masse, driving the price down. That price fall may then present a buying opportunity for investors who anticipate better news in the future.

Companies that are public are also easy for prospective investors to research.

Regulations

Private companies do not have to face the same level of regulatory rigor, and therefore, can keep their information largely private. They are not regulated by a government agency that requires them to report. Rather, private equity is governed by the company itself and by its private stakeholders.

One condition of listing on a financial exchange is that a public company is regulated by the SEC. The agency’s reporting requirements include filing annual, quarterly, and periodic reports with the SEC, and reporting to shareholders.

Who can invest

Shares of private companies are held by employees, startup investors, institutional investors, accredited individual investors, or private equity firms. If private shareholders intend to buy, sell, or trade their shares, they can trade among themselves. After coming to an internal agreement, private investors can also offer shares directly to accredited individuals.

By contrast, anyone can buy or sell shares of a public company listed on an exchange—regardless of income or net worth.

Liquidity and risk

Investors in private companies are obligated to hold on to their investment until they can exit via a leveraged buyout, a company sale, or an IPO. When such exit opportunities arise, private equity returns can be high. But holding periods for private equity can range from three to seven years or more, so investors need to prepare for cash to be tied up until their exit. The perception of risk in private equity is, for this reason, typically higher. 

Investors in public companies, by contrast, can sell their stake at any time, because the public stocks are liquid. This means that public equity offerings can also be more volatile, since the market reflects the sentiment of the public. Investors in the public realm may be influenced by world news, government policy changes, earnings reports, and inflation, among other things. More buyers lead to an uptick in prices, and sell-offs lead to drops in prices. Still, because of the liquidity, investors may feel there is reduced risk, since they can exit by selling off shares if they get nervous or if they have made money and want to take their profit and go.

The bottom line

There are key differences between private and public equity, including who may invest, how and where the equity is exchanged, and how investors gain profits. Either route, prospective investors typically weigh the risks and potential rewards of investing, understanding that the availability of information, level of regulation, and reporting requirements are different.

Public equity is accessible to all investors via a financial exchange, and investors may take out their profits at any time by simply selling their shares. Meanwhile, private equity is typically the domain of high-net-worth individuals and institutional investors, who pool their money to buy entire companies—waiting until the group exits the investment via an IPO or company sale to take and distribute profits to investors.