What it is:
A privately owned company is different from a publicly traded company in that its stock is not traded on public exchanges like the New York Stock Exchange, Nasdaq, American Stock Exchange, etc. Instead, shares of privately owned companies are offered, owned and traded privately among interested investors.
How it works (Example):
Privately owned firms are run the same way as publicly traded firms, except that ownership is limited to a relatively small number of investors. Some of the most famous companies in the world are privately owned, including Facebook, Ikea, Cargill, and Mars.
Though privately owned companies come in all sizes, a vast majority are small businesses. Investors in privately owned companies tend to be people closest to the founders: family, friends, colleagues, employees and angel investors.
If a small privately owned company needs to raise money to grow, the next round of financing often comes from venture capital (VC) firms who specialize in providing capital for high-risk, high-reward opportunities. Privately owned companies can also get financing from large institutional investors via a private placement.
If a privately owned company grows large enough, it may eventually decide to "go public," meaning it issues shares via an initial public offering (IPO). Shares are then traded on public stock exchanges. To learn more about the process of going public, click here to read about The Three Most Popular IPOs of 2010.
The reverse can happen in a process known as "going private." In that scenario, a large investor, usually a private equity (PE) firm, buys a large percentage of outstanding shares and then tells the Securities and Exchange Commission (SEC) that the shares will be delisted at some point in the future. To learn more, click here to read Flip Flops: Going from Public to Private.
Why it Matters:
Shareholders of privately owned companies are entitled to profits and dividends, just like the owners of publicly traded companies. But there are some major differences between being a shareholder in a privately owned company and being a shareholder in a publicly traded company.
First, shares of privately owned firms are often illiquid, meaning it may take a lot of effort to find buyers or sellers of a private company's stock. This becomes extremely important if an owner wants to exit and cash out his or her shares. Often times, figuring out the price of the shares becomes a one-on-one bargaining exercise with the person who wants to buy the stock.
For this reason, coming up with a correct valuation of a privately owned company is more challenging than for a public company. Because shares don't trade very often, it can be extremely difficult to determine how much a privately owned company is worth at any given point in time.
Finally, because its shares are not available to the public, a privately owned company does not need to file the same paperwork with the SEC as its publicly traded counterparts. This makes the financial position and operation of a privately owned company less transparent, with the trade-off being that the private company is not exposed to as much government or regulatory interference.
Certain companies stay private as a matter of choice. Private company's management enjoys greater leeway to make decisions without the public or regulators looking over their shoulders. However, this freedom also means that privately owned companies can be riskier than publicly traded companies because they're subject to less oversight.