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How Firms Issue Securities
Firms regularly need to raise new capital to help pay for their many investment projects. Broadly speaking, they can raise funds either by borrowing money or by selling shares in the firm. Investment bankers are generally hired to manage the sale of these securities in what is called a primary market for newly issued securities. Once these securities are issued, however, investors might well wish to trade them among themselves. For example, you may decide to raise cash by selling some of your shares in Apple to another investor. This transaction would have no impact on the total outstanding number of Apple shares. Trades in existing securities take place in the secondary market.
Shares of publicly listed firms trade continually on well-known markets such as the New York Stock Exchange or the NASDAQ Stock Market. There, any investor can choose to buy shares for his or her portfolio. These companies are also called publicly traded, publicly owned, or just public companies. Other firms, however, are private corporations, whose shares are held by small numbers of managers and investors. While ownership stakes in the firm are still determined in proportion to share ownership, those shares do not trade in public exchanges. While many private firms are relatively young companies that have not yet chosen to make their shares generally available to the public, others may be more established firms that are still largely owned by the company’s founders or families, and others may simply have decided that private organization is preferable.
Privately Held Firms
A privately held company is owned by a relatively small number of shareholders. Privately held firms have fewer obligations to release financial statements and other information to the public. This saves money and frees the firm from disclosing information that might be helpful to its competitors. Some firms also believe that eliminating requirements for quar- terly earnings announcements gives them more flexibility to pursue long-term goals free of shareholder pressure.
At the moment, however, privately held firms may have only up to 499 shareholders. This limits their ability to raise large amounts of capital from a wide base of investors. Thus, almost all of the largest companies in the U.S. are public corporations.
When private firms wish to raise funds, they sell shares directly to a small number of institutional or wealthy investors in a private placement. Rule 144A of the SEC allows them to make these placements without preparing the extensive and costly registration statements required of a public company. While this is attractive, shares in privately held firms do not trade in secondary markets such as a stock exchange, and this greatly reduces their liquidity and presumably reduces the prices that investors will pay for them. Liquidity has many specific meanings, but generally speaking, it refers to the ability to buy or sell an asset at a fair price on short notice. Investors demand price concessions to buy illiquid securities.