- August 22, 2019
- Posted by: Ramkumar
- Category: Strategy
Private companies like to get acquired
In this blog, we shall discuss why private companies like to get acquired by Public companies or controlled by a Private Equity firm.
We shall also cover why Private companies face a higher cost of debt compared to Public companies and how Private companies can mitigate this issue.
Private companies like to get acquired due to high cost of debt
- Private companies face a higher cost of debt compared to a Public company.In the present market, Private companies face higher interest rate of ~1% more than Public companies when looking for debt financing.
- This is because Private companies do not face stringent rules on disclosures and transparency of information when compared to Public companies.Public companies need to be highly transparent and should adhere to the regulatory norms of financial disclosures and reporting.
- Public companies issue corporate bonds to raise capital from public.This option is not available with a Private company.
- Private company need to depend on their owners for funding and expanding.The probability for funding and additional capital decreases during the economic downturn and recession.
Access to Equity Markets
- Public companies have access to equity markets to raise additional capital.This option is not available with Private companies.
- Even during the recession, Public companies can issue more equity to raise the required capital.The investors would be interested to invest as they know they can sell their equity at any time due to higher liquidity of equity market.
- Private companies are not liquid and hence investors needs to spend marketing to sell their investments.This makes the private investments to be valued at discount.
How can Private companies grow in recession or economy downturn?
- For a private company especially those which are not big, cash is the lifeline for the organization.
- Hence in order to expand and grow or even sustain their operations, private companies require external funding. The founders with deep pockets can provide that funding when the economy is doing well.During the economy downturn or recession, founders will be reluctant to spend money.
- Private companies also have a higher default rate compared to Public companies.In addition to this, Private companies do not have high reporting standards and do not disclose all information.This increases the cost of capital for Private companies when looking for debt financing.
- Hence Private companies either approach Private Equity firms for funding or look at being acquired by Public companies. If the Private company feels that it can contribute higher synergies to a strategic acquirer, then it will approach a banker for exit options.
- A Private equity firm will not have same amount of interest and motivation in expanding its portfolio company. A Private equity firm will look to exit its portfolio company in 3-5 years.At the same time, PE firm rely only on few of its portfolio companies to be successful to generate a higher return on its investments.
- A Private company can also decide to go for an IPO but during the economic downturn or recession, the chance of having a successful IPO is minimal.
- In order to have a better chance to be acquired, Private companies need to improve their financial reporting, accounting standards and be able to disclose information transparently to its investors.
- Private equity firms like KKR which have high reputation and deep pockets would be interested to burn cash on their portfolio companies even during the recession if they are convinced of the company fundamentals and value proposition.
- Private companies face a higher cost of debt compared to public companies due to their lack of transparency in disclosing information and poor quality of reporting standards.
- Private companies do not have access to equity markets to raise additional capital.
- Private companies have a higher default rate compared to Public companies.Hence Banks treat them as risky loans and charge higher interest rates compared to a Public company.
- All these factors compel a private company to look for Strategic or Financial acquirers to access capital for future expansion.