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Published: January 21, 2020
Updated: April 26, 2023
The number of Canadian companies going public is declining while the number of private companies is increasing. One of the most recent deals was the privatization of WestJet, which Onex completed the acquisition of in December 2019. The privatization trend isn't just occurring in Canada, but it's also happening in the United States and around the world.
The advantages of being a private company are now better understood by most market participants. This narrative has become more mainstream over the years while the scrutiny and other issues that go along with being a public company have increased.
Here are some reasons for public companies to go private:
In the past, being a public company meant there were more ways for businesses to raise capital. Now, private markets are flush with cash. Institutional investors—such as investment banks, pension funds, sovereign wealth funds, private equity firms, hedge funds, insurance companies, and other institutional or private investors—are turning to private markets in order to beat the market. While public markets will still likely play a role for people that value liquidity, investors are looking to invest in or lend to both small and large companies.
Private equity funds also have a lot of so-called “dry powder”. Research firm Preqin estimated that these funds were sitting on US$1.5 trillion of money at the end of December 2019.
Being a public company can be difficult because there's a lot of focus on short-term results. Companies are in a constant battle as they try to meet or exceed analysts' expectations. Missing the street's expectations can lead to a big drop in a company's stock price.
On the other hand, private companies don't have to answer to analysts or activist or impatient shareholders, nor do they have to worry about meeting quarterly results expectations year-after-year. Instead, they can invest in growth or training, spend more on upgrading systems and technology, or other capital expenditures that will pay off in the long run. While a short-term focus is good for analysts or shareholders seeking to change their near-term view or trading position, it may not be good for a company's long-term goals and objectives.
Small-cap stocks have outperformed large-caps historically. But recently, investors have begun showing a preference towards large-caps. For instance, the S&P/TSX SmallCap Index was up 15.8% in 2019 while the S&P/TSX Composite Index rose 22.9%. The same is true in the U.S. The S&P SmallCap 600 rose 22.8% in the 2019 while the S&P 500 rose 31.5% in the same time period. Over the last five years, the S&P 500's annualized returns have outperformed the S&P SmallCap 600 by more than two percentage points annually.
Investors are also investing differently. Passive investing has grown because of the popularity of exchange-traded funds (ETFs). Retail investors can buy a low-cost ETF instead of buying a mutual fund that usually charges a high fee. According to the Canadian ETF Association, ETF assets have more than quadrupled over the last eight years. And the largest ETFs are heavily weighted towards large caps.
A deal involving a public company can take months to close. The company being acquired must send out proxy material to shareholders and hold a special meeting where they must approve the deal. In most cases, two-thirds of shareholders must vote in favour of the deal. A court must also give its stamp of approval. There can also be formal valuation and fairness opinion requirements that need to be fulfilled to protect minority shareholders. All these factors increase closing risk and transaction costs. The process is much faster in private markets because the management team, a small group of shareholders and the advisors of the company being acquired are often the only parties involved on the sell side of transaction.
Public companies have higher general and administrative (G&A) costs beyond the out of pocket costs, and management tends to spend significantly more time on compliance and reporting needs. This can often include compliance with ongoing regulatory, securities, and corporate governance rules. In particular, public companies have to pay for annual stock exchange listing fees, accounting, auditing, legal and internal controls activities, as well as printing and other costs related to filing periodic, quarterly, and annual reports—all mainly for compliance purposes.
There are also costs related to having investor relations personnel, a stock transfer agent, and an investment dealer. Being listed on more than one exchange can multiply these costs, making the administrative burden even larger. For example, companies with a $10 million to $200 million market capitalization, on average, can save between $1 million to $3 million annually when they go private, in addition to significant time savings and an increased focus on long-term value creation for the business.