Public Markets vs. Private Markets – What Are The Differences?
Public markets vs. private markets (public equity vs. private equity) is one of the most fundamental debates in the world of finance.
How companies can raise money
Companies have a variety of methods by which they can raise capital.
The two most common are debt and equity.
Debt can take the form of bonds, which are essentially IOUs that the company promises to repay with interest.
Equity is when the company sells ownership stakes in itself, typically in the form of common stock.
Debtholders have higher priority than equity holders as stakeholders in the company. If a company faces insolvency, stockholders commonly receive nothing.
As a result, stockholders demand higher compensation for this risk.
Private stockholders demand even more due to the illiquidity risk premium, given their stake is not liquid and therefore not easy to get out of.
Public equity vs. Private equity
There are two main types of markets: public and private.
Public markets are where most companies raise money by issuing stock.
The best-known public market is the stock exchange, where stocks are bought and sold by individual investors and institutional investors such as banks and hedge funds.
Other public markets include the bond market and the commodities market. Equity allocations dominate for many types of investors, including pension funds and individual traders and investors.
Private markets, on the other hand, are where companies go to raise money from a smaller group of investors, typically wealthy individuals and large institutions such as pensions, family offices, and sovereign wealth funds.
Investors in private markets are typically looking for a higher return than what they can get from public markets, as they are taking on more risk, primarily due to the lack of easy liquidity.
Private markets are illiquid, which means that investors may have difficulty selling their stake in a company.
The main types of private equity are venture capital and buyout.
Venture capital is when investors provide money to early-stage companies with high growth potential.
Buyout is when investors purchase a controlling stake in a company, typically one that is struggling (i.e., perhaps distressed) or inefficient, in order to turn it around.
What is the illiquidity risk premium?
Private markets are viewed as better than public markets in terms of return largely due to the illiquidity risk premium.
The illiquidity risk premium is the return that an investor requires for bearing the risk of investing in an asset that cannot be easily sold or exchanged for cash.
This type of risk is typically associated with private company stocks, which can only be traded through private hands.
Public markets
The public markets are liquid, meaning that assets can be easily sold or exchanged for cash.
This liquidity allows for greater price discovery and faster access to capital.
It also means that public companies are subject to more rigorous disclosure requirements than private companies.
Differences between public and private markets
Intermediaries
One key difference between public and private markets is the role of intermediaries.
In public markets, there are a number of middlemen involved in the process of buying and selling securities.
These include stock exchanges, brokers, and investment banks.
In private markets, there are typically fewer intermediaries.
This is because private markets are often dominated by large institutional investors, who have the resources to directly invest in companies.
Regulation
Another key difference between public and private markets is the role of government regulation.
Public markets are heavily regulated by government agencies such as the Securities and Exchange Commission (SEC).
The SEC’s role is to protect investors from fraud and ensure that public companies disclose material information to the public.
Private markets are not subject to the same level of government regulation.
This is largely due to the fact that private companies do not sell their securities to the general public.
As a result, there is less need for the government to protect investors from fraud.
Listing requirements
The final key difference between public and private markets is the listing requirements.
To list on a public exchange, a company must meet certain financial and disclosure requirements.
This listing process can be costly and time-consuming.
Private companies are not subject to these listing requirements.
This allows them to avoid the costs associated with going public.
What are the benefits of investing in public markets?
The main benefit of investing in public markets is liquidity.
Public markets are liquid, meaning that assets can be easily sold or turned into cash.
This liquidity allows for greater price discovery and faster access to capital.
It also means that public companies are subject to more rigorous disclosure requirements than private companies.
What are the benefits of investing in private markets?
The main benefit of investing in private markets is the potential for higher returns.
Private markets are illiquid, which means that investors may have difficulty selling their stake in a company.
However, this illiquidity also allows for a higher return on investment, as investors are compensated for taking on the extra risk.
Another benefit of investing in private markets is the lack of government regulation.
Private markets are not subject to the same level of government regulation as public markets and generally only have to please a smaller client base.
This can allow companies to avoid costly and time-consuming regulatory compliance.
When do companies make the transition from private markets to public markets?
Most companies will consider going public when their value reaches a billion dollars, also known as attaining unicorn status.
Are stocks “soft investments”? (In comparison to real estate and private markets)
Stocks, private equity, and real estate are all forms of equity. A stock isn’t just a piece of paper; it’s a securitization of a stream of cash flows generated from the assets of the company.
The securitization simply makes it liquid, unlike most real estate, which isn’t securitized and illiquid. (Many private equity firms are publicly traded, such as KKR, Carlyle, and Apollo.)
With stocks, you’re buying the earnings or future earnings of a cash flowing business to generate an income.
As long as that company is sending you a dividend regularly because it’s earning money in excess of its expenses, it’s no different than the concept of a landlord who won’t care much about the price of the property as long as the tenant(s) are paying their rent or it generates income in excess of the expenses in the way it’s intended.
Returns of Public Markets vs. Private Markets
Investors looking at a variety of investment options may be interested in assessing the returns of the stock market versus private markets.
The most popular market gauge globally is the S&P 500. The Dow Jones Industrial Average is closer to a value index with the Nasdaq Composite index more tech-heavy.
However, there is no widely published private equity index. There are private market return indices with monthly or quarterly industry reports from companies like Boston Consulting Group, Bain Capital, and Private Equity Wire.
Generally, there should be some premium in private market returns due to its lower liquidity, which creates a premium.
Moreover, many private market opportunities have less competition and lower capacity but higher returns.
For example, many would argue that it’s easier to find a great real estate opportunity versus finding a cheap/good stock opportunity to invest in that’s combed over by the whole world.
Public Markets vs. Private Markets – FAQs
Do private markets outperform public markets?
There is no easy answer to this question. Returns on investments in public markets are typically lower than returns on investments in private markets.
However, public markets are more liquid, which means that investors can more easily sell their stake in a company.
Like most investments, there are no easy answers, only trade-offs.
What is the difference between public and private equity?
One of the main differences between public and private equity is the level of government regulation.
Public companies are subject to stricter disclosure requirements than private companies.
What is the difference between public and private debt?
The main difference between public and private debt is that public debt is issued by the government and is backed by the full faith and credit of the government.
Private debt is issued by corporations and is not backed by the government.
What are public markets?
Public markets are financial markets where stocks and bonds are traded.
The most well-known public markets are the stock exchanges, such as the New York Stock Exchange (NYSE) and the Nasdaq, which are both located in New York.
What are private markets?
Private markets are financial markets where investments are not traded on public exchanges.
Private equity and venture capital are examples of private market investments.
How do I invest in public markets?
The easiest way to invest in public markets is to buy shares of a publicly traded company through a brokerage account.
Why invest in private markets?
Investing in private markets can offer a number of benefits, such as higher returns and less government regulation.
However, it is important to keep in mind that private market investments are illiquid and may be more risky than public market investments.
What is a unicorn?
A unicorn is a privately held startup company with a valuation of $1 billion or more.
What is an IPO?
An IPO is an initial public offering. This is when a company first sells shares of itself to the public.
IPOs are often done by young, high-growth companies looking to raise capital.
What are the risks of investing in public markets?
The risks of investing in public markets include the possibility of losses due to economic downturns or market volatility.
Other risks include company-specific risks, such as fraud or mismanagement.
What are the risks of investing in private markets?
Risks associated with investing in private markets include the illiquidity of investments, which means that it may be difficult to sell your stake in a company.
Other risks include the lack of public information about a company, as well as the typical risks associated with public companies.
How can I diversify my portfolio with private equity?
Diversifying your portfolio traditionally means investing in a variety of asset types, such as stocks, bonds, and interest-earning (or risk-reducing) cash.
You can also diversify by investing in private businesses.
This can provide exposure to different sectors and help mitigate the risks associated with public markets.
Some investment entities, such as pension funds, are also struggling to generate returns and are increasingly turning to private investments.
What is a public market equivalent?
A public market equivalent (PME) is a metric used to value private companies.
It is calculated by taking the total value of a company and divided by the number of shares outstanding.
This metric can be used to compare valuations of public and private companies.
What are some examples of public markets?
The most well-known public markets are the stock exchanges, such as the New York Stock Exchange (NYSE) and the Nasdaq.
Other examples of public markets include government bonds and commodities.
What are some examples of private markets?
Examples of private markets include venture capital, growth equity, and private equity.
Other examples of private market investments include hedge funds, real estate investment trusts (REITs), and private debt.
Summary – Public Markets vs. Private Markets
The key difference between public and private markets is that public markets are financial markets where stocks and bonds are traded on public exchanges, while private markets are financial markets where investments are not traded on public exchanges.
Private market investments may be riskier than public market investments (especially startup businesses) but can offer higher returns.
It is important to diversify your portfolio by investing in a variety of asset types in order to mitigate the risks associated with any one type of investment.