Reading Financial Reports For Dummies. Lita Epstein

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KEEPING IT IN THE FAMILY

      Mars, one of the world's largest private companies, makes some of your favorite candies — 3 Musketeers, M&M's, and Snickers. Mars has never gone public, which means it has never sold its shares of stock to the general public. The company is still owned and operated by the family that founded it.

      Frank and Ethel Mars, who made candy in the kitchen of their Tacoma, Washington, home, started Mars in 1911. Their first worldwide success was the Milky Way bar, which became known as the Mars bar in Europe in the 1920s.

      Today Mars is a $40 billion business with operations in more than 56 countries and sales of its products in over 100 countries. Mars isn't just making candy anymore, either. It also manufactures Whiskas and Pedigree pet food, Uncle Ben's rice products, vending systems, electronics for automated payment systems, and information technology related to its manufacturing operations. The family is still in control of all these businesses and makes the decisions about which businesses to add to its portfolio.

      One of Mars's five key principles that shape its business is “Freedom.” The company's statement about the importance of freedom clearly describes why the family decided to stay private:

      Private ownership allows Mars to remain free. The nature of freedom demands that it be used responsibly by Associates and units alike. Our way of doing business allows us to remain free as a company and gives Associates as individuals the freedom to innovate, act and grow while achieving our common goals. This creates the kind of environment in which we are all excited to work. Our private ownership, unanimity of purpose and high ethical standards allow us to move quickly in exploring new ground, act boldly in the face of competition, and take risks wherever they are justified. Above all, our private ownership gives us the freedom to take a long-term perspective on making investments, building businesses and providing for the wellbeing of our Associates. This spirit has driven Mars in the past. It remains for each of us to make it the guiding force for our future.

A private company gives owners the freedom to make choices for the firm without having to worry about outside investors’ opinions. Of course, to maintain that freedom, the company must be able to raise the funds necessary for the business to grow — through either profits, debt funding, or investments from family and friends.

      Checking out the benefits

      Private companies maintain absolute control over business operations. With absolute control, owners don't have to worry about what the public thinks of its operations, nor do they have to worry about the quarterly race to meet the numbers to satisfy Wall Street's profit watch. The company's owners are the only ones who worry about profit levels and whether the company is meeting its goals, which they can do in the privacy of a boardroom. Further advantages of private ownership include

       Confidentiality: Private companies can keep their records under wraps, unlike public companies, which must file quarterly financial statements with the Securities and Exchange Commission (SEC) and various state agencies. Competitors can take advantage of the information that public companies disclose, whereas private companies can leave their competitors guessing and even hide a short-term problem.Owners of private companies also like the secrecy they can keep about their personal net worth. Although public companies must disclose the number of shares their officers, directors, and major shareholders hold, private companies have no obligation to release these ownership details.

       Flexibility: In private companies, family members can easily decide how much to pay one another, whether to allow private loans to one another, and whether to award lucrative fringe benefits or other financial incentives, all without having to worry about shareholder scrutiny. Public companies must answer to their shareholders for any bonuses or other incentives they give to top executives. Private-company owners can take out whatever money they want without worrying about the best interests of outside investors, such as shareholders. Any disagreements the owners have about how they disburse their assets remain behind closed doors.

       Greater financial freedom: Private companies can carefully select how to raise money for the business and with whom to make financial arrangements. After public companies offer their stock in the public markets, they have no control over who buys their shares and becomes a future owner. If a private company receives funding from experienced investors, it doesn't face the same scrutiny that a public company does. Publicly disclosed financial statements are required only when stock is sold to the general public, not when shares are traded privately among a small group of investors.

      Defining disadvantages

      The biggest disadvantage a private company faces is its limited ability to raise large sums of cash. Because a private company doesn't sell stock or offer bonds to the general public, it spends a lot more time than a public company does finding investors or creditors who are willing to risk their funds. And many investors don't want to invest in a company that's controlled by a small group of people and that lacks the oversight of public scrutiny.

      If a private company needs cash, it must perform one or more of the following tasks:

       Arrange for a loan with a financial institution

       Sell additional shares of stock to existing owners

       Ask for help from an angel, a private investor willing to help a small business get started with some upfront cash

       Get funds from a venture capitalist, someone who invests in start-up businesses, providing the necessary cash in exchange for some portion of ownership

      These options for raising money may present a problem for a private company because

       A company's borrowing capability is limited and based on how much capital the owners have invested in the company. A financial institution requires that a certain portion of the capital needed to operate the business — sometimes as much as 50 percent — come from the owners. Just as when you want to borrow money to buy a home, the bank requires you to put up some cash before it loans you the rest. The same is true for companies that want a business loan. I talk more about this topic and how to calculate debt-to-equity ratios in Chapter 12.

       Persuading outside investors to put up a significant amount of cash if the owners want to maintain control of the business is no easy feat. Often major outside investors seek a greater role in company operations by acquiring a significant share of the ownership and asking for several seats on the board of directors.

       Finding the right investment partner can be difficult. When private-company owners seek outside investors, they must ensure that the potential investors have the same vision and goals for the business that they do.

      

Another major disadvantage that a private company faces is that the owners’ net worth is likely tied almost completely to the value of the company. If a business fails, the owners may lose everything and may even be left with a huge debt. If owners take their company public, however, they can sell some of their stock and diversify their portfolios, thereby reducing their portfolios’ risk.

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