CHAPTER NINE: Part B – While going public can signify to the outside world that your business has achieved a special kind of success, the strategy has its own fair share of ugly cons. Before taking your company public, it is advisable to weigh the advantages and disadvantages of doing so; and you should do so alongside a group of trusted advisors.
I have written an article in the past titled “The pros and cons of doing business as a public corporation” and this article will just be a re-validation of my previous points. Now what are the advantages and disadvantages of going public?
Top 10+ Advantages Taking your Company Public
“If you are acquired, a company validates you. If you go public, the market, the world validates you.” – Fortune Magazine
Taking your company public has a number of tangible and intangible benefits, including the following:
1. Access to more capital
“We have to still develop the IKEA group. We need many billions of Swiss francs to take on China or Russia.” – Ingvar Kamprad
When your company’s growth can no longer be financed internally from private equity investments or borrowed funds, an IPO can give you the additional funds needed to meet working capital needs, acquire other businesses, invest in facilities and equipment, or pay off existing debt. You can also use publicly traded stock of mergers and acquisitions.
“I think you might see us growing much deeper into banking. You might see us acquiring companies in the banking area. You might see us acquiring companies in the retail area. I think you might see us acquiring companies in the telecommunications. I think you will see us getting stronger in business intelligence.” – Larry Ellison
2. Increased visibility
Taking your business public will give it ongoing exposure through global media coverage of the financial markets. And your company will become the object of publicized analysis and comparison by broker-dealers. The enhanced visibility an IPO brings to your business can create opportunities for your company to expand even more in the future.
3. Less dilution
If your company has grown to reach a stage at which it is ready to go public, you can command a higher price for your securities through an IPO than through other forms of equity financing. In other words, you give up less of your company to get the same amount of funding.
4. Improved financial position
By taking your company public, it will experience an immediate improvement in its balance sheet and debt-equity ratio, since an IPO is usually in the form of an equity-based security.
A market will be established for your stock once your company goes public. Such a public market provides liquidity for management, employees, and existing investors. Your stockholders can sell their shares whenever the need arises (although this is subject to applicable laws and regulations).
6. Enhanced ability to raise more capital in the future
If you have any need to raise additional permanent financing in the future, you will get this easily by selling additional stock or debt on favorable terms. However, this depends on how well your stock performs in the stock market. If your company continues to grow and your stock continues to appreciate, you will attract more investors and get more funds.
Major shareholders, such as angel investors and venture capitalists, would require liquidity in your company. And they generally invest in your business for a specified time frame. After this period, they need to liquidate the fund in order to get back their investment (plus profits). By taking your company public, you will be able to pay off these shareholders, as they will be able to sell their holdings in the company.
8. Improved credibility with business partners
The awareness alone that your business is “public” will create a good impression among business partners such as suppliers, distributors, and customers. In addition, since taking your public provides the public with more information about the company, people will deem your company credible and substantial, and they will feel more secure about entering into a relationship with the company. As a public company, you may also be perceived as a more attractive partner in a joint venture or other similar relationships.
9. Better ability to attract and retain personnel
By taking your company public, you will be able to offer your employees stock options and other incentive compensation plans. This way, you can motivate your company’s personnel to participate actively in the company’s growth and success without necessarily increasing their wages or offering cash compensation. Owning stock in the company they work for can motivate your employees to take a longer-term view of your company.
“The competition to hire the best will increase in the years ahead. Companies that give extra flexibility to their employees will have the edge in this area.” – Bill Gates
Taking your company public can also enhance the company’s chances of attracting and retaining top talent. Of course, people want to work with reputable companies.
10. Improved personal net worth
Going public can significantly enhance your net worth. Even if selling some of your stocks in the IPO does not bring immediate gain, you can secure huge borrowings of a personal nature by using publicly traded stock as collateral. Since they are liquid, shares of publicly traded stock can facilitate personal financial and estate planning.
Eight Disadvantages of Going Public
The dramatic wealth that an IPO creates for a company’s founders and management team can be very tempting. The prospect of having enough capital to finance future growth of your company can be alluring. And paying off major equity holders in your business (such as angels and VCs) can be very freeing.
Yet, you need to consider the disadvantages of taking your company public and weigh them against the advantages before taking a plunge. Here are the disadvantages of going public:
a. Increased financial transparency and loss of confidentiality
Since an IPO transforms your company into a publicly held corporation, the company’s operations and financial situation are subject to public scrutiny. The general public—including your competitors, customers, employees, and others will suddenly gain access to information concerning the company, officers, directors, and certain shareholders, which may not necessarily be disclosed by privately held companies.
In addition, information about your company’s sales, profits, and executive information, such as compensation of your employees and directors must be disclosed not only initially, but on a continuing basis afterwards.
b. Pressure to maintain growth pattern
Another disadvantage of going public is that there can be considerable pressure—from within and without—on your company to maintain the growth rate you have established. If your sales and earnings taper when compared with initially established trends or projections, shareholder may become apprehensive and sell their stock, driving down its price.
Although a reduced stock price may not affect your company financially, it may affect its reputation, employee compensation (if you offer compensation by stock), and the value of subsequent offering (causing more dilution to existing shareholders).
c. Management demands
Detailed information about the management of the company must be provided frequently to shareholders, brokers, analysts, and the media. Company executives (such as the CEO) must be also be actively involved in the preparation and certification of written information about the company’s financial results and other company matters, all of which must be reported to the public as well as the securities and exchange commission.
d. Ongoing reporting obligations
After taking your company public, you will have to begin reporting operating results on a quarterly basis with the SEC. In addition, you will need to disclose material items that arise during the year. This means that third parties can now evaluate and scrutinize your company throughout the year; a development that can intensify the pressure and may significantly shorten your planning and operating horizons.
e. Greater legal exposure
Another negative consequence of taking your company public is the greater legal exposure for the company and its officers and directors. Directors are increasingly being sued for decline in stock prices resulting from their breach of fiduciary duty. In addition, directors and officers are sometimes queried or penalized by the SEC over alleged misreporting of financial reports or other violation of law or regulations.
The IPO itself places you and other stakeholders in your company under the obligation that all communications, written or oral, relating to the offering or included in periodic reports or other public disclosures must be accurate. This means, you can get sued for securities fraud if these communications were materially misleading.
So, going public will require you to become much more formal in your decision-making. You can no longer operate informally with respect to director involvement as private companies do.
f. Less control and more influence by board of directors
Taking your company public means practically diluting your ownership and control of the company.
“Unfortunately, we are not a public company. We are a private group of companies and I can do what I want.” – Richard Branson
In addition, depending on what your trading market stipulates, you are likely to be required to have a Board of Directors comprising a majority of independent directors. This board is responsible for protecting the interests of shareholders, and you will need to consider the board’s recommendations when making decisions. Additionally, as your ownership is diluted, the possibility for a hostile takeover increases.
g. Huge financial requirements
Both the initial and ongoing costs of taking your company public can be very substantial. As for the initial costs, the underwriters typically charge a commission of between six to seven percent of your total offering proceeds. In addition, even a small IPO will require significant out-of-pocket expenses.
There are also significant on-going expenses—periodic public reporting expenses, directors’ and officers’ liability insurance expenses, SEC rule compliance expenses, independent director fees in the form of cash payments and option awards, and other expenses.
h. Potential for increase in income taxes
In some countries, current income tax laws provide for special credits and deductions to private corporations. These deductions and credits will no longer be available to a company once it goes public, and this may result in an increase in taxes.