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Going Public - Opening the Books
Or Pandora’s Box?

General Business News

January 2006

Going Public - Opening the Books
Or Pandora’s Box?

There was a time, a long time ago, when the idea of "going public" was a magical thing. If you took your company public, it was almost as if you had "arrived" as a businessperson. Sure there were headaches, but they were manageable with the team of internal and external managers and advisers you had assembled. The payoff, aside from the potential for cashing out in the future for a high price instead of passing the business on to your kids, was the pride in knowing you created a company that the general public valued enough to buy. That’s pretty heady stuff!

Those days are long gone. Now, the goal of cashing out for big bucks is harder to attain and the headaches sometimes require major surgery rather than two aspirin to control. Some people in the know might tell you to take your company public while some people tell you to run from it like the plague. So what’s the truth? In this and the following two month’s General Business articles you will find out how to determine your own truth, so let’s get started.

Going Public

So what does the term "going public" really mean?

For purposes of this article, "going public" means offering to sell a portion of a company to the general public in exchange for capital in the form of cash. Sometimes the sale will include not only newly issued stock of the company, but also some shares of current shareholders, commonly referred to as "selling shareholders." When a company goes through this process for the first time, it is referred to as "going public" since the company is giving up ownership by a few shareholders and offering to sell to a disparate group of unrelated shareholders throughout the United States.

The capital obtained by the sale must be used in accordance with the Registration Statement required to be filed with the Securities Exchange Commission prior to any offering to the public. The process of getting to the filing of the registration statement and actually obtaining the cash will be described in more detail over the course of the next two articles.

Advantages of Going Public

Access to capital - One of the chief advantages of going public is it allows a company to raise capital from the general public rather than going to banks or other private lenders and/or investors. Sometimes, the capital needed may be so great that obtaining bank financing or funds from private investors would be impossible. The ability for investors to sell their shares in an established market may entice them to risk their money with the safety valve of having the ability to sell if the stock loses too much value.

Stockholder liquidity - Let’s face it, eventually you are going to want to retire from your business and live the good life without the pressures of running a business. You can give the business to the kids, sell it to the kids or third parties, or liquidate the assets and head for the Riviera. If you intend to live the good life, chances are you can’t afford to just give the kids the business, and liquidating a thriving business will probably not give you the highest value for the years of hard work in building the company’s good reputation. This leaves you with the sale alternative and the kids may not be able to afford to buy the business from you. This leaves a sale to unrelated parties and that can be to a few individuals or the public at large.

Bear in mind that while you may be able to cash out to some extent in a public offering, you will likely have some portion of your stock ownership declared restricted, which means you are limited in the amount of stock you can sell and the timing of the sale. Assuming continued success, you should eventually be able to sell most, if not all of your ownership, over time.

Better strategic alternatives - The ability to issue stock that is readily tradable on an established exchange to acquire potential rivals or other merger candidates is a significant advantage of going public. If your goal is to grow market share through acquiring other companies, the owners of those companies will want to have the ability to liquidate their investments. That means you pay cash, give them stock that is readily convertible to cash or some combination of both. Issuing stock in a privately held company that is not readily tradable is unattractive to sellers.

Diversification of ownership - As any entrepreneur will tell you, there’s nothing like being the master of your own fate or captain of your own ship. Unfortunately, it’s sometimes not wise to rely on just one key person for capital in a company. What happens if there is a small group of owners and one decides to cash out? The remaining shareholders may have a burden to heavy for them to carry. Going public can make the risk of losing an investor much lower by spreading ownership over a large group of stockholders. When one chooses to sell his or her shares, the chances of having any real effect on the company are virtually nil.

Greater access to talent - While the past few years have shown the ugly side of stock-based executive compensation, there is still a place for it in corporate America. If you have the ability to hire top managers and tie part of their compensation to readily marketable securities, the pool of candidates rapidly widens.

Prestige of the founders and company - From a business perspective, the fact that you have taken a business from nothing to being traded on a stock exchange does nothing but enhance your prestige. While not always true, people also look at public companies and privately-held concerns differently (i.e. ascribing greater stability and competence of the public versus privately-held company).

Disadvantages of Going Public

Costs - A very major drawback of going public is the cost of doing so. The process is long, arduous and very expensive. Management must determine if the advantages gained justify the cost expended. On-going reporting costs will also be greater for the public versus private company. Cost will be discussed in detail in later articles.

Undue pressure on short-term profits - One of the nice things about owning your own company is the relative calm at stockholder’s meetings. You are not as likely to step up to the microphone, pound your fists and ask, "Where's the beef," when research and development costs eat up the bottom line. You realize those costs are an investment in profits two, three, five or more years down the road. Unfortunately, the price of a public company’s stock is heavily influenced by its earnings. Management of a public company can sometimes sacrifice the future by refusing to incur costs needed for long-term growth to bolster stock prices and this can ultimately be disastrous.

Transparency - As a privately-held company, your business does not need to provide sensitive information to competitors to keep regulators happy. Public companies, however, are required to provide sufficient information with respect to their prospects so an investor can evaluate the investment. Sometimes, this provides a competitor with information that can be used against you in the marketplace. Reporting regulations try to avoid this, but the public demand for transparency sometimes forces the disclosure of sensitive information.

Loss of control - As the owner of a privately-held corporation, you enjoy a great deal of control over the direction of the company. You can also design programs to benefit you at the expense of the corporation. The minute the business goes public, you have a legal and moral responsibility to manage the business for the benefit of shareholders. Part of our current problems with public companies stems from the executives forgetting they are no longer running the show for their own personal benefit.

Restrictions on stock - Management and large shareholders of a privately held company are not prevented from selling their ownership interests based on inside information. The market value of the stock also won’t be affected by sales of large blocks of privately-held stock, except for the various control premiums or minority discounts inherent in such trades. This is not true in the case of a public company. Trading on inside information is a crime punishable by jail and other sanctions. Many times, investors will want some portion of management’s holdings in stock restricted as to sale in the market to avoid possible dilution of value.

Conclusion

There are many benefits and many costs in obtaining capital through public markets. If you are currently looking to go public or if you have long-term goals that include taking the company public, give us a call. Let’s talk about your plans and begin now to assemble a team that will help you maximize the value of your company while minimizing the cost of going public.

Have a Happy and Prosperous New Year.
 

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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