Going Public . . .

refers to a company’s first sale of its securities (usually common stock) to the general population of equity investors. It is accomplished by registering those securities with the federal Securities and Exchange Commission and state securities commissions, preparing a detailed offering circular called a prospectus and then selling the securities to the general public. Public offerings are typically conducted by a team of professional underwriters. Going public is a goal of many companies that seek venture capital. It enables them to raise money from the public, creates a market for subsequent sales of their stock and raises their public profile. It also creates an easily ascertainable market value for shares.

Many company entrepreneurs consider going public a business rite of passage that legitimizes their efforts and confirms their success. Many plan long and hard for the opportunity to run a public company. Most who take their companies public, believe that the offering proceeds generated by their offering and other benefits of being a public company are worth the effort and expense required to complete a public offering.

But going public is not the right decision for every company and does not insure future success. Seeking funds from private investors or from traditional lending sources may make more sense. At times, going public may be impossible because of market conditions unrelated to a prospective candidate’s strength.

Determining whether going public makes sense requires consideration of a number of factors including timing, company history, company prospects for future growth and management’s personality. The advantages and disadvantages of going public should be weighed carefully before a decision is made to seek funds in the public markets. Among the advantages management should consider are:

  • Lower cost of capital

  • Capital for continued growth

  • Increased shareholder liquidity

  • Future financings

  • Enhanced ability to expand

  • Improved company image

Lower cost of capital. Going public is often triggered by management’s belief that it can raise more money and get a better price for its stock by selling to the public than to a venture capitalist or other private investor. When this is true, a public offering can raise money at less cost and with less dilution of management’s shareholdings.

Going public becomes cost effective for most companies when they finally meet the profile required to attract institutional investors to the offering. While these profiles vary according to market conditions and offering company industry, it generally requires sustained growth and profitability over a significant period of time, a company valuation of at least $10 million, and prospects for continued growth at a rate greater than the industry average. When a company matures to the point of meeting this profile, its ability to attract institutional investors often boosts the price of its stock high enough to make going public the most economical way to raise capital.

Capital for continued growth. Perhaps the most obvious benefit of going public is the proceeds (cash) of the offering. These moneys can be used for a variety of company purposes as long as they are disclosed in the company’s offering documents. Typical uses are: to increase working capital, to acquire new divisions or technologies, to increase marketing efforts, to pay for research or plant modernization, or to repay debt.

Increased shareholder liquidity. Going public makes it easier for company shareholders to sell their shares by creating a public market for the company’s stock. Shareholders who register their shares in the company’s offering hold freely tradable shares once the offering is completed. Even the shares that are not registered in the offering become more liquid. Because of the offering and the periodic reporting requirements it imposes on the company, they often qualify after a prescribed period of time to sell limited numbers of their shares under Rule 144. If they want to sell more shares than Rule 144 permits, they can benefit from easier and less expensive methods available for registering their shares that are available to public companies. See: Restricted Securities.

Future financings. Most public offerings raise a significant amount of equity capital and thus dramatically improve the company’s net worth and debt-to-equity ratio. This, in turn, makes it easier for a company to borrow money from commercial lenders at competitive interest rates. Also, an existing public market for the company’s stock makes it easier for the company to sell additional equity. If the company’s stock does well (that is, increases in price), the company can offer for sale additional shares of stock or a new class of stock.

Enhanced ability to expand. The market created by going public makes it easier for a company to expand through acquisitions and mergers. Because registered shares can be converted into cash, a public company can often use its stock instead of cash to acquire a company or other valuable property. With the proper deal structure, the use of shares instead of cash can ease the immediate tax burden of the seller caused by the sale of his company and, thereby, make the acquisition easier and less expensive to close. Liquid stock also increases the value of a company’s stock and option plans, making it easier for a company to attract and retain the key employees it needs to help it grow.

Improved company image. Going public, with all the financial disclosure and investor relations planning it requires, usually attracts the attention of the business and financial press. Free publicity, coupled with the perception that going public is a significant milestone of success, enhances a company’s image.

This improved image can make it easier for management to deal with suppliers and customers. Many privately held companies that compete with public ones find their customers and suppliers reluctant to deal with them on equal terms because of their lack of operating history and the confidentiality of their financial data. Going public can erase this distinction and make it possible for the company to compete more effectively.

The advantages of going public can be substantial, but they can be outweighed by the disadvantages. It depends on management’s goals and the circumstances of the company. Among the disadvantages that should always be considered are:

  • Expense

  • Loss of confidentiality

  • Periodic reporting

  • Reduced control

  • Shareholder pressure

  • Restrictions on stock sales

Expense. Going public is expensive. The underwriter’s discounts alone can amount to as much as 6 to 10 percent of the total proceeds of the offering. (In a $10 million offering, this can be as much as $1 million.) Other expenses, which include the underwriter’s out-of-pocket expenses (typically not included in the underwriter’s discount), filing fees, transfer agent fee, legal fees, printing fees, and accounting fees can add another $200,000 to $500,000 to a company’s cost of going public. Most of these expenses must be paid at the closing of the offering.

Going public also subjects a company to annual and quarterly financial reporting requirements imposed by the Securities and Exchange Commission. Complying with these requirements increases the company’s costs of doing business. Time and money are required to generate the information necessary for these reports.

Loss of confidentiality. Going public forces a company to prepare and distribute to potential investors a complete description of the company, its history, its strengths, its weaknesses, and its future plans. Detailed disclosures of financial information are required. Information about the shareholdings and compensation arrangements of management and holders of large blocks is made public. All of this information must be updated and supplemented in reports required by the Securities and Exchange Commission. Once information is filed, it becomes readily available to competitors, employees, customers, suppliers, union organizers and others.

Periodic reporting. Going public subjects a company to a number of periodic reporting requirements with the Securities and Exchange Commission. These requirements include annual and quarterly financial reports (on forms 10-K and 10-Q) as well as prompt reporting of material events that affect the company (on form 8-K). For most companies, these and other reporting requirements, which force the company to maintain audited financial statements, increase the company’s cost of doing business by imposing more stringent accounting practices and by making additional demands on management’s time.

Reduced control. A public offering can reduce management’s control over a company if outsiders obtain enough stock to elect a majority of the company’s board of directors. Whenever this is true, outside shareholders can remove members of the management team. (This is not a risk inherent only in public offerings, however. Any sale of voting stock to raise money reduces the percentage ownership of management. Sales of a majority of the company’s voting stock to a few private investors, in fact, may make management’s ability to retain control less certain than a public offering, which distributes those same shares to a greater number of investors. The larger number of shareholders in a publicly held company can make concerted action by the outsiders more difficult.) Public companies are more susceptible to unfriendly takeover because their shares are easy to accumulate.

Shareholder pressures. Even managements that retain voting control over their companies find that going public subjects them to pressures that can affect the way they run their businesses. Many entrepreneurs find that shareholder expectations and the quarterly reporting requirements of the Securities and Exchange Commission combine to create significant pressures on a company to continually improve its performance on a quarter by quarter basis. Failure to meet these shareholder expectations can cause the market value of the company’s stock to decline, making it more expensive for the company to raise money or acquire other companies using its stock. This pressure to meet short-term goals can tempt management to forgo necessary long-term planning when it includes present-day sacrifices that will be reflected in the company’s quarterly reports.

Restrictions on stock sales. Only those shares registered and sold in the offering become freely tradable. Unregistered shares remain subject to the same trading restrictions as they were before the offering. Moreover, the Securities and Exchange Commission imposes additional restrictions on the ability of major shareholders and company insiders to sell company stock.

The factors that should be considered when contemplating a first public offering are numerous and complex: This discussion does not cover them all. Entrepreneurs should consult with their accountants, attorneys, investment bankers, and other advisers before taking their companies public. See: Control, Investment Bankers, IPOs (Initial Public Offerings), Penny Stock, Private Placements, Public Offering, Restricted Securities, Unit Offerings.