Many issues to consider
when weighing an IPO
By JUSTIN DOYLE - 10/31/1997
Going public can sound like a great idea for an aggressive and successful privately owned company. The immediate infusion of capital to expand the business is the most obvious attraction. Going public also seems like the thing to do during a hot market. Last year, a record 870 companies went public and, in doing so, raised nearly $50 billion. But there are a number of considerations, both positive and negative, that should be evaluated before the decision to go public is made.
In addition to the cash generated for internal expansion or other company business purposes, a public offering of securities also enables access to the public market for additional capital subsequent to the initial public offering. A public market provides liquidity for the company's securities and a classic exit strategy for founders and other investors. Also, the price a business can command on its capital in a public offering should be greater than that it could realize in a private offering, because any investment that can be sold freely is intrinsically more valuable than its illiquid counterpart.
There are benefits beyond market access, price and liquidity. The company's securities are often purchased by its customers and suppliers, which stimulates their interest in the company's profits and products. Being public provides the company a currency, through options, restricted stock and the like to attract and motivate key employees who increasingly are demanding substantial equity positions, and liquidity for the same, over time. In addition, with publicly traded securities, the company will be able to use its stock to grow by making acquisitions of other companies, which may be more preferable than using cash.
One of the largest negatives associated with going public is the loss of privacy, both corporate and personal, followed by the increased accountability to security holders. The registration statement filed with the Securities and Exchange Commission, which includes a prospectus to be furnished to potential and actual purchasers of the company's securities, is easily available as part of the "public record.'' It includes financial and other details regarding the company's business and management compensation.
Public companies are required to keep the marketplace continuously informed of material development in their businesses, developments that they would often prefer to keep confidential. They are required to pepper the marketplace with information through periodic public reports and annual proxy statements. As a result, customers can learn about the company's margins and may be able to squeeze it in certain product areas. Competitors will know the company's financial results, general product strategy, and research-and-development plans. Some managers refer to being public as doing business in a fishbowl.
In addition to this loss of privacy, the directors and management will be publicly accountable for mistakes and failings of the company. They will have to answer to security holders, analysts and underwriters whenever a substantial contract or customer disappears, production falters, or revenues, margins or earnings do not meet company projections or analysts' estimates. Being public creates significant pressure on management regarding sustained sales growth and increased earnings; each fiscal quarter becomes an opportunity to succeed or fail.
The public company's directors, officers and 10 percent shareholders will be subject to strict rules regarding trading in a company's equity securities. For example, they will be subject to Section 16(b) of the Securities Exchange Act of 1934, which recaptures any profit realized on any sales matched by purchases of the company's equity securities within a six-month period, and imposes related public reporting requirements on such company "insiders.''
Also, the threat that an insider will be deemed to have traded on "inside information'' means that insiders may choose to confine their trading of company securities to specified "window'' periods, such as immediately after the public release of annual or quarterly reports. This, in effect, hampers the liquidity of insider holdings, and still does not ensure that they will not be the object of a class action suit if the price of the stock behaves erratically.
Once a company goes public, depending on the percentage of outstanding voting securities sold to the public, it subjects itself to the threat of a takeover by a hostile tender offer, proxy contest or other means. Unlike private companies, public companies are always "for sale'' in the sense that they may be the target of a takeover attempt. To deter hostile takeovers, it is often desirable to insert "shark repellent'' measures into the company's charter and bylaws prior to the IPO.
An IPO involves an arduous process that requires a significant amount of time, energy and money. When the time needed to prepare the registration statement, wait for and respond to SEC comments, and mount the necessary marketing effort is considered, it becomes clear that it is difficult to complete an IPO in much less than three months, and it may take longer depending upon market conditions and other circumstances. This creates substantial market risk, and the costs that must be "wagered'' by the company are substantial.
The cost associated with an IPO includes, most notably, the underwriters' discount, which can run from 7 percent to 10 percent of the gross proceeds. Also, an issuer will incur, among other expenses, substantial legal, accounting and printing costs in connection with the offering, which have to be paid for even if an offering is not successful or is delayed.
After a company concludes an offering, both management time and company funds must be budgeted for compliance with the legal obligations of a public company. Routine accounting and legal fees can be expected to increase substantially, and it will be necessary to pay the cost of preparing, printing and distributing proxy materials and annual and quarterly reports to equity security holders.
An evaluation of company attributes to determine the potential for a successful offering is a wise first step. Those attributes include, among other things, the demonstrated marketability of the company's products or services, growth potential and experienced management. Most importantly, a candid assessment must be made of the organization's appetite and tolerance for the benefits and burdens of public ownership.
(Justin P. Doyle is a partner with Nixon, Hargrave, Devans & Doyle LLP.)