Business

EXPERT ADVICE

Tackling the Big IPO Question

Though there are many benefits to bringing your company public, there are also disadvantages to be considered. Therefore, the process of deciding whether to launch an initial public offering should be a deliberate, well-thought-out process made by a team of professionals, including management, your board of directors (if you have one), financial advisors and attorneys.

There is no doubt that a well-executed plan to bring your company public can result in substantial financial benefits both to the stockholders and the company itself. It can make the difference between remaining a small, moderately funded company and becoming a large, well-financed organization.

Let’s consider the pros and cons to such a critical decision.

Benefits of an IPO

If your stock is publicly traded, assuming that there is sufficient volume in the stock, there is constant access to liquidity both for the stockholders and for the company itself. A stockholder who needs fund merely has to sell shares in the open market. When the company needs additional funds, assuming that the business has been successful and market conditions are favorable, the company can execute a secondary offering by selling additional shares thus bringing more capital to the company.

In the vast majority of cases, a publicly held company is worth more than if it is privately held. For example, private companies often sell from anywhere between three to 10 times annual earnings (price/earnings ratio or p/e ratio). A publicly held company, assuming that it is in an upcoming industry, can sell from as much as 40 times earnings to 50 times or more.

A recent example of this amazing leveraging phenomenon is Priceline.com. In early December of 2010, it had a p/e ratio of about 44. This means that people were willing to pay 44 times annual earnings for a share of stock. Would you be willing to buy a privately held company for 44 times its annual earnings? Unlikely!

Price/earnings ratios go into the stratosphere when investors anticipate that the company has great prospects for increased future earnings. They are, in effect, discounting the future anticipated earnings and relating them to the present value of the company’s stock.

Let’s look at this from another perspective. If on a particular day you owned a privately held company that could be sold at a p/e ratio of five, and you decided to go public with your company, that same company, depending upon market circumstances, could be worth 44 times annual earnings once it became public. In other words, your investment would jump more than 800 percent on the day you went public with your company.

I realize that this is a simplistic example. However, there is no doubt that a publicly held company is usually worth much more than a similar privately held company. It is a matter of market dynamics — the universe of buyers dramatically increases once the company is publicly held.

An additional benefit relates to the liquidity of your shares. Again, there is no doubt that the shares of a publicly held company are generally far more liquid than those of a privately held one. Again, it is a matter of market dynamics. There are simply more buyers out there (a larger universe) for a public company than there are for a private company.

This liquidity can provide you, the owner/shareholder, with a ready source of cash. The liquidity can also be used for estate planning purposes or, for that matter, any other cash needs that you, the stockholder, might have.

This financial alchemy — the skyrocketing value of a company and the liquidity of its stock, once it’s public — is certainly a major driving force impelling people to take the plunge and bringing their company public. But, what are the disadvantages?

Disadvantages of an IPO

There are, however, downsides to going public. First of all, there are many business owners who don’t want the world to know how much their annual salary is. When a company is public, this information is available in its filings with the Securities & Exchange Commission. Likewise, there are also many business owners who don’t want to answer to a regulatory authority, namely, the SEC.

The reality of the situation is that being public creates a long list of regulatory requirements, such as the need for an independent board of directors, the need to file certain documents on a regular basis with the SEC, and the general scrutiny that comes with being a public company. Obviously, these hurdles are not insurmountable — just look at how many companies are publicly traded!

The fact remains, there are entrepreneurs who are running profitable companies who just don’t want the scrutiny and additional reporting requirements that come with running a company whose stock is publicly traded — and they don’t want to spend money for additional accounting, legal, and reporting costs.

What’s the Easiest Way to Go Public?

The quick answer to this question is that you should surround yourself with seasoned legal, accounting and financial advisors — people who know the terrain and can guide you through it in a rather seamless fashion.

Given that, there is an alternative to a regular IPO that your lawyers can explain to you. This is a so-called reverse merger, in which your company’s shares are exchanged with the shares of a publicly held shell corporation. Your company will be the surviving company, with the original shareholders of the shell owning a minority of the stock of your company.

This sounds like a complex process, but it really isn’t. Let’s say that a company that is public goes dormant for one reason or another. It could be that its business model just didn’t work out and the shareholders decided to keep the public entity public, though there is no real activity in it — no revenue and no expenses to speak of.

However, the shareholders realize that although the company has no value as a going concern, it does have value in that the stock of the company is publicly traded and it is a reporting company — meaning that it is filing the requisite reports with the SEC. There are people who will pay a handsome price for a reporting corporate shell because they realize that it is a vehicle that can be used as a quick route to being publicly traded.

Sound Legal, Accounting and Financial Advice

Whatever route you decide to take — going public or remaining private — your best bet is to make that decision after serious and lengthy consultation with your advisors. Their input is invaluable and can save you time, money, and headaches in the long run.

Good luck!


Theodore F. di Stefano is a founder and managing partner at Capital Source Partners, which provides a wide range of investment banking services to the small and medium-sized business. He is also a frequent speaker to business groups on financial and corporate governance matters. He can be contacted at [email protected].

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