Deciding whether to "go public" is one of the most important decisions a successful private company can make. "Going public" presents many attractive opportunities to a growing company and its founders. At the same time, the process can involve many issues which must be carefully considered. Making the right decision requires a thoughtful balancing of the relative benefits and burdens in each situation.
Benefits and Opportunities
When a corporation makes its initial sale of stock to the public and thereby "goes public," both the company and its founders may enjoy numerous benefits and advantages. Some major benefits include the following:
Going public generates additional capital for growth without the risks of debt or the restrictions that may be demanded by venture capitalists. Assuming that the stock is sold in a "primary" offering, one in which stock is sold for the account of the company, new capital is raised without the associated risks, restrictions and costs of debt or the constraints of venture capitalists. Although the company's use of the proceeds of the offering must be explained to potential purchasers of the stock in the prospectus given to them by the underwriters, the funds can be used for any proper purpose which has been disclosed in the prospectus. Of course, if the stock sold is that of the shareholders in a so-called "secondary" offering, the proceeds go to the selling shareholders. Often the initial offering is a combination of both a primary and secondary offering, thereby providing both new capital to the company and investment diversification and liquidity to the founders.
A company's ability to raise additional capital is often enhanced after going public. Since the sale of stock by a corporation increases the company's net worth and decreases its debt-to-equity ratio, the company is often able to increase its borrowings and obtain terms more favorable than before the offering. Furthermore, if the company and its stock have performed well, the company can return to the market at a later time and sell additional shares to the public.
The founders of a company which has gone public will achieve a much higher degree of liquidity for their investment. The common stock of a privately held corporation is generally an asset without a readily available market or an easily determinable value. A publicly traded company, however, has a ready market for its stock at quoted prices. In addition to the portion of their stock that the founders may have sold as part of the original public offering, the founders will have the ability to sell additional shares for diversification or other reasons, although such sales may be subject to significant limitations.
Acquisitions by the company may be made with publicly traded stock. If a public company anticipates growth through acquisition, and its stock has performed well in the after-market, the company may be able to preserve its cash position and make acquisitions using its own stock as payment.
A public company can often attract and retain better employees. Before a company goes public, particularly when it may not be able to pay market salaries to its executives or other employees, it often uses its potential for going public to attract and retain the best personnel by offering stock to such employees that will likely be significantly more valuable upon an offering. Likewise, in the period after the public offering, various types of employee benefit plans using the company's common stock are generally used to attract and motivate employees at different levels. Examples of equity participation devices for management and other employees include stock purchase plans, stock bonus plans, restricted stock plans, non-statutory stock options plans and incentive stock option plans.
A public company, as well as its founding shareholders, may gain a significant amount of prestige and positive publicity, benefiting the business operations of the company. A company's going public is a mark of success. Also, publicly held companies and their disclosures of information are followed by industry analysts and others in a position to publicize the company. Additional customer awareness often results from the successful image and publicity both received as a result of the public offering and generated after the offering if the stock does well. However, while a private company in financial trouble may be able to avoid public knowledge of its situation and improve its position without negative publicity eroding customer and supplier confidence, a public company must continuously reveal to the public its true condition.
Burdens and Challenges
Some of the major challenges or burdens in going public that must be weighed against the opportunities and benefits are as follows:
The initial, pre-offering expenses for a publicly held company are not insubstantial. In addition to an underwriter's commission of approximately seven to ten percent or more of the total offering proceeds, there will be expenses for attorneys, accountants, printers and filing fees. These costs can vary significantly depending on the unique circumstances of each public offering and company.
Significant reorganization of corporate matters may be required before an initial public offering. This "housekeeping" process could require changes which are necessary for the Securities and Exchange Commission ("SEC") registration, advisable from a tax, corporate or timing viewpoint, or easier to accomplish while the company is still private. "Cleanup" or "housekeeping" may involve such items as:
Modification of the company's organizational and capital structure, articles of incorporation, bylaws, board of directors and shareholder rights and restrictions.
Review of pending litigation and related matters such as potential claims and adequacy of insurance coverage.
Modification of employment agreements, management compensation arrangements and employee benefit or stock plans.
Modification or elimination of certain insider or affiliate transactions and relationships.
Provision of written contracts where necessary.
Modification of material contracts, leases and loan agreements.
Substantial modification of accounting practices and preparation of financial statements.
Deciding to effect (or not to effect) certain acquisitions, mergers or other transactions.
Modification of corporate procedures regarding record-keeping, minutes, board and shareholder meetings.
- Review and cleanup of other matters which may raise problems in SEC registration or "being public."
Even if the initial decision to go public is changed, the pre-offering period can be a valuable learning process for the company and its management. In general, management will have a more meaningful view of the company's structure, operations, strengths and weaknesses. Also, many of the changes suggested by the corporation "cleanup" process may still be advisable from a legal, policy, planning or operations viewpoint. Further, certain relationships established during the pre-offering period could prove very helpful if the company decides to go public in the future.
The post-offering duties to comply with federal securities laws can become substantial for new companies. Although difficult to estimate, there will be a substantial increase in the amount of ongoing expenses due to a company's public status and in employee time spent on public/investor relations and administrative and compliance matters. In addition, routine legal and accounting fees can increase significantly in connection with such matters, which include:
Registration of the company's securities and the filing of periodic company reports (Forms 10-Q, 10-K, 8-K, etc.) under the Securities Exchange Act of 1934 (the "'34 Act") and SEC rules thereunder.
The preparation and mailing of proxy materials prior to a shareholder meeting or written shareholder vote on a matter, and the filing of such materials with the SEC pursuant to the '34 Act.
The filing and reporting requirements of the National Association of Securities Dealers (if the company's stock is traded on the national market system or over the counter) or a stock exchange (if the stock is listed for trading on an exchange).
The filing of certain stock ownership reports by all owners of more than 5% of the company's outstanding stock, as required by the '34 Act and SEC rules.
The filing of certain shareholding reports by all "insiders" (for example, directors, officers and owners of more than 10% of the company's outstanding stock) to report ownership and changes in ownership as required by the '34 Act.
Compliance with SEC rules regarding insider trading, company transactions in its own stock, the sale of company stock by affiliates (Rule 144) and other matters.
Foreign Corrupt Practices Act compliance.
General duties of the company regarding timely disclosure of material information and Rule 10b-5.
- Additional registration of company stock for stock option plans, acquisitions or other purposes.
A company must disclose details, potentially valuable to its competitors, about its operations and financial situation, not only upon going public but also on a continuous basis after the initial offering. The required disclosures include sales, profits, operational methods, compensation of executives, important contracts and other information which closely held companies would not generally release to their competitors and the public. Although this normally does not have a significant detrimental effect on the business, the loss of privacy and confidentiality should be considered.
Founders and insiders may be threatened with the loss of control of the company. After a company is public, the founders' or insiders' percentage ownership may be less than an absolute controlling interest, and may be less than actual working control. Such relative loss of control, however, may be essentially the same when compared with successfully raising equity capital through venture capitalists. By selling equity at the public market, control of participation may be dispersed to a broader group, at least when compared to fewer investors in other private financings. Whether the financing is public or private, consideration must be given to the relative shareholders' blocks and their voting authority and the composition of the board and its relative authority as contrasted with management's.
Publicly held companies often tend to focus on short-term results due to shareholder expectations and pressures of the market. Public companies must disclose financial results every quarter, and there will be pressure to perform. Results which do not satisfy the analysts and watchful shareholders may cause the price of the stock to fall. Thus, there is pressure to make short-term decisions which will boost or maintain earnings per share or other key indicators when the long-term prospects of the company would be better served by another decision.
Publicly held companies often lose a degree of flexibility due to their responsibilities to and the scrutiny from public shareholders. The adequacy of required disclosures and the occurrence of significant corporate actions by publicly held companies are subject to the scrutiny of the SEC, public shareholders and the investment community, judged in hindsight by such persons and may be a source of litigation with respect to the company. In addition, the ability to take major steps quickly may be lost as approval for corporate actions may be required from public shareholders. Your primary duties are to the public shareholders, not to yourself as when you were privately owned.
Controlling or major shareholders and directors and officers are restricted in their ability to sell (and to some extent, buy) shares in a public company. Although "going public" may create a ready market in which shares can be sold, major shareholders, officers and directors will be subject to various securities laws (for example, Rule 144, Section 16 and Rule 10b-5) affecting such insiders' transactions in the company's securities.
Due to the complex interaction of the many issues discussed above, it is usually never too soon to begin the "going public" planning process. To successfully "go public" and then deal with life as a public company, it is important to work with experienced advisors whose judgment you can trust.