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- Raising Capital
- The Advantages & Disadvantages of IPOs
- Advantages and Disadvantages of Going Public Using an IPO
- MANAGING YOUR MONEY
- Advantages of increasing the size of an ipo
- How a Company Benefits from the Stock Market
- The Advantages & Disadvantages of Going Public Using an IPO
- IPO Advantages and Disadvantages
- There are benefits and drawbacks to raising money through an IPO.
- Advantages and disadvantages of an IPO
The closing concludes and a company suddenly has $50 million cash in its bank account from the sale of its stock.
Champagne corks are popped and celebration ensues―for a brief period. “Going public” is an exciting event for all involved and may provide many advantages to the company’s operations. However, being a public company has certain disadvantages that should also be considered.
“Going public” refers to a sale of stock or debt in an initial public offering or IPO registered with the Securities and Exchange Commission (SEC).
Stay up to date with the latest on the law!
A “public company” refers to a company that has undertaken an IPO or is otherwise required to be a reporting company under the Securities and Exchange Act. A “private company” typically has a limited number of owners or investors and is not required to file reports with the SEC.
This article discusses some of the advantages and disadvantages of “going public.”
Advantages of an IPO
An IPO and the result of being a public company may provide significant advantages to the company and its stockholders. These include cash infusion, ability to “mint coin,” easier future access to equity and debt markets, liquidity for pre-IPO stockholders and institutionalization of the company.
The common theme of these advantages is that a liquid market for its stock “unlocks” value that the company could not otherwise access. By having publicly traded stock, the discount that is attached to stock of private companies no longer applies.
The result of an IPO is a significant and immediate infusion of cash into the company. This cash is typically “earmarked” for specific items described in the IPO disclosure documents, which can be for a variety of purposes.
For example, the company may use the proceeds of the IPO to expand its inventory, property and equipment base, reduce debt, further research and development or expand its services.
Minting of Coin. Having an established value and liquid market for its stock creates additional “coin” for the company through issuance of additional stock.
This “coin” may be used as consideration to acquire other business and to compensate both current and future employees.
The ability to utilize the company’s stock for an acquisition significantly decreases its cash needs and allows it to engage in transactions without tapping into its “war chest” of IPO proceeds, which can be put to use to fund future growth. In addition, acquisitions using the company’s stock as consideration may be structured as a “tax-free” reorganization, which can allow the sellers to defer taxes on gains associated with the sale of their business.
Using stock as consideration for acquisitions also provides sellers an opportunity to participate in the future growth of the combined organization.
Another benefit of a liquid market for a public company’s shares is that its stock may be used to compensate both its existing and future employees through the grant of options or direct issuance of shares.
The Advantages & Disadvantages of IPOs
Grants of options or stock provide a means to share the company’s success and are a great tool for attracting talented management and employees.
Access to Capital Markets. Being a public company enhances access to both equity and debt markets.
After the company has been a reporting company for 12 months, it may engage in follow-on offerings using a “short form” registration process. The ability to use this process reduces both the time and expense of future equity financings.
As a reporting company, the transparency of its financial position and operations makes it better suited to obtain debt financings.
The infusion of cash from an IPO also enhances the balance sheet and makes the company a much stronger candidate for debt financings.
Liquidity. An IPO provides liquidity to the company’s founders, employees and pre-IPO investors holding the company’s stock.
While the liquidity may not be immediately realized due to “lockup” requirements imposed by underwriters and other SEC rules, being a public company provides a means for the pre-IPO stockholders to monetize the value of their stock at some point in the future.
Institutionalization. Being publicly traded adds to a company’s stature as an institution, which can enhance its competitive position.
The IPO process itself generates publicity that may enhance the company’s recognition in the marketplace. As a result, suppliers, vendors and lenders often perceive the company as a better credit risk and customers may perceive it as a better source of products or services.
Advantages and Disadvantages of Going Public Using an IPO
The stature of a public company can also enhance its ability to attract top level executives and employees.
Disadvantages of an IPO
While going public provides significant advantages to a company and its stockholders, the requirements imposed by securities laws produce disadvantages to the company and its operations. These include increased costs, securities law compliance, changes in corporate governance structure and becoming a “slave to the stock price.”
Costs. The costs of an IPO include both the costs of engaging in the offering process and the future costs of being a reporting company.
Typical costs of raising $50 million through the IPO process can range from $3.5 million to $5 million. Raising less money can increase the percentage of offering costs significantly. These costs include underwriting commissions, legal and accounting fees, SEC and National Association of Securities Dealers (NASD) filing fees, exchange fees, financial printing, travel and other miscellaneous costs related to the offering. In addition to these initial costs, as a reporting company subject to securities laws, including Sarbanes-Oxley, and exchange listing requirements, the company will have significant ongoing costs associated with its operations.
MANAGING YOUR MONEY
These costs include outside directors’ fees and expenses, directors’ and officers’ liability insurance, accounting and legal costs, internal control costs, printing costs for stockholder reports and proxies and costs of investor relations. According to a survey published by Foley & Lardner LLP, these costs average approximately $2.37 million per year, not including lost productivity costs, for public companies with revenue under $1 billion.
The costs are not just monetary.
The IPO process can take up to six months or longer. During this period the company’s executive management team must devote substantial time and energy to the IPO.
Advantages of increasing the size of an ipo
This takes away from management’s time and ability to run the company’s business, and operations may suffer during the IPO process.
Securities Law Compliance. A myriad of compliance issues results from an IPO. The IPO process imposes severe restrictions on the company’s marketing and publicity activities during the “quiet period” preceding the filing of a registration statement.
The registration and reporting process involves the disclosure of significant information about the company that is readily available to the company’s competitors. Following completion of the IPO, the company will be required to file quarterly, annual and current reports detailing its operations and announcing major events.
This disclosure includes detailed information about operations, executive compensation, financial results and significant customers and vendors. Proxy statements must be filed with the SEC before a stockholders meeting can be called.
The company cannot release information on a selective basis and must be careful to assure that the information it releases is accurate and complete. Company insiders and major stockholders also must comply with the Exchange Act requirements for reporting their stock ownership and prohibitions on short swing trading.
Finally, the exchanges where the company’s stock is traded have various listing standards that impose additional governance and disclosure requirements.
The changes to the securities laws resulting from the Sarbanes-Oxley Act have greatly increased the compliance issues that a public company must meet (with corresponding cost increases). These include enhanced auditing and governance standards, additional responsibilities for the company’s independent directors, development and documentation of control procedures and certifications by the CEO and CFO.
How a Company Benefits from the Stock Market
The certification requirements are backed up by possible criminal sanctions for violations.
Change in Corporate Governance Structure. A listing requirement of the major stock exchanges is that the company’s board be comprised of a majority of independent directors. Independent directors cannot be officers, employees, major stockholders or outside service providers.
The Advantages & Disadvantages of Going Public Using an IPO
Independent directors must comprise the audit, compensation and corporate governance committees. This means that the duties of selection and oversight of auditors, setting executive compensation and determining board candidates and litigation issues are taken away from management and given to “strangers” that may have little past experience with the company’s operations.
Another listing requirement is holding annual stockholder meetings. Matters such as calling meetings and presenting proposals to stockholders must now be accomplished in compliance with SEC rules.
A major change brought about by Sarbanes-Oxley was empowerment of the independent directors.
Previous “best practices” of having a majority of independent directors are now mandated by exchange listing requirements.
The independent directors are charged with oversight of the company’s management and auditors. For most companies, particularly where the founders are executive management, the change in corporate governance structure resulting from being a public company may take some adjustment.
Becoming a Slave to the Stock Price. It is often said that a professional baseball pitcher is only as good as his last outing and that a CEO of a public company is only as good as her company’s last quarter.
While a fluid and liquid market in a company’s stock unlocks value, a public company’s stock price is frequently subject to rapid fluctuation. The stock price can be affected by a variety of factors, over which management may have little or no control.
IPO Advantages and Disadvantages
Reporting of quarterly earnings can lead to decision making based on the short term result when a longer term perspective would be better for the company. The close ties between executive compensation and their personal net worth to operating results enhances the dilemma of seeking short-term results at the sacrifice of long-term perspective.
Wall Street can be impatient and, as with baseball pitchers, may have a tendency to look only to immediate past results rather than the big picture.
A loss of stock value can lead to dire consequences, such as stockholder lawsuits, loss of confidence in management and possible hostile takeovers.
Lawsuits can stem from a sudden decline in stock price.
A stockholder lawsuit can be very costly and distract management from running the business. Recently stockholder activism has been on the rise and dissatisfaction with directors (including executive management on the board) has been evidenced by stockholders withholding approval of directors.
There are benefits and drawbacks to raising money through an IPO.
Various proposals, such as mandatory removal of directors that do not win a majority of stockholder approval in elections, are increasing the pressures on management to perform on a quarterly basis. If a company loses favor with analysts and stockholders, its stock may suffer additional devaluation, which could lead to it becoming attractive to a hostile takeover bid. A successful takeover, particularly a hostile takeover, could result in the company’s founders being removed from management positions.
While going public can have many positive effects on a company and its operations, these positive effects must be balanced against the disadvantages.
Going public drastically changes a company’s culture and has an ongoing impact on business operations.
Advantages and disadvantages of an IPO
Determining if going public is the right course for a company to pursue is a major decision and must be carefully considered by management before this course is taken.
Thomas Morgan is a partner in Lewis and Roca’s (www.lrlaw.com) Phoenix office in Phoenix, Arizona. He practices securities, corporate and tax law with an emphasis in public and private securities offerings, private equity fundings, mergers and acquisitions, regulatory compliance, and general tax planning.
He can be reached at602.262.5712 or [email protected]