You have spent years building a successful company. The company is now profitable and still growing. How will you finance the future growth of the company? Should you continue to finance the company privately, or should you sell stock to the public through an initial public offering? Here are some issues to take into consideration:
It may take years to prepare yourself and your company for an IPO. An experienced management team, a history of sales and earnings growth, and a strong competitive position are qualities the public market will value highly. Audited financial statements for the past three years are very desirable. Companies with a revenue base of $15MM to $20MM, net income over $1MM and a growth rate in excess of 20% (likely to continue) should be able to engage major-bracket underwriters to manage an IPO. Of course, a private company can be any size.
Initial costs of an IPO include legal and accounting fees ($100K-$200K), NASD and blue-sky filings ($10K-$30K), printing and mailing ($50K-$150K), and the underwriter’s discount (usually 7-10% of gross proceeds). A significant hidden cost is that executive attention will be focused on the IPO for months. Ongoing administrative costs include quarterly and annual reports, Sarbanes-Oxley Act compliance, transfer agent, public relations, and taxes (franchise, transfer, etc). After the IPO, a large commitment of time from executives is required for investor relations to inform the investment community and answer questions from shareholders. Do not begin an IPO unless you have the financial and emotional reserves to endure a failed IPO.
In the public market, your goal is to get and maintain a lofty price-earnings multiple like 50 (P-E = 50). Every incremental point of P-E is value in your pocket (as a shareholder). However, in the public market, only companies displaying uninterrupted up-trends in sales and profits are awarded stellar P-E ratios. The instant a public company departs from its expected up-trend its shareholders are promptly handed a severe and virtually irreversible cut in P-E ratio (with a corresponding loss of wealth). If you want to get and maintain a lofty P-E ratio, stay private until all the growing pain of corporate development is surely behind you before taking your company public.
Public companies must routinely disclose sensitive financial information including executive compensation, sales, gross margins, and profits. Some of this information may be used against the company. For example, if your company negotiated product pricing with each customer, you may not want your customers to know your gross and net profit margins.
Executives of publicly traded companies are under constant pressure to increase net profit per share and to avoid earnings shocks. Financial performance of the company is reported every quarter, so there is intense pressure on management to focus on the short-term. This is in sharp contrast to a closely held company in which tax reduction is a primary goal.
Liquidity for the company and owners is a major benefit of an IPO. The company can raise substantial working capital for expansion, debt retirement, R&D, etc. Within certain restrictions, owners can sell their shares in the public market for cash. Having a public market for your shares can increase an owner’s ability to take out personal loans. The liquidity of stock in a public company facilitates the use of stock (as opposed to cash) to effect mergers/acquisitions, and the recruitment and retention of key employees through stock and/or option arrangements.
A company that performs well in the public market will be able to raise additional equity from public and/or private investors more easily than a private company. The stock of a public company can appeal to a broad range of investors because of its liquidity and a readily identifiable market value.
Going public is not the only way to raise money for your company or to achieve some liquidity for the owners. The Securities Act of 1933 allows for private offers that are exempt from the SEC’s registration requirements. Such exemptions include Regulation D, Private Placements, Section 4(6), and Intrastate Offerings. Purchasers for such offerings could be venture capital firms, institutional investors, and accredited or sophisticated private investors.
If you need capital to fuel continued growth, then your story is one of the most appealing to prospective investors. While going public may offer some benefits, there are also negatives and it is a one-way process. Weigh all your options in light of an overall, multiyear financial strategy. An optimal financial strategy might involve several financings in the coming years in order to meet the capital needs of the company while minimizing owner dilution.
For more information, contact our team of industry experts at Impact Capital Group