Why Go Public?
This blog post is the first installment of our "Going Public" blog series; a collection of blog articles dedicated to educating readers on the legal and financial considerations companies need to have when and if they decide to go public. Next week, we'll be covering the different ways a company can go public so please stay tuned.
Why Go Public?
Going public can be the most significant milestone in a company’s life cycle. Thus, it is important to determine whether going public is the appropriate strategy for a company. Certainly, there are a number of advantages and disadvantages that a company must consider in making the decision to become a public company.
Advantages of Being Public
- Access to Capital: Perhaps the most important advantage of going public is that raising capital is much easier, and it will generally be done at a more favorable price (or valuation) than if the company is private. In other words, a lower cost of capital generally leads to an increase in a company’s ability to raise capital.
- Public Disclosure: The continuous disclosure requirements set forth in the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are intended to level the playing field between investors and to reassure investors that they are being treated fairly by promoting transparency in the information provided by companies pursuant to the Exchange Act. These disclosure requirements also make it more likely that financial research analysts and media outlets will cover a company.
- Liquidity: With publicly traded stock, all of a company’s previous investors (generally speaking), including founders, have the opportunity for an exit from their ownership when they believe the price is right. The liquidity derived from having stock freely traded on an exchange or market also provides liquidity to future investors who buy stock in the company after it is public.
- Growth Strategy: If a company is public and wishes to acquire another company, the company can offer consideration in the form of stock. Because the stock can become publicly traded, it has real value and can be used as a form of currency in acquisitions. This also allows the company to keep its cash for other purposes.
- Employee Retention: A public company can use stock options and similar investments, which vest or are earned over time, in order to incentivize employees to help build the company's stock price and to remain with the company to earn the right to exercise the options, which provides employees shares of common stock that are far more liquid than those issued by a private company.
Disadvantages of Being Public
- Cost: For some companies, the increased cost of being public can mean the difference between being profitable or not. The Sarbanes-Oxley Act of 2002 (“SOX”) added even more costs to being a public company, including the requirement that a public company set up, maintain and assess certain internal financial controls. Furthermore, public companies may face litigation from stockholders, creditors and regulators. In some cases the board of directors may feel pressured to settle to avoid bad publicity even where the suit has little or no merit.
- Public Pressure: The pressure to beat Wall Street's short-term goals and meet expectations for quarterly performance can be great. While it is certainly important for a company to show continuing growth, focusing on short-term profit can make it more difficult for the company to invest in longer-term opportunities. For example, if a company wants to hire individuals and make investments in a new business which may take several years to develop, the drag on earnings resulting from that effort may cause investors to be less interested in the stock.
- Disclosure Obligations: Public companies have extensive and continuous public disclosure obligations, including executive compensation, related party transactions, ownership of company stock, litigation, regulatory problems and risk factors. This disadvantage can be especially pronounced, given the “real time” disclosure regime under the Exchange Act and SOX. Indeed, the Exchange Act and SOX may require a company to disclose non-public business information at times when it is competitively inconvenient or even damaging to do so.
- Management Decision Making: Besides the time constraints on management arising from the going public process, pressure from investors to focus on short-term gains can lead to bad management decisions and may impose greater accountability to the company's stockholders for those management decisions. Also, managers and owners of a company will likely be diluted upon completion of a going public transaction, such that they might cede some control of the company and it is possible that the company’s affairs could be swayed by third parties outside of the company’s original control or management base.
- Insiders: In terms of certain going-public transactions such as an initial public offering, it should be noted that the United States’ securities laws impose restrictions on the sales of securities by company insiders, such as directors, executive officers and large stockholders of the company. Insiders must also be aware of their continuing obligations to avoid insider trading when in possession of material non-public information, and to disgorge certain short swing profits for certain transactions made within specified windows that apply to the company’s public disclosures.
Written by Marc Adesso, Esq.
The information in this article is for general, educational purposes only and should not be taken as specific legal advice.