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Why go public?

14 Sep

…and its advantages and disadvantages…

 

Being a “publicly traded” company means that the company has registered its securities with federal (U.S. Securities & Exchange Commission, “SEC”) and state authorities to provide consistent disclosure to the public.  These securities may be sold or traded through a stock exchange (e.g. NYSE, NASDAQ, or AMEX) or quotation service.  The stock exchanges consist of a group of licensed “broker-dealers,” licensed by a financial regulatory body called FINRA, that make a market in the stocks traded on the exchange and interact through intermediaries called “market makers” that provide an efficient way of exchanging shares, even when immediate buyers or sellers are not present.  Basically, being public provides an efficient and transparent means of trading ownership units.

 

As with most business endeavors, there are advantages and disadvantages with being publicly traded.  When the Sarbanes – Oxley Act of 2002 (“SOX”) was enacted to combat large scale fraud in public markets (in response to the Enron scandal), the costs associated with being public have risen and most business people have come to believe that going public was not the ultimate goal of every business – private equity and hedge funds’ rise allow huge private or leveraged buyouts to replace “going public” as the penultimate event in an emerging company’s lifetime.  Still, “going public” is an exercise that can bring benefits, including:

 

  • Increased capital liquidity
  • Increased financial transparency
  • Increased prestige / image through publicity

 

Even then, the disadvantages are great and many times overwhelm the advantages:

 

  • Perceived loss of control
  • Increased complexity of reporting
  • Increased fiduciary responsibilities and management liability
  • Increased business management costs

 

The advantages are almost mirror images of the disadvantages, and the characteristics that tip the scales in favor of the decision to go public can differ wildly from company to company, but may include:

 

  • Being in an industry that the investing public is interested in investing in currently
  • Having financial systems, both personnel and computer applications wise, in place already
  • Having a revenue base large enough or with high enough growth rate to support added costs
  • Having a sound management control system in place to control operations
  • Having professionals in place with experience being publicly traded

 

Of course this is just a sampling.  Here are some of the reasons to go public:

 

  1. Current shareholders want to diversify their holdings, thus offering or being able to sell a portion of their holdings in a liquid marketplace.  Theoretically, an efficient market for the company’s shares will increase the price of the shares, given thriving operations.
  2. There is higher access to capital and more financing alternatives, due to the transparency provided by public reporting requirements.
  3. Being able to provide publicly traded stock options and other stock related compensation allows publicly traded companies to attract and retain high caliber professionals and management.
  4. In almost every instance, there is an arbitrage, or price differential favoring public companies, between public and private multiples (as in multiples of revenue or earnings, such as P/E).  In mergers or acquisitions, this can allow a publicly traded company to purchase other operations less expensively than growing its own operations.

 

Two sides of the business

As the management or controlling interests of a publicly traded company, you actually have two different companies – the operational component and the publicly traded shares.  The publicly traded shares’ parameters, having nothing to do with the operations, will make the shares more or less valuable based solely on themselves; for example:

 

  • Shares are highly liquid (liquidity), evidenced by a high number of trades per day[1], then shareholders are more likely to be able to liquidate their shares without negatively affecting the share price.  Normally, averaging over 100 trades per day qualifies for high liquidity in the micro-cap range.
  • A share price that would provide impetus for “retail investors”, non-professional traders without any SEC or FINRA licenses, to purchase shares (usually I think of the retail bands as $0.01 to $0.50, which normally catches the casual trader, and then $2.00[2] to $25.00).
  • A company’s shares that have share price volatility with strong liquidity (as defined above) is very attractive to “day traders”.
  • A large number of shareholders with over 100 share blocks.  Usually 3,000 or more shareholders is considered a large shareholder base.

 

Every publicly traded company can use its shares as a currency in order to accomplish many things, but let’s focus on using those shares to build either the operations, maybe through acquisitions, hiring professional managers, paying professionals / consultants with shares[3], or securing financing through selling large blocks of shares in exchange for cash.  Those same company can enhance it’s stock by paying for awareness campaigns, employing broker dealers to support its share price, or media campaigns.

 

An interesting phenomenon happens when a company’s publicly traded shares are doing well, defined as the “daily dollar volume” increasing, and the operations are absolutely putrid.  This might happen due to current shareholders coming to a point of liquidity and working in conjunction with an awareness campaign or selling shares into a market that had pent up demand for the shares.

 

Wrapping it up…

 

So, to answer the question, “why would you want to go public”, we have many answers, but most if not all of them have their negative consequences.

 

  1. Your company has another currency, your publicly traded shares, to build your operations.
  2. Your company is considered more prestigious and has more exposure in the media.
  3. Your company provides investors the ability to invest with “an exit” through liquidity and transparency.
  4. You are looking to diversity your holdings in your company and don’t want to sell the whole company.

 


Copyright © 2010 by Rhodes Holdings LLC
Originally published by Pub Articles on September 14th, 2010 (their website version)


 

[1]Many people would think that “number of shares traded per day” or “daily dollar volume” (which is number of shares traded multiplied by the share price at which they were traded) would be important, but if a company is traded below a penny, the number of shares per trade will necessarily go up without being a good gauge of the liquidity.

[2]Licensed stock brokers cannot legally recommend “penny stocks”, defined archaically as those stocks whose shares trade below $2.00.

[3]Unsettling to some investors, a company can immediately pay “non restricted” shares to consultants under an “S8” employee stock option plan.

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Posted by on September 14, 2010 in BLOG

 

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