Should We Go Public? – The Capital Decision

William McMahon
William L. McMahon

In prior newsletters, we have discussed the need for companies to do exit planning and we have demonstrated our expertise in assisting in that evaluation. A corollary discussion may be appropriate for a company which has begun to grow – and that is to determine the optimal capital structure for the company, a structure that provides the most capital and flexibility at the least cost.

Options include increasing vendor credit lines, adding debt, or adding equity. A further question becomes whether that equity should be from private sources or should the company make the leap and go public. There is no cookie cutter approach because each company and each situation present different considerations. We, in conjunction with other professionals, are prepared to help the company analyze its position and make the appropriate recommendations.

The capital decision should be initiated by an analysis of the company’s business plan. The business should take a long-term view of its growth prospects, profitability and its cash requirements – including capital expenditures, repairs and maintenance, human resource requirements, training, R&D, etc. The analysis should include a balance sheet along with the income statement. The company needs to assess its tax position, both current and long-term.

This analysis provides the understanding of the amount of capital required and, just as importantly, the timing of when that cash is required. Based on the indicated requirements, the company and its advisors can look to the advantages and disadvantages of its capital raising efforts.

The capital raise effort is also not an either/or, all-or-nothing event. The company can look to remain private and seek needed capital during early growth and plan to go public later.

The process we are discussing is understanding the advantages and disadvantages of each. We can leave raising debt through loans or mezzanine structures to another time.

The company can choose to stay private and can look to raising capital through various vehicles, whether it be from the owner’s own cash resources, or those of his family and friends, or the owner could branch out to meet with venture capital or angel investors.

There are numerous advantages to remaining private. There is an overall lower cost of compliance, the company can choose to have their financials audited or not, there is no requirement for quarterly reporting, and major events can remain private. The business owner/entrepreneur can make business decisions more rapidly without being tied up in corporate governance matters. Major commitments do not require public disclosures. The entrepreneur can, for the most part, choose who his shareholders can be.

There have been recent rule changes which have made raising private capital less onerous, particularly for companies seeking smaller amounts of capital. Restrictions on private placements of capital have been reduced and caps have been raised to allow companies more flexibility. The concept of crowdfunding has made private capital raising up to $1,000,000 much easier.

With those advantages, however, come disadvantages which need to be evaluated. Stock options, which are important for attracting and retaining employee talent, become less liquid and less valuable. Warrants which can be attached to other forms of capital raises also become less valuable and, in both instances, the owner may need to provide more shares as incentives or more cash compensation to employees. The owner may also find that there is limited liquidity for his ownership. The private investors that the owners seek, whether venture capital or angel investors, may require significant dilution of current shareholders. The process of valuing the business become more complex.

Because of these limitations and risks, the owner may consider taking the company public. Again, there are advantages and disadvantages to the owner and the business.

The initial advantage is the access to larger pools of capital and investors, including institutional investors. Going public can provide a source of liquidity for the current owners and shareholders of the business. The company can use its public stock to enhance its position and stature in the eyes of the public. The shares have a known value and can be used as currency in acquisitions, or to provide options to retain talent. The process of going public provides the potential for a positive message to be sent to its customers and vendors and employees, giving the image of stability and growth.

Offsetting these advantages are the substantial costs of going public, both in terms of cost and in terms of management time. Going public involves a great deal of regulatory burden and will require multiple years of audited financial statements. The process needs to be planned well in advance. In addition to the documentation requirements and the hiring of professionals to manage the process, the executive management team will have to spend considerable time on road shows, presenting the company to potential investors. There is always the risk that even after spending substantial sums, the initial public offering may not be successful or yield the amount of cash planned. Unfavorable market conditions or other events, outside of the control of the company, can impact on the timing and the yield.

There are also substantial costs going forward involving regulatory filings, legal and accounting expenses. Sarbanes-Oxley and other regulations have an impact on the corporate governance requirements for management and the board of directors. Independent directors have more oversight and responsibility for the reporting and controls.

When publicly traded, the company has no real control over who buys the company stock and management becomes much more sensitive to market price fluctuations and short-term decision making in order to keep investors appeased.

In short, the process of raising capital needs to be well thought out and managed. Outside assistance is critical to the success of any decision on raising the proper amount of capital. If you are considering raising capital to expand the resources of your business, Nperspective can assist in this effort.

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