Weigh expense vs. benefit before deciding to go public

by Doug Bennett

for the Business Journal

To many owners, going public represents a public recognition of corporate success a financial milestone. It also can be highly profitable.

Yet, the public sale of securities is an expensive process that can subject the institution and its owners to liabilities well in excess of the amount of securities sold, particularly if the sale is poorly planned and supervised. It also can add pressures and continuing costs to the business without contributing to its success.

What going public means.

Going public means registering a company's shares with the Securities and Exchange Commission (SEC) and selling those shares to the public. A first-time offering to the public is referred to as an initial public offering (IPO).

The registration process involves submitting extensive disclosure documents to the SEC for review, which must be approved by the SEC before any shares can be sold. An underwriter will be responsible for marketing the shares.

Once a company has gone public, it faces ongoing reporting obligations with the SEC and its shareholders (quarterly 10-Qs, annual 10-Ks, annual reports to shareholders) for as long as it remains public.

Advantages for the institution.

?Obtaining financing. The sale of stock to the public may provide financing that is either cheaper or more manageable than traditional debt financing. To evaluate the benefits, there must be an in-depth comparison of the costs of public vs. conventional financing.

?Using stock as an employee incentive. Stock options, stock appreciation rights or stock bonuses can be used to attract and retain key personnel. Employees benefit from a sense of ownership, and can benefit from tax breaks and the chance to gain if the stock appreciates.

?Improving the institution's financial condition. The infusion of cash or the refinancing of debt with public equity funds provides liquidity that allows the institution to do something specific pursue acquisitions or provide working capital for expansion of operations. This equity infusion improves the company's financial strength and may open the door for regulatory approval of transactions.

?Stock for acquisition purposes. Public stock can be issued for acquisitions giving the institution greater liquidity. Potential sellers may be more willing to accept public company stock that provides them with greater flexibility and liquidity.

?Leverage future earnings. In the public equity market, an institution can use future earnings to support current financing. Conventional financing frequently relies on current cash flow and capital levels to justify the credit risk. Public equity securities markets give more emphasis to future growth and profitability, which can make more financing available than through traditional sources.

?Prestige. The institution becomes more visible if it is listed on a stock exchange or traded on a NASDAQ market, and it attains increased prestige through press releases and other public disclosures. The institution becomes known to the business and financial community, investors, the press and the general public.

Disadvantages for the institution.

?Loss of management's freedom. Management of a public company must report to a board of directors that owes allegiance to the stockholders. While management of a financial institution may be accustomed to some regulatory scrutiny of decisions, the level of such scrutiny will increase significantly in the public environment. Also, the nature of the public equity markets is to reward short-term profits over long-term potential.

Therefore, management frequently must alter long-range strategies to provide current earnings and dividends. If management personnel also are stockholders, they may make decisions based on this short-term impact on the stock value rather than the long-term impact on the business.

?Loss of privacy. The expectations of new investors and the requirements of the SEC will combine to require disclosure of many financial and personal facts for everyone to read (including neighbors, competitors and the media).

Public companies must not only circulate their financial statements to investors and the public at large, but also explain why performance didn't meet expectations. These annual reports also include information about management compensation and related-party transactions.

?High costs. Going public is expensive. The cost of underwriters, lawyers, printers and accountants can use up to 20 percent of the proceeds of a securities offering. If the offering fails to sell or sells at a price or volume below what was anticipated, the costs may exceed the proceeds, making the entire effort a waste.

Successful offerings also use huge amounts of management time in meeting with brokers and potential investors, developing a marketable prospectus and answering long lists of questions from lawyers, accountants and underwriters. Many business opportunities may have to be bypassed while management focuses on "going public" activities.

Advantages for the owner

?Marketability. The owners gain liquidity now that shares can be freely sold into the market (subject to certain restrictions if their shares are unregistered) or used for collateral for loans.

?Value. The value of the stock may be enhanced due to upward valuation by the stock market. Those institutions in favor with the market tend to trade at higher multiples, which result in greater values than their nonpublic counterparts.

The value of the stock also may increase due to improved marketability of the shares, the perceived maturity or sophistication of being a public company and the availability of more information.

?Sharing risk. A public offering allows spreading the risk of ownership. By selling some of the ownership to the public, the owner uses the public's risk as a hedge against unexpected business reversals.

?Management compensation. Stock options and related types of incentive compensation can provide an owner-manager means of leveraging compensation beyond cash salary, frequently in a tax-advantaged way.

?Diversification and estate planning. Some diversification in personal assets is frequently desired, not only to avoid concentration in risk but also to make a person's portfolio more liquid. Having a public market provides a means to cash out the investment in the institution without a complete sale of the business.

Disadvantages for the owner.

?Sharing rewards. A public offering means sharing the future growth and profitability of the institution. Selling stockholders may feel they gave up too much ownership for too little value if the institution grows significantly.

?Potential loss of control. Once an institution goes public, it becomes a potential target for acquisition or change in control. For some, this is exactly what is desired; for others it is unacceptable.

The degree of risk is related to the dispersion of ownership. A few substantial public owners can force institutions to sell out or buy them out. (Careful planning before an offering can establish important defenses against unfriendly takeover attempts.)

?Stock restrictions. Securities are restricted unless they have been registered in a public offering. Restricted securities must be held for specified periods before they can be sold, and the number of shares that can be sold is limited.

Underwriters usually limit the number of shares the owners can sell in an IPO to avoid the appearance of a bailout by existing owners and maximize the proceeds to the institution.

Of course, the owners can make a secondary offering of their shares any time they wish, but much of the cost of going public must be incurred again as a new prospectus is drafted and new underwriting agreements are completed.

?Increase in management liability. Federal securities laws treat certain types of misinformation as fraud, regardless of the best intention of the manager providing the information. These laws also penalize managers for failing to provide information (as well as communicating incorrect information).

If you are considering going public, contact your financial adviser to evaluate the pros and cons, and determine whether going public is the right choice for your institution.

(Doug Bennett is associate director of accounting and auditing at the Springfield administrative office of Baird Kurtz & Dobson.)

INSET CAPTION:

Once a company

has gone public, it faces ongoing reporting obligations with the SEC and

its shareholders for as long as it stays public. [[In-content Ad]]