Entrepreneurs who plan to take their company public one day can look forward to announcing their IPO by ringing the bell on the Wall Street stock exchange and celebrating at an extravagant closing dinner with the founding team. However, these heady pre-IPO dreams can quickly collide with a number of significant real-world challenges that public company executives routinely face. This blog post reviews some of the serious issues that public companies routinely face, which should be carefully weighed by private business owners before they decide to go public.
The cost factor – SOEs are heavily regulated
The big difference in how public and private companies are run results from the extensive federal regulations that govern the operation of public companies. Entering the public domain requires company management to learn an entirely new language filled with acronyms, for example, only a few of them are Sarbanes Oxley (SOX), the Securities & Exchange Commission (SEC) and the Federal Trade Commission (FTC). Precepts of federal law and regulations promulgated by federal agencies will require the company to engage in detailed internal compliance procedures, file financial reports, accept independent third-party audits of their financial performance, and comply with operational requirements that did not exist when the company flourished as a closely held private enterprise.
While a successful IPO will generate a sizable financial war chest, there are trade-offs that should be considered by company founders. Once the owners of the company have successfully taken the company public, their management team will have to spend more time and incur significantly greater expense to comply with the federal regulatory regime. Research indicates that the cost for a small company to enter the IPO market averages around $2.5 million. And after a small-cap company goes public, it can then expect to pay an average of about $1.5 million a year in compliance fees. (Read: The cost of regulation on small cap companies)
The Short-Term Pressure Factor – SEC Reporting Requirements
A private company founder accustomed to pursuing a long-term vision for the company is likely to have a rude awakening when forced to deal with the inflexible demands of Wall Street, which focuses on quarterly financial results. The SEC requires all public companies to issue regular quarterly and annual financial reports to all shareholders, and this reporting schedule translates into a short-term mindset for managers and investors. Atlantic magazine dove into the data regarding quarterly reporting requirements and reports that:
“The average length of stock ownership has fallen from eight years in 1960 to eight months in 2016. Nearly 80% of CFOs at 400 of the largest U.S. public companies say they would sacrifice a company’s economic value to meet earnings expectations for the quarter. And companies are increasingly spending to buy their own stock to drive up stock prices, rather than investing in equipment or employees. (Read: How to stop short-term thinking in corporate America)
This short-term focus on financial results imposes such rigid constraints on the operation of the business that, for a private company founder, it can rob the fun and passion of running the business. One question that company founders will want to assess before taking the plunge and going public is whether the big payday the company will get from the IPO is really worth going through the change in vision to a direction. short term for the company.
The Control Factor – Threats to Management from Shareholder Activism
In addition to cost factors, private company founders who take their company public may enter the lion’s den of shareholder activism, which threatens their control over the company. This threat is due to the huge increase in the size and scope of institutional investors, who collectively own 70-80% of all public companies. The Harvard Law School Forum reports that in 2014, the number of activist hedge funds around the world had grown significantly over the past decade with a total of over $100 million under management, and during the period from 2003 to May 2014, 275 new activist hedge funds were launched. (Read: Shareholder activism: who, what, when and how?)
The result is that a small number of fund managers control substantial stakes in most public companies, and they frequently use proxy contests and other tools to pressure the companies they invest in to make major changes. Some shareholder activists today are legitimately concerned about environmental or social issues, but others pose as “benefactors” when, in fact, they are the same or similar to the corporatists of the 1980s. These shareholder activists seek only their interests in disregard of what is best for the company or other shareholders, and they may demand immediate changes to “unlock” unrealized value in the company, then quickly exit the company as soon as possible. the stock price increases. It is a sometimes overlooked fact that these shareholder activists can be wrong in their assessments of the company, and the pressure they exert on the company can therefore be misguided and harm the company.
Even though the demands of an activist investor help produce favorable financial results for the company in the short term, the aggressive tactics that these activists employ often create a big distraction for the company’s management. Additionally, there are other negative impacts that activist investors can have on the business. According to the World Economic Forum:
“. . . Activist investors tend to negatively impact two crucial areas of modern corporate life: sustainability and diversity. There has been an observable decline in board diversity after activist investor campaigns. Some CEOs report that they have had to scale back or eliminate environmental initiatives and Sustainable Development Goals under pressure from activist investors. This raises the question of whether these investors are creating sustainable business value over time, or simply by extracting short-term value through buyout programs, additional dividend payments, or similar types of financial engineering. . (Read: Activist investors are more powerful than ever)
In the private enterprise space, corporate leaders operate largely anonymously, giving them the freedom to take risks, make mistakes, and then quickly adapt to the market and implement changes that will help the business succeed. In contrast, public companies are subject to scrutiny and every major action by the management team will be open to criticism. The company’s annual meetings are open to all company shareholders, as well as industry analysts and the press, and company executives can be pressured to provide answers on a host of business-related topics. business.
Along the same lines, when businesses operate in the private sphere, they will have an easier time keeping their business plans private. Once the company goes public, however, executives have a duty to share information about the company’s projections, plans, and goals. Additionally, the investment community and industry analysts will indulge in rampant speculation about what they expect from the company in the future and they will leak/report information that may or may not be entirely accurate. This type of ongoing, 24/7 public scrutiny therefore adds another layer of difficulty to the successful management of a public company.
Investopedia outlines the dynamic choice that business owners will face when considering moving forward with a potential public offering for the company:
“By selling all or part of a company in a public offering, companies going public receive an immediate influx of capital. While this may appeal to some companies, others understand that public ownership comes at a price. By choosing to remain private, they are not accountable to a large group of shareholders and are able to keep their business plans and finances private. (Read: Why companies stay private)
Access to public markets is tempting. Access to a substantial pool of capital will give the business the opportunity to compete and grow in a way that might not have been possible when operating as a private company. But the factors discussed above that apply to public companies – the strict regulatory regime, increased administrative costs, loss of control, potential shareholder fights and intense public scrutiny – can cause the compromise is not worth the influx of capital that will be obtained through the IPO. These factors drive many business founders to leave soon after IPO to return to the intense freedom, flexibility, and freedom from control that is associated with private companies.
Five different entrepreneurs who have been through the IPO process were interviewed earlier this year by fast company magazine, and they shared highlights of what they learned from their experience in this interesting article. One of the comments that stood out was the following:
“Sometimes the management team of a public company must ignore the relentless short-term focus of the market in favor of the necessary longer-term strategic decisions.” (Read: Patagonia has the perfect gift for your uncle who doesn’t believe in climate change)