Going Public: The Disadvantages
While going public is often touted as a cure-all, surefire way to gain funds for a company, its not without its drawbacks. If a company is not in a good position to go public, the decision may actually hurt the corporation more than it helps. Even as money flows in from the offering, the costs of setting up and maintaining a public corporation are high, and should be taken into consideration before such a drastic step is taken.
Even before a corporation actually goes public, the costs are high. Its not uncommon for a company to spend a year beforehand just to get the company in shape and gather necessary documents. Day-to-day activities become difficult as employees struggle to perform preparation work and their normal duties. Since investors want to see a company in excellent financial health, every aspect of the corporation must be examined in advance. If a company decides to go public and the offering is unsuccessful, it loses legal and underwriting expenses in addition to the lost capital.
For many business owners, the biggest costs of going public are personal losses. Privacy vanishes in a flurry of disclosure requirements, allowing investors, competition, and the general public to peer into previously confidential details of the company. Cost of sales, net income, major customers, and management salaries become available to anyone who cares to look. In some cases, these disclosures could give a substantial competitive advantage to competitors, especially those that havent yet taken the step of going public.
Those disclosures can also mean huge expenses after a company decides to go public. Quarterly and annual SEC filings are required, and regular tax preparation becomes more complicated than before. Additional legal and accounting staff may be necessary to keep up.
When a company decides to go public, decision-making privileges are quick to go. Instead of making instinctual, unilateral decisions, shareholders must be considered and it may be necessary to consult with the board of directors. The kind of decision-making that made the company successful can give way to actions borne out the desire to minimize immediate risk and maximize shareholder revenue. Unhappy shareholders can drive down the companys value, damaging employee morale, personal wealth, and company reputation.
If insiders of a company fail to hold onto a majority of the corporations shares, the loss of control can be even greater. While this can be mitigated by limiting the number of shares made available, its a costly option to a company that is attempting to raise money. Some corporations going public prefer to offer voting-restricted shares. Such restrictions reduce raised capital in a more subtle way. Investors pay less for shares with fewer privileges, so the total funds raised are lower, even though a large number of shares is being offered.
Despite the drawbacks, many corporations find that going public is the most effective way to expand a business quickly without the use of traditional debt financing. For those that have carefully considered the positives and negatives, the transition can be smooth and prosperous for everyone involved.
Joel Arberman is the Managing Member of Public Financial Services, LLC. We help private companies through the process of becoming publicly traded via an initial public offering (ipo) or direct public offering. Learn more at Public Financial Services.
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