November 26, 2013
By Michael Kirchner, CPA
There are many reasons why a company might be motivated to go public. Going public can:
- Be an exit strategy for owners or investors, to increase the company’s net worth so they can cash out.
- Create brand awareness and help increase market share
- Raise more capital to complete a merger/acquisition of another company
- Provide compensation options when acquiring and retaining top talent
When raising capital, a public company’s stock vs. a private company’s stock might be more attractive to investors; however, there are negatives to consider. When a company goes public, previously confidential business information will need to be made public, and your competitors will know more about your company's market share and financial position than they would have, had the company remained private. Another concern is that the formality of reporting to shareholders and boards of directors can slow day-to-day decision making.
Here are some real-world examples of why some companies in the technology sector recently went public.
Facebook’s IPO in May 2012 is best known for its technical problems but, despite this difficulty, it set a record for trading volume of an IPO and ended up raising $16 billion. Increasing brand awareness may not have been the motivating factor since Facebook was already a popular household name even before going public -- in fact, many people wondered why they waited so long! What may have pushed the decision was that their business valuation was good and this was an opportunity to make a smart business decision by cashing out at the right time. Going public also helped Facebook fund the acquisition of Instagram for approximately $1 billion in cash and stock.
Twitter is another technology company that was started just 2 years after Facebook and just recently became a public company. Like Facebook, the brand was already recognized before going public. Their business valuation may also have been an important factor in deciding to go public and made the company examine its strengths and weaknesses. Twitter made some important business decisions right before their IPO to show they are evolving to meet the expectations of investors. They added images and video capabilities, and expanded their advertising revenue possibilities.
From these two examples, it’s clear that valuations are important in determining whether it’s the right time for a company to go public. Like the housing market, an independent third party looks at comparable companies to determine what the company is worth. If the valuation matches what the owner/board director’s expectations are, then going public looks attractive.
With all of the benefits of taking a company public come elements of risk. Public companies must abide by strict rules of information disclosure and transparency, which Netflix learned last year. The Securities and Exchange Commission initiated an investigation over a Facebook posting made by Netflix’s CEO, which implied that Netflix’s monthly online viewing had exceeded one billion hours. This came under scrutiny because the information was not shared with investors in a press release or 8K filing prior to the initial Facebook post and, as a result, the stock price of Netflix had posted gains from the time the Facebook post occurred to the following trade day. (View the full story here: Social Media Acceptable to SEC.) A private company is not subject to this type of oversight. In this case, the SEC investigation fortunately did not result in an enforcement action against Netflix.
So what are the indicators that going public might be right for your company? Timing the market is very important. If a certain product or technology is hot at the time and the general industry sector is thriving, that might be a good indicator that a valuation will come back positive. Also, examine whether the benefits of going public with your company are worth the tradeoff of having to adhere to more strict rules and regulations.
In next week’s blog, we’ll discuss how to grow a business in preparation for becoming a public company.