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Considering Your Financing Options When Your End Goal is an IPO

Dec 12, 2013

As a company grows, there is often a need for capital. Many business owners want to know whether certain financing options can impede their ability to go public. Let’s look at some of the issues.

Debt Financing

Loans are the typical example of debt financing, where a business borrows money and agrees to pay it back in a particular time frame at a set interest rate. There are some issues here with the amount of debt adversely affecting a business valuation. The valuation can then negatively affect the company’s ability to go public. Investors might wonder whether their money is just being used to pay off the company’s debt. They want to see profit and whether the company has a good enough product to grow. A company with very little debt may be more attractive.

Equity Financing

This type of capital comes from selling partial ownership of the company in exchange for cash. These investors have a ‘stake’ in the company and typically become more involved in decisions that affect the business. They also have their own specific exit strategy in mind. Be aware that preferred stock and other options can dilute an owners’ share in their company. Owners need to be careful that they don’t give up too much control of their company and become a minority stockholder. Generally, financing a public company is more attractive to investors than funding a private company but it may be easier and quicker to get a deal done as a private company. The SEC doesn’t need to be involved and the accounting is somewhat easier. For example, private companies may work on a yearly accounting schedule whereas a public company has to prepare quarterly financial statements.
But some private equity companies will only work with private companies and take advantage of an IPO as an exit strategy. A skilled private equity fund manager will be good at coming to market at the best time, and this could be a benefit to the company. Another advantage of working with private equity investors is that the company will gain experience in dealing with investors before going public. They will have to answer for their company’s performance and prepare the quarterly financial statements required of a public company.
Keep in mind, there is a concern that a private company gives up some of its rights by taking on venture capital or private equity financing. The private equity company is now part of the board and they, like the owner(s), have their own exit strategy. If the company wants to go public, the board (investors) could say no.  It depends on the attractiveness of the IPO.

In conclusion, carefully consider all financing options as you raise capital. Watch for the pitfalls of giving away too much control or ownership, and be careful not to adversely affect the future valuation of your company. Remember from our previous blog that the valuation will be important in determining whether the company should have an IPO.

In next week’s blog, we’ll discuss the benefits of a risk assessment before a company goes public.

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