Corporate structuring Featured

9:51am EDT August 29, 2005
For many years, there has been a general assumption that going public through an initial public offering (IPO) is a desirable and important rite of passage for an emerging growth company. However, due to the financial costs, increased responsibilities and greater potential for civil and criminal liability of directors and management, many have no doubt hesitated at the suggestion of an IPO.

Despite these and other new challenges, emerging companies should anticipate the eventual return of a sustained, healthy IPO market. Due to the sheer size, liquidity and relative transparency of the public capital markets, new public companies will inevitably emerge from the ranks of companies now building their businesses. The SEC is currently considering comprehensive rulemaking proposals to modernize the offering process under the Securities Act of 1933.

To go public
Below are some of the traditional reasons companies offer when going public.

  • Gain funds. When the securities are sold for the account of the company, the substantial funds derived may be used for such common purposes as increasing working capital, performing research and development, expanding plants and equipment, retiring existing debt, acquiring other businesses or diversifying company operations.
  • Increase company value. A public offering of stock will improve net worth, enabling the company to obtain capital or borrowings on more favorable terms.

  • Find new opportunities. Many companies contemplate expansion through acquisitions of other businesses. A company with publicly traded stock is in a position to use its own securities to make acquisitions without depleting its cash resources.
  • Improve work force. The business may be better able to attract and retain personnel if it can offer stock or options to purchase such stock.
  • Gain personal protection. Public ownership may enable company principals to eliminate existing personal guarantees to lenders, landlords and suppliers, and generally to avoid any future personal guarantees.

Not to go public
In addition to the new burdens placed on public companies by Sarbanes-Oxley, there are disadvantages to going public.

  • Disclosure. Once the public is admitted ownership, information must be disclosed on a quarterly and annual basis.
  • Loss of flexibility. By incurring a responsibility to the public, the owners of a business lose some flexibility in management.
  • Influence. Once a company is publicly owned, management inevitably will consider the impact on the market price of its stock when making various decisions.
  • Costs. Routine legal and accounting fees can increase materially.
  • Loss of control. Insiders may be threatened with by loss of control of the company if a sufficiently large proportion of the shares are sold to the public.
  • Legal action. In the current legal environment, a public company and its officers and directors may become subject to a class-action or derivative lawsuit alleging violations of corporate and securities laws. Even if the claim has no merit, establishing a defense can be time-consuming, distracting and expensive.

A company’s success (or lack of) in an IPO also depends on timing. Consider the predictability of the business’s operating results. The more predictable the operational results, the more prepared a company is for an IPO. For companies that do not have a long or consistent operating history, meeting performance expectations for one or two additional quarters before going public can often add significantly to their credibility with potential investors. Examining the track records of comparable companies that have recently gone public and their subsequent performance in the stock market also provides useful guidance. A company that attempts an IPO before it is ready runs the risk of an unattractive IPO valuation, a postponed transaction, or even worse, disappointing investors with its operating results after going public.
Verne C. Hampton II is a consulting member in Dickinson Wright’s Detroit office. For additional information, visit