Why an IPO May Be a Bad Goal

By Robert Moskowitz

3 min read

Every small-business owner needs an exit strategy, but you may want to take one possibility off the table: an initial public offering.

Although going public seems like a great way to become a billionaire, the current outlook for IPOs is disappointing. Only 350 IPOs have been successfully completed so far this year, compared with 1,967 in 2007, Ernst & Young reports [PDF].

This shouldn’t come as a surprise. When you look at the recent history of IPOs, you can find some powerful reasons not to follow suit.

Many startups anger their investors. There’s something broken about the IPO process these days. Facebook’s offering isn’t the only one that has angered investors and turned a good deal of sentiment against an otherwise popular company. It’s become almost routine for startups to suffer financial and technical glitches when they first try to sell stock to the public.

Going public is expensive. IPOs were never cheap [PDF], but today the price of one can easily top $1 million in filing, legal, and consultant fees. This is true even for a small company and even if the offering gets canceled midway through. “Going public is hugely expensive in three ways: the cost of filing for the IPO and selling the offering to institutional investors; the ongoing overhead a public company must take on to comply with regulations; and the non-financial cost of the distraction it creates for management and board members, who are focused on the IPO rather than building the business,” says Karl J. Stark, co-CEO and managing director of Avondale, a strategic advisory firm.

There’s pressure to increase earnings at any cost. One of the biggest differences between running a private company and a public one is that public shareholders tend to steadily (and legally) insist on regular increases in stock prices. They not only hope to sell at a profit, but also want to feel good about their holdings. This puts heavy pressure on management. “The real cost,” Stark says, “is the pressure on annual earnings [instead of] long-term return on capital. Analysts and public shareholders tend to focus on short-term earnings rather than long-term returns, which causes management to shift their focus as well.”

Company secrets get publicly disclosed. Once your company is public, you must reveal all of your decision-making criteria, financials, pending lawsuits, and even your personal compensation. Even worse, you must deal openly and honestly with shareholders who question everything.

SOX compliance costs plenty. The Sarbanes-Oxley Act makes sense from a public-policy perspective, but that doesn’t lighten the burden on management or the company. Even for small public companies, there are heavy requirements for timely reporting on a host of issues. The time, energy, and expense required to comply with SOX can sap your ability to compete with private companies in your niche.

You risk a hostile takeover. With your stock available in the public markets, you may lose control of your company through a variety of takeover strategies. Your board of directors and public stockholders no longer need to support your vision for the company or its role in the world. “This may not be a universal negative,” Stark says, “but it may be a negative for the management team [that] wants to keep their jobs.”

The business is exposed to liability. Civil and criminal penalties hang over the heads of managers who make false or misleading statements, who misrepresent company situations in their public statements or SEC reports, or who can be accused of insider trading or illegal employment practices. “Public companies are subject to shareholder lawsuits, as are private companies,” Stark reminds business owners contemplating IPOs. “So there’s not necessarily increased exposure relative to private firms. But I would think [public companies] have an increased number of lawsuits to deal with.”

Market fluctuations can diminish your net worth. With your stock trading in the public markets, your net worth becomes subject not only to market forces beyond the realm of your company and your industry, but also to emotional swings that can sweep through the ranks of amateur investors like wildfire.

Founders often flounder in public companies. History shows that many founders of highly successful startups simply don’t enjoy operating in a public setting. Beyond the aforementioned pressures, they are often prevented from running the company to the best of their abilities. They also must live with the knowledge that they can be fired solely on the basis of image or relationship failings.

Is all this any way to run a company? It’s better to decide before you go the IPO route.

Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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