This year, the public markets have been off to a shaky start: The month of January saw the S&P 500, Nasdaq 100 and DJIA fall off over 5%. This poor performance is expected to have a chilling effect on this year’s IPO market, causing some companies preparing to go public to re-think their strategy – after all, why jump into public markets if you’ll be given a lower value than the company is intrinsically worth? As it turns out, some may find this to be a blessing in disguise, as the public markets are not always kind to private market darlings. Since their IPOs, many such companies have seen massive underperformance compared to the market as a whole: Angie’s List (-42%), Groupon (-91%), Zynga (-78%), and several more.
Going public has not been kind to these companies and perhaps would have fared better had they stayed private. Many companies choose to stay private, some even refuse outside money altogether, taking a bootstrapping approach to raising cash. In other cases, public companies are taken private, either to be re-introduced to the public markets at a later date, like Wendy’s (+100% since its IPO), or to be kept private in a long term play, like Dell or Burger King. It’s a major decision with enormous ramifications either way, and, as such, it should be a well-informed one. In that spirit, here’s list of the pros and cons of staying private.
Pro: An IPO can be remarkably costly
Going public is fraught with costs. Upfront costs such as legal fees and underwriting fees – not to mention the underwriter’s discount – can quickly add up. An often overlooked cost is the roadshow fee, which bankers charge to generate interest in the company before the IPO, as most companies going public don’t have the cachet of a Facebook or Google. PWC estimates the average company spends approximately $3.7 million directly attributable to the IPO itself, while 87% of CFOs surveyed indicated they spent over $1 million. Additionally, there are incremental business expenses associated with being a public company: Quarterly filings, extra personnel, resources, compliance, all of these add costs. In fact, over 50% of CFOs surveyed by PWC said that going and being a public company was more costly than they’d expected.
Source: “Considering an IPO? The costs of going and being public may surprise you,” by PWC.
Con: Staying private can restrain growth
Avoiding outside money, whether through publicly listing shares on an exchange or accepting VC or PE investment, can cut off major, sometimes vital sources of funds for some small companies. Many startups have negative cash flows, called burn rates, which would put them out of business without an injection of cash. This problem has two possible solutions: 1) Cut spending, or 2) Increase cash-flow in. A lean startup can really only utilize option #2, which itself can be done by increasing profitability or raising cash in the form of debt or equity.
While debt can be extraordinarily useful, it can also kill a company if mismanaged. Equity, on the other hand, is a much more lenient source of funding. The cash from a round of equity investment can be used to grow the business more quickly, driving both the top and bottom lines. Additionally, outside investors can bring great experience, networks, and know-how to the business, making an equity offering potentially far more valuable than just the amount of cash raised.
Pro: Staying private means maintaining control
Many an entrepreneur has refused outside equity investment in order to maintain control over their company. While it is possible to maintain control even throughout equity offerings, it invariably will erode the founder’s hold on the business to some degree, and the dilution of ownership is understandably undesirable. Take Dov Charney’s ongoing struggle over ownership of American Apparel as an extreme example. However, even if a company’s ownership structure is designed such that the founder maintains majority voting control of the shares, much like Mark Zuckerberg did with Facebook, they will have to deal with many more voices as the number of shareholders increases and each one gives their two cents’ worth of advice. If it becomes too much to handle, the company could lose focus and value could end up being destroyed.
Con: An IPO sometimes means raising capital for the sake of raising capital
Ask the owner of any successful privately held company and they will tell you their phones ring off the hook with offers from early-stage investors and investment banks wanting a piece of their pie. Yes, it’s always flattering to be sought after and it may sound like a good problem to have, but raising money when not necessary can be just as bad for a small business as not having enough. “Because we can” is a bad reason for any company to raise capital, as it indicates management has no plans for the cash and it will probably end up being wasted.
It’s very exciting, and a definite ego-boost for the owners, but if management is blinded by the dollar signs, spending can quickly spiral out of control, leading to negligent expense, ranging from developing products that have no market to odd, out-of-place acquisitions, to a bloated workforce. Sometimes, it’s better to just say “thanks, but no thanks.”
Pro: Staying private makes it easier to keep your company’s culture
While some brush off corporate culture as unimportant, this is really more of a reflection that these individuals work for a business with a less than stellar environment. Fantastic culture is what keeps employees engaged and productive in the often demanding environment of a startup company. Bringing in outsiders, public or private, means also bringing in outside cultures, which can clash with the internal one. Further, outside investment solidifies a company’s valuation in the minds of its shareholders, the biggest of whom are often company insiders. Executives becoming paper millionaires overnight may change their attitudes and mindsets with potentially negative consequences. Maintaining a unique culture ensures a tightly-knit team that leverages their strengths, insulating against becoming a bureaucratically burdened cubicle farm of dispirited workers.
While this list is hardly exhaustive, it hits some of the big issues to think over when considering an equity offering for your business. It’s an enormous decision, with major ramifications and compelling arguments to be made for both sides and definitely not something to be taken lightly.