Anyone that watches financial news on cable television has likely witnessed this scene before: Company XYZ Inc. has just commenced their initial public offering (IPO) and the company executives are out in force, ringing the opening or closing bell on one of the major exchanges or on the floor giving interviews. Going public is like an anniversary, birthday and Christmas party rolled into one event. Simply put, it's a big deal for any company and one of the most noteworthy days in its corporate history.
So if becoming a public company is such a big deal, why would any company decide that it no longer wants to be public and retreat to private life? Are there benefits to a quieter existence? How does a company arrive at the decision to cease being publicly traded, and how does it execute a plan for privatization?These are valid questions worth pondering, but to know these answers it helps to first understand why companies want to go public in the first place. First -- and even though this is superficial it is important -- is the prestige factor. For better or worse, investors seem to hold public companies in higher esteem than they do private firms.
Second, a public company has an easier time tapping capital markets to generate funding for day-to-day operations, mergers and acquisitions, and other business. The IPO isn't the only way a public company can use the markets to print some cash. Secondary offerings generally follow IPOs and public companies, particularly larger ones, will frequently sell corporate bonds that are freely traded and readily available to investors to access funding.
Now that we know the two primary reasons for a company going public, let's look at why they may end up private and how this impacts investors.
An Invitation Only
Public companies can be acquired by private firms. There is no law barring this action from occurring and more often than not, the larger private buyer will offer shareholders in the public entity a premium over where the shares last traded since those shares will eventually disappear. For example, let's say XYZ is trading at $25 when a private rival announces its intention to buy XYZ for $30 a share. This means XYZ shareholders will get $30 in cash for every share they own. Not a bad deal if you paid less than $30 a share.
Private equity firms are notorious for taking public companies private only to sell shares to the public again down the road. Private equity groups generally use leveraged buyouts or buyouts financed by large debt levels to fund their acquisitions, but the result is the same: The shares that are currently public will go away.
Public companies that are bought out and turned private generally opt for privatization because the offer is too good to pass or because they are struggling with a languishing stock price. Activist investors have also been to force privatization on struggling public companies.
The Cost of Being Public
Make no mistake about it, being a public company in the U.S. isn't cheap. On top of the annual report and four quarterly earnings updates that have to be filed with the Securities and Exchange Commission (SEC), there are a host of other filings public companies must keep on record to be compliant with federal laws. This requires auditors, lawyers and other professionals and when the tab gets tallied up, some public companies may say it's simply cheaper to go private.The cost of being a public company trading on a US exchange has soared since the passage of the Sarbanes-Oxley Law in 2002. A raCommissiontion to the Enron bankruptcy, the law's true intent is to provide more transparency for investors, which means more scrutiny on public companies. An unintended consequence of this law has been more public companies delisting from US stock markets in favor of private life and fewer foreign firms listing their shares in the U.S.
There are other costs to consider when going public. Issuing proxy mateiouls, hiring a custodian bank, paying dividends, and holding shareholder and analyst meetings all add up. For some companies that are struggling just to turn a profit, it may be a better financial decision to go private. In this case, the company will buy shareholders out, though there is no guarantee of a lofty premium.
Sometimes Private Life Is Better
Most famous people would agree that at some point, fame isn't all it's cracked up to be and being a public company can lead to the same feelings for its executives. In many ways, it's easier to effectively run a business with fewer shareholders to appease. Private companies don't have to worry about what Wall Street analysts are saying or deal with tedious regulatory filings. For selfish reasons, executives may prefer their firm be private so they can pay themselves more and be free of public scrutiny for doing so.
In fact, if recent trends continue, it's a fair bet that more and more companies will turn to privatization as a way boosting profits and executing a better business.
So as I have shown you, there are positives to being public, as well as private. There’s just a lot more to the public versus private debate than most analysts would lead you to think.