Almost every business owner dreams of hitting the jackpot by going public on a stock exchange. Yet when many find out what is involved in taking their company public, they recoil in horror, rapidly coming to the conclusion that this is not for them. This article summarizes the pros and cons of going public for mid-sized businesses in Central Europe.

The case against going public

The case against going public could be summarized under the following headings:

(a) Costs and risks of going public.  Taking a medium-sized company public on a Central European stock exchange can easily cost hundreds of thousands of euros, possibly even millions.  The company must fund these costs prior to the IPO.  If market conditions change and the IPO fails, the company will still be saddled with considerable expenses; despite the fact that the majority of costs are usually success related, there are still likely to be considerable fixed costs (e.g. legal fees).  The risk of such a public failure concerns some business owners, not just in terms of the money involved but also because of the possible negative publicity.

(b) Costs of ongoing information provision and compliance.  A public company must be fully transparent.  At the time of going public, an Offering Memorandum must provide full disclosure of all the information relevant to potential investors assessing the company.  After going public, the company must generally file quarterly statements intended to update the shareholding public with respect to all material developments concerning the company.  Collecting and disseminating this information has a cost, in terms of the staff time required to collect the information and create the reporting. Furthermore, giving your competitors detailed information on your operations may also have a less quantifiable but potentially very damaging cost.  Also, there are various costs related to compliance: stock exchanges will generally require public companies to have a board of directors (who will in turn ask for liability insurance) and various committees of the Board (e.g. Audit Committee, Compensation Committee, etc.) and the costs involved in these can be significant.

(c) Cost of shareholder communications and public relations.  Once a company goes public, it must maintain ongoing communications with shareholders and the general public.  The company must develop a core of analysts who follow and report on the company.  This is generally only worthwhile for analysts once a company’s market capitalization reaches a certain scale (e.g. often in the hundreds of millions of euros).  If such a following in the analyst community fails to develop, the general public does not receive the information and independent verification that it requires in order to develop the confidence necessary to invest in the company’s shares.  This can cause the share price to languish far below the price at which the company initially went public, and also far below the real worth of the company.  This in turn then may make it more difficult to raise additional financing or to engage in Mergers & Acquisitions, as any investors will tend to use the market capitalization of the company as a proxy for the value of the company. 

(d) Possible liabilities.  A company that does not give full disclosure (e.g. where there is an error, omission or delay in information provision) may face potential liabilities.  Class actions by shareholders are common in the United States.  Fortunately, the Central European environment is not as litigious, but the possibility of liabilities still remains.

(e) New skill sets and corporate culture.  Going public often requires new skill sets and corporate culture—more emphasis on reporting may diminish entrepreneurialism.  The corporate culture may need to change to one of greater transparency, or to a more “short-term” way of thinking (e.g. meeting targets for the next quarter).

(f) Possibility of hostile takeover.  Once the owner of a business sells more than 49% of their shares, he or she may wake up one morning to face the risk of losing control of his or her company in the event of a hostile takeover bid.

The case for going public

The main reasons for going public on the other hand can be summarized under the following headings:

Raising equity at favourable valuations.   An IPO may allow shareholders to raise substantial fresh equity at favourable valuations.  This may be used to fund the exit of one or more existing shareholders, or to raise fresh equity for the company.  If the timing is right, when market conditions are good, the equity raised can be extremely cheap—for example, on the Warsaw Stock Exchange, at the peak of the market several years ago, IPOs were carried out at over 25 times EBITDA (Earnings Before Income, Tax and Depreciation). 

Creating a currency for acquisitions or compensation.  Where a company has an aggressive acquisition program, it may use its own shares to fund acquisitions, rather than cash.  Similarly, it may offer shares rather than cash to management or other staff, in lieu of bonuses.  This permits the company to conserve cash and may motivate management (or shareholders in the acquired company) to work hard in order to further improve share prices.

Conclusions

articol scris de Les Nemethy - CEO of Euro-Phoenix Financial Advisors Ltd. (www.europhoenix.com), a Central European corporate finance company focused on Mergers & Acquisitions