The suitability of going public

AT SOME point, private companies begin to open up to the possibility of selling stock to the public, a process known as initial public offering (IPO). Growth is the goal of every commercial enterprise, and going public is a tried-and-tested, though fiddly, way to generate the much-needed capital.

“Companies often issue shares to the public to raise capital,” writes Mary Jade T. Roxas-Divinagracia, deals and corporate finance managing partner at Isla Lipana & Co., a member of the PricewaterhouseCoopers network, in an article posted on the company Web site.

“Business owners believe that by conducting an IPO, one can raise significant capital that can then be used to develop new products and services, increase capacity, expand to new markets or acquire new businesses,” she adds.

Being public traded also gives companies easier access to equity and debt markets, and there are follow-on offerings available that can raise more capital.

“The growth capital raised during the IPO would have also strengthened the company’s balance sheet. This, coupled with the perceived improvement in corporate governance and transparency as a public entity, makes it easier to raise debt financing,” Ms. Divinagracia says.

Liquidity is another benefit that going public provides. Ms. Divinagracia says shareholders can liquidate their ownership in the future at lower transaction costs.

Acquiring businesses is relatively easier for public corporations because they can do so using a combination of hard cash and shares. “This allows companies to expand faster without draining its stash of cash or incurring more debt,” Ms. Divinagracia says.

Before taking the plunge, private firms must first examine themselves. They ought to determine, first and foremost, whether or not they are financially healthy enough for an IPO.

“Aside from this being a requirement of the Philippine Stock Exchange, studies show that companies that performed well and were profitable before going public are more successful. Companies who had weak financial performance before their IPO are more likely to drop out of the exchange,” Ms. Divinagracia says.

“Investors will be attracted to put money in companies that have proven business models and only need capital boost to grow. Track record provides evidence of management being able to deliver on the strategy and add value to the business.”

Unlike their private counterparts, public companies cannot afford to keep all their affairs confidential. Being listed on a stock exchange requires compliance with reporting and disclosing requirements about major business decisions, long-term commitments and compensation of management.

To maintain the confidence of the investors, especially long after the IPO, Ms. Divinagracia says companies should take the time to understand the needs and information requirements of their investors and devise an effective communication strategy.

The quality of the management matters so much because investors, who do not actively participate in an investee company’s day-to-day operations, rely on the management for the growth of their investments, Ms. Divinagracia notes.

“Good governance is critical to a company that is looking to have an IPO. It gives comfort to investors that the company is led by a professional team and a well-functioning board, working together to safeguard the interest of all stakeholders,” she says.

Companies should be aware that there is the constant pressure to show stakeholders only great results, which can lead to questionable practices, especially if there are no check and balances, Ms. Divinagracia adds.

“This risk is further magnified if compensation is linked to movement in the company’s share price, possibly leading management to perform somewhat questionable practices in order to boost earnings.”

It will also be critical to know if the organizational tax structure is optimized for an IPO and life as a public company. Ms. Divinagracia recommends prioritizing tax strategy and tax planning to avoid any leakages that may result from going public.

To be sure, going public can unlock vast financial resources that staying privately run cannot. But, as Ms. Divinagracia puts it, it is not for everybody.

“One has to look at its long- term objectives and assess whether an IPO is the way to go or there are alternative and better ways of getting there. It is a major decision and should be carefully considered. Getting a financial advisor to assess the pros and cons of various alternatives may be expensive but it may help the company avoid an even costlier decision,” she writes.

“Going public is like the ‘ coming of age’ for a person. You can only do it once so it is extremely important to do it right.”