Corporate law, cost of equity, and pressure from the board of directors — crucial STO nuances to consider.
Let’s imagine, you are successful (sounds crazy, I know). You founded a company, raised some money, started growing more and more. Now with that success, you are probably thinking about the holy grail of all businesses – initial public offering, going public on a stock exchange. But as it is said “with great power comes great responsibility”, and being a public company creates new problems and challenges. In this article, you will find certain non-obvious pros and cons of being a public company outside of simply “cashing out” that will help you in making a more informed decision or at least will entertain and educate if you do not belong to an elite caste of pre-IPO founders.
How added liquidity impacts the cost of equity and capital structure
The cost of capital is a financial concept, which tells how expensive the capital is for you, i.e. how high is the interest rate for debt or how much equity you give away in exchange for equity financing. If you are interested in digging deeper into the topic, check other articles in our blog devoted to the topic of the cost of capital and how to reduce it.
How expensive the capital is for you basically depends on the risk of investing in your business and the potential return it may deliver. Going public dramatically reduces the potential risk of investing in your company because of two reasons:
- As now your shares are traded freely, in case an investor is unsatisfied with your performance they can simply sell their stake on the stock market. Otherwise, they could have waited long for years to exit the investment, while the losses would amplify.
- In case of problems with debt repayments, you can always raise more on a stock market or pay your debt with shares, which also reduces the risk for your lenders.
Reduced risk means lower cost of raising capital because you can have a more balanced capital structure, i.e. split fundraising between equity and debt.
Why Facebook would not buy Instagram and Salesforce would not buy Slack if buyers were private companies
Acquisitions are an extremely powerful way to grow. They provide access to new technologies, customers, and markets. However, acquisitions may be very costly. You have probably heard that Facebook bought Instagram for 1 billion dollars, Salesforce bought Slack for a mind-blowing 27.7 billion dollars. Spending such a huge amount of cash is ridiculous, and even the biggest companies don’t have that much on account. What they do instead is they pay with their shares, which they can freely issue and give to owners of the business being acquired. This would not have been possible if the shares were not liquid.
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How corporate law impacts company’s bottom line due to reporting requirements
There is a direct and indirect increase in costs related to being a public company. The direct increase is caused by government reporting requirements, which cause the need to have more people in the legal and accounting departments, the need for annual audits, and similar things. Depending on the size of the business it may cost starting from several million dollars per year. If you are a huge company like Alibaba or Uber you probably don’t care but for smaller businesses, this is a significant cost to consider.
The indirect cost is related to the increased overall bureaucracy. Now you will have stricter financial controls so that shareholders can control spending, decisions will take more time and longer meetings to get approved, public statements will have to be screened by lawyers and PR department so that they don’t impact the share price. All of these are additional overhead costs that slow you down.
Mergers and acquisitions, reverse mergers, hostile takeovers, and leveraged buyouts for public companies
In order to let the company public you have to give up control over it. As a founder, you are likely to remain the CEO but the board of directors may decide to fire you. There are very few companies, such as Facebook, at which founders hold full control over the company.
This also creates additional vulnerability for a company when things go badly. You can actually become a subject of a hostile takeover when someone buys your company on the market against your will. There are the so-called “activist investors” who buy companies they consider underperforming and try to turn them into growing again. There are shady businessmen who will be looking at you to conduct the reverse merger. Instead of taking their company public, they will buy your company, and use it to buy theirs so that they don’t have to go through the audit and legal checks. You will be under the constant need to keep your company strongly performing to overcome such threats.
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How the pressure from the stock market and board of directors impacts the strategic planning horizon
When you become a public company, your share price will be the key metric of your success and performance in the eyes of shareholders and the wide public. Even in the eyes of your executives who will be compensated with shares. This means that “shareholder value” becomes the main buzzword in your board meetings.
This is problematic because it incentivizes short-term thinking. When the company is your own you can navigate the company through the short-term decline or stagnation in revenue that aligns with a greater vision. However, in the case of a public company, you will be under the pressure of shareholders and the public who may not share your vision and will demand changing the direction the company is heading in. Staying long-term-oriented is a big challenge for executives of public companies.
Whether to go public or not is a tough choice, and there are many things to be taken into account. But you should be aware of the fact that there are many forms of going public and there are some alternatives, such as tokenization of your shares, which may work for you if you are not financially prepared for all IPO expenses. Learn more about IPO vs direct listing.
Stobox offers a set of technology tools as well as legal and digital assets consulting in the fields of fintech and digital securities. If you are interested in applying tokenization to your business and getting benefits from the digital transformation, subscribe for a 30-minutes free STO advisoryhere.
Watch our video on “IPO: subtle nuances. Corporate finance, corporate governance, and corporate strategy” and check our other videos on innovative forms of fundraising that can reduce the cost of going public 10-fold or serve as an intermediary option. Subscribe to our channel and watch other videos to learn more about business financing opportunities.