June 25, 2003

All Dressed Up and Nowhere to Go? Go Private.

With the IPO heyday of the technology boom a couple years behind us, a growing number of public companies are re-thinking their decision to go public. The costs of being a public company are increasing significantly, while the benefits are decreasing for many companies. The adoption of the Sarbanes-Oxley Act, the pending reforms to the NYSE and Nasdaq listing standards and the increased scrutiny by the investing public have increased the burden of complying with the regulations that govern public companies. The additional time and effort required of management and the additional costs may be more than small public companies can afford.

New Costs of Being a Public Company

Public companies have always been subject to disclosure and governance requirements. However, recent reforms have increased significantly the costs of compliance. For example:

  • Companies are required to release more detailed information in a shorter period of time and are required to maintain disclosure controls for doing so.
  • Companies are required to have independent audit committees and are required to report on whether they have an audit committee financial expert.
  • Audits of public companies are more expensive because auditors of public companies are required to follow additional procedures, such as the auditor attestation.
  • Increased liability for directors and executive officers deters qualified individuals from serving and the cost of obtaining D&O insurance is increasing.

Some have estimated that these new reforms will almost double the costs of being a public company. Unlike many larger public companies that have ample resources, smaller public companies may not be able to handle these increased costs or attract the necessary personnel.

And, Fewer Benefits . . .

Two of the greatest benefits of being a public company are liquidity and access to additional equity capital. However, as a result of layoffs by investment banks and declining stock prices, many companies have lost analyst coverage. In addition, the pressures of providing reliable guidance in an uncertain economy and the loss of investor confidence in corporations have led to increased stock price volatility. As a result of these factors, many public companies face decreased market visibility, weak valuations, lower trading volumes and greater difficulty accessing the public equity markets.

A Good Time for Going Private

The increased costs and liabilities resulting from Sarbanes-Oxley and other reforms may make going private an attractive option for many public companies that have been "orphaned" by Wall Street and other small to mid-size companies. Leaving Wall Street gives companies an opportunity to get back to basics and focus on their business operations, which may be the only way for a company to turn itself around. As a private company, it is much easier to make decisions for the long-term, such as restructuring or spending time on R&D, without worrying about the ramifications on short-term earnings. Relatively low interest rates may make financing a going-private transaction with borrowed money a possibility. Due to limited activity in 2002 and the large amounts of capital raised in prior years, private equity firms have a significant amount of available capital. As a result, management buy-outs and acquisitions of small public companies may be easier to complete. In addition, there are many large companies with lots of cash that they haven't been able to spend in the recent volatile M&A market who may view small public companies as attractive M&A targets.

Not a Perfect Solution

While going private may eliminate some of the increased costs incurred by public companies, costs may still be higher for everyone in this post-Enron world. Many venture capitalists and institutional shareholders expect private companies to maintain corporate governance standards similar to those found in Sarbanes-Oxley and the evolving corporate governance "best practices" may become the standard for all corporations.

In addition, employee and customer morale often suffers when the company loses the prestige often associated with being publicly-traded. Companies that aren't able to provide a fair price, often with a premium, to their shareholders may also face shareholder lawsuits as a result of the transaction. Finally, going-private transactions can be complicated and may take longer than the company can afford to wait.

A Path for Some

Going private is not the right choice for all public companies. The decision to go private involves careful consideration by a company to determine if such a transaction is the correct choice for it under its particular circumstances. Many companies will be looking for ways to escape the pressures and costs of life as a public company, and going private may present an attractive solution for some.

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