The decision to stay private or to remain public is one of the most critical in the life of a company. The availability of a variety of financing options from the private equity and banking sectors has provided both large and small businesses with an alternative to a formal listing on one of the main stock exchanges.
Many companies are also considering de-listing from the stock exchanges through public to private transactions. There is often a belief that the market is undervaluing their business prospects or that life outside the public gaze is less onerous.
However, the public markets, at the appropriate time, provide excellent liquidity for investors and facilitate the use of company shares for fund raising, acquisitions and strategic purposes.
In our latest newsletter, we explore the options of staying private or remaining public. The ultimate decision for the company rests with the option that facilitates the growth in shareholder and stakeholder value.
Why do companies want to go public?
There are many reasons for companies to seek a listing on a major stock exchange and in the appropriate circumstances these far outweigh the associated regulatory and related costs. These are:
- Capital for growth. Fast growing companies are often constrained from rapidly raising funding in the private markets. Public companies can raise funds efficiently from equity investors through rights issues and the sale of shares to domestic and international investors. Similarly, once a company is listed and has developed a diverse investor base, it opens possibilities to access the domestic and international bond markets. The hybrid securities markets are also available and provide a variety of options such as convertible securities.
- A currency for acquisitions. When a company is public, shares can be used for acquisition purposes as the stock market provides both liquidity and a clear valuation of the business. The shares can be exchanged for those of a target company or funds can be raised from investors to pay for a specific transaction.
- An opportunity to exit the business. For the shareholders in a private company and for employees with stock options, a stock market listing provides a market valuation for their equity holdings. It also provides the opportunity to sell all or part of their shares and to exercise their options.
This is of particular importance to short-medium term financial investors looking to exit all or part of their investments. However, it is normal practice when a company obtains its primary listing for existing shareholders and particularly for management to be locked-in and prevented from selling their shares for a short period.
- Prestige and peer pressure. Companies on attaining a certain size in an industry and where the leading players are all listed on major stock exchanges often feel that it is necessary to join the “club” of their listed peers. A listed company can also attract talented management and employees in an industry helped by the resulting transparency of the business prospects.
Becoming a public company is an important milestone in the development of many businesses. Being under public scrutiny requires more rigorous regulatory and governance procedures. In addition, a company must be prepared for the enhanced financial reporting requirements and the resulting analyst and investor attention. However, these procedures can be very effective in professionalising and in providing a strong platform for the development of a business.
Why are many companies looking to revert to private status?
Notwithstanding the many positive benefits of a public listing, there are a number of public companies or large private companies that have eschewed the public markets and have remained private. The main reasons are as follows:
- The availability of alternative sources of capital. The phenomenal growth of the private equity market over the past few years provides an almost limitless amount of equity capital for companies with the requisite growth prospects. There are an increasing number of the private equity groups managing funds of several billion dollars combined with an increased capacity of the banking community to provide significant leverage for transactions. This has provided a realistic option for companies with small, medium and large market capitalisations to revert to private status.
- Undervaluation by the public sector. There are certain sectors which at times become unfavourable for institutional investors. This is often the case for companies which are complex to value, including holding and property companies. The market often values such businesses at a discount to the net assets and provides an investor group with the opportunity to purchase the assets at an attractive price.
- One classic example is the Virgin Group in the mid-1980’s. Richard Branson, the flamboyant entrepreneur, wanted to raise funding to develop his airline, music and related businesses and he therefore floated part of his group on the London Stock Exchange. The group’s share price underperformed the market and two years later Richard Branson took the company private, citing that the investor community was short-term focused and misunderstood the growth prospects for his businesses.He has since grown his group internationally in a variety of sectors, including budget and long haul airlines, train operations and mobile phone networks.The group has typically raised finance through individual transactions such as the sale of the music business to Thorn-EMI, the formation of a $600m joint venture between Virgin Atlantic and Singapore Airlines or through the flotation of Virgin Blue, the budget Australian airline.
Ability to restructure a business outside the public eye. An undervalued business or a business in need of restructuring can be taken private and reorganised without the quarterly reporting requirements and the associated analyst and media attention.
Management and investor incentives. Taking a company private, restructuring it and then concluding a sale of the business either in the private or public markets can be very profitable for the management teams and their financial backers.Institutional investors are however aware of the upside potential in a successful public to private transaction and are consequently demanding a higher premium for the initial sale. They are also often sceptical about the upside potential when a company returns to the public market following a restructuring. Notwithstanding these reservations, there remain significant incentives for a successful public to private transaction.
Whilst strong corporate governance is required for all companies, a private company has a reduced regulatory, media and analyst burden as compared to a public company. However, private equity investors and bankers are rigorous in their monitoring role of their investments and the management team are set strict performance targets. Successful exits are very well rewarded with management teams typically awarded 10-20% of the equity in the business.
With the availability today of almost limitless amounts of capital, large and small companies with solid growth prospects have a wide range of options in deciding on their public or private status. The regulatory burdens of running a public company today have become onerous and this is prompting a number of companies to consider the attractive option of private status. Whilst the governance and professional requirements are the same whether a business is private or public, the ability to restructure and refocus outside the public eye is a tempting option and provides the management team and the shareholders with strong potential financial incentives.
Selecting and executing the appropriate strategy to support a business throughout its development cycle requires the necessary management expertise, combined with sound financial advice.
The views expressed in this newsletter are those of DC Dwek Corporate Finance Limited and are provided for information purposes only.