3 Reasons Not to File an IPO
Ever since the dot-com era of the 1990s, many management teams at high-growth companies have fallen for the lure of the IPO as the most important validator of success. For most growing companies, however, the IPO is more a submission to a slower-growth future than a mark of accomplishment.
Here are three reasons why growing companies should strive to stay private rather than aim for the public markets:
No. 1: Private companies can ignore “annual” targets
Who made the rule that the 365-day period matters more than a 300-, 600-, or 2,000-day plan? Value creation is about creating cash flow in excess of the cost of capital. It’s about returns to capital over the life of the investment, which in this case is the shareholder’s equity. The annual time period just doesn’t matter in this calculation.
Yet for most public companies, an accounting concept called “annual earnings” gets the most attention. Public growth companies become slaves to managing to analyst expectations. As a result, management incentives/options become easier to manipulate and become a distraction.
This distraction also discourages cash investments, since companies are under greater pressure to show pure growth for growth’s sake. Think about it: Do most public companies avoid better long-term investments in lieu of quick short-term hits? Private companies, when operated to maximize long-term value, can allocate shareholder capital toward projects that create the highest return.
No. 2: Private companies can “sell” when they need the cash
Make no maistake, an IPO is a “sale” of the company to public shareholders. In cases such as the recent Groupon IPO, the existing shareholders only sold a small sliver of their business, but retained the ability to sell more at a later date.
Granted, if a growth company needs to raise significant capital, an IPO might be the most efficient route. But the M&A market for middle-market firms is surprisingly robust, and in some cases may be as liquid and “fair” as the IPO market.
In many industries, eager strategic buyers (e.g., a larger company buying for a strategic reason) are plentiful, and when they aren’t available there are often private equity investors eager to take all or part of the business off your hands. Plus, as is widely accepted, sellers get a control premium for selling to a single majority shareholder. Although a sale may take months and can be fraught with pitfalls, the IPO process is equally challenging and requires disclosing a large amount of confidential company information, which can be exploited by competitors, even well before the IPO occurs.
No. 3: IPOs often inhibit future growth
The resources and dispersion of ownership caused by IPOs may actually limit your growth opportunities. An IPO process and the regulatory requirements of a public company can drain a growing business of much-needed resources. The IPO process alone often consumes a year or more and becomes a full-time job for many of the finance and legal staff, in addition to the valuable time of the CEO and management team. A company also incurs the cash costs of legal and regulatory filings–cash that could otherwise be invested back in the company. Plus, the company must hire a team of people to maintain Sarbanes-Oxley processes, quarterly SEC filings and investor relations.
The bottom line is that an IPO is no panacea. If raising outside capital is not your primary objective, try to temper your IPO dreams and focus instead on investing in your business.
KARL STARK AND BILL STEWART | Columnist | Co-founders, Avondale
Karl Stark and Bill Stewart are managing directors and co-founders of Avondale, a strategic advisory firm focused on growing companies. Avondale, based in Chicago, is a high-growth company itself and is a two-time Inc. 500 honoree.