Why some of America's best private companies have chosen to ignore this year's hot stock market and decided to keep their companies to themselves.
GOING PUBLIC. IN SOME CIRCLES, IT is considered the ultimate rite of passage for any company, the entry as a legitimate member in the nation's most exclusive business community. Companies that don't trade on Wall Street -- or ones that don't plan to -- exist in the dim netherworld of the national business consciousness, undiscussed and unheralded or even dismissed.
Earlier this year, with the market for initial public offerings as hot as it had been in three years, the pressure to take a company public and cash in for millions was all the more intense. In the first nine months of 1986, more than 400 companies opted to play under Wall Street's glaring lights, netting $12 billion for company owners, investors, and their minions of investment bankers. By now, you've probably read at least one of the accounts of Bill Gates's score with Microsoft Corp.'s offering or heard the fantastic story of Home Shopping Network, which jumped from 18 to 42 2/3 on its first day of trading. It's unlikely, however, that you've ever heard of Warren Braun or ComSonics Inc., which is precisely the way Braun prefers it.
"The problem is that people mistake Wall Street for business. You end up putting all the focus on impressing the folks in New York with short-term earnings," says Braun, chairman and chief executive officer of a $7-million cable-television equipment and service company in Harrisonburg, Va. "A private firm can focus on the more crucial things, like maximizing long-term growth and profits."
These are not just penny-ante companies that are choosing to stay private. Many have respectable sales, healthy profits, and histories of steady growth in attractive industries -- just the sort of firms that make investment bankers salivate.
"We're hit up all the time, at conventions mostly, with propositions from investment bankers and business consultants," says Carlton Cadwell, president of Cadwell Laboratories Inc., a medical-electronics firm in Kennewick, Wash. "But I don't need them. To me, it would be like selling my soul. Having investment bankers on my board doesn't turn me on."
It's not hard to figure out why investment bankers swarm around Cadwell's convention booth. Since its founding late in 1979 by Cadwell and his brother John, a physician and medical researcher, the company has established itself as a world leader in electronic devices that measure various brain functions. With sales now well over $10 million, Cadwell Laboratories has been growing at nearly 40% annually and has never had a year without a profit. Staying private, he figures, is the best way to continue the trend.
"The disadvantage to us, if we go public, is that we would no longer be primarily accountable to our customers and our products," says the 42-year-old dentist. "You become prisoner to a quick-hit mentality. I'm a long-term-planning kind of person."
Last year, for instance, Cadwell siphoned much of its double-digit profit margins to finance the yearlong development of a revolutionary new machine that evaluates brain functions. Using novel software developed jointly with New York University Medical Center researchers, the Cadwell Spectrum 32 can track brain-wave patterns that aid psychiatrists in diagnosing and monitoring treatments for such disorders as alcoholism and depression. Now, instead of selling his machines only to the nation's 8,000 neurologists, Cadwell has a big, new market: 30,000 psychiatrists.
"The Spectrum 32, I'm convinced, will be our leading revenue producer in a year," Cadwell predicts. "But would they -- the stockholders, the investment bankers -- have sacrificed much of last year's profit for this? I doubt it. I guess it boils down to the fact that these high-rolling types just aren't my kind of people."
Kenneth George, on the other hand, makes his living off high rollers. Still, as president of Birr, Wilson, a small brokerage and investment-banking firm in San Francisco, George has turned down numerous offers from other investment banks to merge or go public. Instead, he prefers the ambience of a comfortable regional firm that affords him and his 170 brokers the luxury of concentrating on providing quality service to local clients. George watches the public markets for a living, and he shudders at what their relentless need for ever-greater profits would do to his own firm.
"When you get hooked on the numbers, you tend to become mass merchandisers," explains George, whose $35-million firm has been growing 15% a year over the past decade. "You tend to stop doing what the client needs and start peddling whatever the company needs, just to keep the stock moving."
George says his decision to stay private is a matter of preference, not principle. But he adds quickly that even some of Wall Street's biggest and most profitable investment-banking firms, such as Goldman, Sachs & Co. and Lazard Freres & Co., remain proudly private.
How large is this universe of private companies that are big enough to go public, but don't? There's no way to tell exactly, but David Birch, Massachusetts Institute of Technology's small-business expert, estimates that private companies with more than 100 employees now account for nearly one-fifth of the U.S. economy. By comparison, all public companies account for about twice that amount.
Some of these private firms are actually quite large and well known, like Bechtel Group, the world-class construction and engineering firm, or Ernest and Julio Gallo's wineries, or the Pritzker family's private conglomerate, which includes a law firm and divisions that manufacture everything from aluminum forgers to boxcars.
But by and large, this is a hidden economy, wedged unobtrusively between the boisterous giants whose shares are traded on Wall Street and the small shops, offices, and factories of Main Street -- midsize firms such as those you might see on the annual INC. 500 list of America's fastest-growing private companies. Only 17 of last year's 500 companies took advantage of this year's hot market. And in a recent survey, more than half the CEOs responding had little or no interest in even considering going public in the future.
Going public, of course, sometimes is more a matter of necessity than simply the desire to cash out. A start-up in the semiconductor industry, for instance, might require a capital investment as high as $30 million, which would be difficult to raise privately. But most firms find themselves in less capital-intensive industries, and they have found ways to finance their growth without surrendering control, whether from reinvested earnings, bank loans, industrial revenue bonds, or employee stock ownership plans.
At Computer Technology Associates Inc., in Englewood, Colo., for example, Carmelo Elliott ("Tom") Velez has financed the growth of a $36-million computer-engineering firm with retained earnings and a modest $5-million bank line, secured by accounts receivable. And although his government clients have begun to demand more cost sharing for research-and-development projects, Velez is adamant that he won't turn to Wall Street for financing.
"If the Department of Defense wants me to bid on something on Star Wars, it might cost me now, but it's key to my long-term business," Velez explains. "In this business, we can't serve more than one master -- and that master is our client. If we have to spend a few dollars to make him happy, I don't want to have to spend my time dealing with investors who want to know why."
Of course, staying private does impose certain constraints and disciplines, particularly on a company that has been growing at a 64% compound annual rate since its launch in 1979. It has no huge corporate war chest, nor does it have any of the trappings of corporate grandeur that became de rigueur for much smaller companies during the last IPO gold rush of 1983 -- the speculative real estate purchases, the fleet of company sports cars, the elegantly furnished headquarters decorated with pricey art.
"I keep my expenses totally in line with my growth, and that's it," says Velez, who grew up in New York City's Harlem. "If I need another office, I rent it.If I need furniture, I rent that. I use the money to do what I need to do. I don't see where it helps just to have millions sitting in the bank."
Often, you'll find some of the largest and most successful private firms in industries that Wall Street now considers unattractive, either because margins are too low or there is too much competition from overseas. Consumer electronics, only a generation ago Wall Street's happy hunting ground, now is something of a no-man's-land among public companies. But the privately owned Bose Corp., headquartered in Framingham, Mass., a worldwide leader in stereo equipment, continues to thrive. Bose's sales have jumped an average of 30% annually, last year to $130 million. And founder Amar Bose credits much of his success to his decision to stay clear of the public equity markets.
"We win only by staying on the cutting edge of technology, and that can't be done by just following short-run goals," Bose says. "No one ever won a chess game by betting on each move.Sometimes you have to move backward to get a step forward."
Recently, Bose sank some $13 million into developing the prototype of a new carstereo system, in the hopes of a long-term relationship with General Motors Delco Electronics Corp. division. Although it was clearly a risky proposition, Bose believed that an eventual deal would provide a vital counterbalance to the company's traditional audiophile market.
"It would have been impossible as a public company," Bose says of the GM project. "I certainly would have lost my job." In fact, he's still there -- and so is the car-stereo line. General Motors started offering Bose's new system as an option one some of its more expensive car lines in 1982, and by 1985, the original $13-million investment had been fully recouped. This year, the General Motors partnership will account for more than 20% of Bose's sales.
Nowhere did IPO fever hit harder in 1983 than in California's Silicon Valley, where going public was the way to instant riches and respectability for hundreds of high-technology companies. Over the past few years, the fever has subsided as the industry slumped. And many of the founders and entrepreneurs who had decided to cash out now find themselves tossed aside like so much excess baggage, often by the same investment bankers who had fawned over them and convinced them of the glories of going public.
Jerry Rochte might have suffered the same fate. Back in 1983, his Cavro Scientific Instruments Inc., in Sunnyvale, Calif., would have been an ideal candidate for an IPO, a $5-million company with sales of precision liquid-handling instruments that had been growing 30% annually since 1972. But a year later, disaster struck. The company's largest customer, Syva Co., a subsidiary of Syntex Corp., cut its orders drastically, and sales dropped 50%.
Rochte envisions what this debacle would have done to a public company."The demand from shareholders would have been to cut back the business," he figures. "With our sales down by half, the demand would have been to lay off workers or get rid of facilities." But as the CEO of a private company, Rochte's highest priority was not to boost the fading bottom line, but to find new customers. Cutting back key sales and development staff might have improved earnings for a few months, but at the expense of undermining the company's ability to bounce back from the doldrums.
"When you're public, the financial people take over," Rochte says. "You end up focusing on today's numbers as the be-all and end-all. Companies lose their identities; they are simply chips on a board. And you forget that profits aren't everything. Survival is everything."
To survive, Rochte covered his operating losses with $2 million from retained earnings and launched a new sales drive, which soon turned the company around. Today, Syva represents only 10% to 15% of total sales, down from 70% in 1984, while the number of other clients has increased sixfold. Sales this year are expected to climb to more than $6 million, a 20% jump from the predisaster period.
Rochte's argument is that the head of a public company inevitably comes to look at his company as merely a financial asset. "You start laying off to make short-range financial goals, and in the process, you destroy the organization. In a private company, you're more apt to have the sense that the organization is an entity with a purpose -- an organization of people with compatible skills who make a product and serve the customers. And that purpose is something worth protecting."
Warren Braun knows firsthand what it's like to be part of a financial asset. For 15 years, Braun worked happily for a Washington, D.C., television broadcaster, rising from engineer to station manager. Then in 1957, the owner retired and sold off his group of stations to the first of a succession of corporate owners. Over the next eight years, Braun worked for four different managements.
"It was terrible," Braun, now 65, recalls. "Wall Street guys come in and load up all the debt. That creates nothing but headaches for the guys doing the work. You don't have any stability on the staff. There's chaos at the top, and it runs through everything the company does."
Frustrated, Braun decided to go out on his own, opening a television consulting business. Slowly, as his client base grew, he saw an opportunity for a service company providing field repair services, system design, and testing for the emerging cable-television industry. He finally incorporated ComSonics in 1972, with a clear sense of what kind of business he wanted to run.
"I felt very strongly about staying private after all that I had seen," Braun says. "I couldn't just talk about it. I had to make it happen." And so every year, Braun has been slowly selling off his interest in ComSonics to company employees, who today own 99.45% of the company. In fact, Braun, who calls himself a "CEO without portfolio," is just about the only person in the company without any stock.
"I have a lot of faith in what employees can do if they are treated right and properly motivated," Braun says. "When I worked for other people, I saw colleagues work their buns off and get nothing out of it. I saw Wall Street rape employees. That confounded drive to make money quickly really does nothing for the whole company's performance."
Today, in an industry racked by pervasive merger mongering, privately held ComSonics has developed a reputation for steadiness. The annual employee turnover rate is less than 3%, about one-seventh the industry average. And an average 25% annual growth has been financed by reinvesting two-thirds of the company's gross profits. In addition, industrial revenue bonds helped finance a factory for manufacturing cable-TV-related products, which now account for roughly one-third of the company revenues.
As for Braun, he's planning to retire soon and walk away with about $1 million in cash, his proceeds from selling his interest in the company.He estimates that had he gone public or sold out to another firm, he might have wound up with two or three times as much.
"I'd be the first to admit I'm not making as much as I could," Braun says. "But I have more than enough to be comfortable. In spiritual and moral return -- well, I'd say my satisfaction is simply far greater."
Staying private, however, does not require such a well-restrained passion for making lots of money. In fact, John Oren, president of Eastway Delivery Service Inc., in Houston, sees staying private as the best way to make the most, while still doing things his own way.
"It comes down to money, and when it comes to me, I don't want to have to ask anyone how I get paid," says Oren, who bought the company in 1979, when he was Eastway's general manager. "I pay myself a salary that shareholders would never give me, pay my taxes, and go down the road. Having total control of my life is where I'm at. The company is a reflection of that."
Like the owners of many other private companies, Oren believes that investing in his own company -- which has been growing at better than 40% for the past six years -- simply represents a better financial alternative than putting his money anywhere else. But that might not be true if Wall Street were calling the shots. Oren believes that he couldn't achieve the same quality of growth if he were pressured, as are his publicly owned competitors, to rack up the numbers by buying up other local-delivery services willy-nilly -- acquisitions that might not be compatible with Eastway's strategy.
There is about Oren the plainspoken, action-oriented aura of the archetypal Texan. So it should come as no surprise that he eschews memos, long meetings, and the other trappings of the publicly held corporation. "We want to be able to move fast," he says. "When I decided to move into Sacramento, we made the decision in a matter of a week. Hell, we make more decisions in the hallways here than most companies make behind closed doors. We like the freedom to make a successful decision, or even an unsuccessful one, without having to explain it to some analyst.
"Just screw those guys on Wall Street."
Mostly, personality and culture separate Wall Street -- the analysts, the fund managers, the investment bankers, the New York business press -- from the world of private companies. Wall Street cannot deal with the idiosyncrasies that provide the energy for so many entrepreneurial ventures. In its paint-by-number universe, there can be little appreciation for the technological artistry of a Carlton Cadwell or an Amar Bose, the survival instincts of a Jerry Rochte, the altruism of a Warren Braun, or the bite-your-neck egoism of a John Oren. Wall Street tends to see money as the only real commodity; how one generates it is not really important. "We're not money hungry," explains Cadwell. "We're good at what we do, and we enjoy what we're doing. We feel we're making a big difference in people's lives, and that turns us on.
"I guess this is something those Wall Street guys can't understand," he adds. "Every year, I see them at the neurology convention, and they can't believe we're still in business. They can't believe we can make it without them. They think I'm a fool. Now we don't even talk to them. We just want them to go away."