Strategic Acquisition or IPO?
Successful entrepreneurs frequently reach a point where they want to monetize a portion of their company's value by selling to either a strategic buyer or offering shares to the public markets in an IPO. While the primary consideration is often price--the greatest amount of money that can be obtained for their company, there are other critical factors to consider as well. The decision also depends on a company's growth prospects, as well as the goals and preferences of the CEO and management team.
If you are in this situation and deciding between an IPO and a strategic acquisition, consider which one is your best choice. An IPO is a financing event, not a liquidity event. Because CEOs and other early investors may not be able to sell immediately, much can happen--both good and bad--before you are allowed to sell shares because the underwriters will demand a lock-up period on your shares. An IPO can be an attractive option, however, if you and your management team value your independence and wish to continue in your current roles.
In a strategic acquisition, by contrast, one of two outcomes will generally occur. In the first case, you will be required to stay on well after the transaction, with your compensation closely tied to the ongoing performance of the firm; in the second instance, you will immediately receive cash or unrestricted stock for the full value of the ownership interest, but will not have a continuing role or direct financial interest in your company's future growth.
Consider the case of Physicians Formula, a California-based premium cosmetics company with an array of innovative, color-corrective products. In 2003, our firm acquired a stake in Physicians Formula. From 2003 to 2005, the company's sales and income from operations grew by more than 20% per year. By 2006, in a strong market for growth IPOs and mergers, the company's board, which included members of the management team, decided it was time to realize some of the company's value.
Given its strong growth and market position, Physicians Formula was attractive to both strategic buyers and the public markets. The company evaluated several offers from acquiring companies before ultimately pursuing an IPO. Physicians Formula's management team chose to go public rather than pursue an acquisition for three primary reasons.
The first deciding factor was value. In many instances, strategic buyers are willing to pay more than the public markets for a specific company because they anticipate synergies--ways in which the acquired company can enhance the value of the overall organization. However, in the case of Physicians Formula, the public markets had been primed by a series of successful consumer product IPOs. As a result, institutional investors were looking for similar companies.
The second consideration involved the company's employees. Physicians Formula's management made it clear that they wanted to take care of their entire team. Knowing that strategic buyers often cut costs by eliminating duplicate departments and functions, they decided on an IPO that would allow them to keep their current employees in place.
Finally, the company's managers--who were not interested in retiring--wanted to continue building and extending the Physicians Formula brand. An IPO not only would provide them with the resources to expand the company's product line and distribution channels, but also would give them the independence to pursue international growth.
For all these reasons, Physicians Formula opted for an IPO. In November 2006, the company went public in a very successful offering that raised $147 million. Physicians Formula's offering (NASDAQ: FACE) was initially priced at $15 to $17 a share. Shares priced at the top of that range, while the size of the offering was raised from 6.25 million to 7.5 million shares with an additional 1.1 million shares offered as a result of the underwriters' exercise of their over-allotment option, bringing total shares as a result of the offering to 8.6 million due to strong demand. Today, the company continues to grow, selling through 26,000 stores nationwide. With its team still intact, Physicians Formula possesses the added stability and resources that come from access to the public markets.
An IPO was the right choice for Physicians Formula. However, that is not always the case for every company. Entrepreneurs who seek immediate liquidity--or who face succession planning--may want to sell to a strategic buyer to realize their company's value and exit the business. Others who are concerned about the costs and burdens of Sarbanes-Oxley compliance may see acquisition as a more attractive and less complicated solution. Furthermore, since the IPO market is cyclical, it may not be open to companies with less-than-stellar growth records; and when a company is finally ready, the market may not be open to any companies. Acquirers, on the other hand, may see the unique value in these companies because of their expected synergies.
Bottom line: IPOs are not inherently better than acquisitions, or vice versa. The right choice depends on your personal goals, your company's objectives, your management team, your investors, your employees, and the market environment. When you are in the process of evaluating these alternatives, having a top-flight board of directors is vital to making the right choice. Only by carefully considering all your objectives and priorities can you come to the best decision.
Walter G. Kortschak is a managing partner of Summit Partners, a private equity and venture capital firm with offices in Boston, Palo Alto, and London. He is a board director of Physicians Formula (NASDAQ: FACE). Summit Partners invests in growing, profitable companies. Walter can be reached at 650-614-6600 or email@example.com.
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