Going public is a move fraught with risk for many family business owners. Yet a surprising number havedone it, greatly benefiting both their companies and their families. In the United States, initialpublic offerings have been popular with owners and investors in the last year, and they are on therise in Europe. Thus it is a good time to review the risks and rewards. Going public can be anexcellent way to raise capital, provide a way for shareholders to cash out, and attract top managers.However, it can virtually eliminate privacy, limit managementÕs power, even set the table for atakeover.
Owners who are thinking about going public must confront some difficult tradeoffs. These weredescribed by respondents to a recent study I completed of 200 owners, managers, and successors offamily businesses from 20 countries, ranging in size from 20 to 2,000 employees. Respondents fromEurope, Asia, and the United States provided extensive written comments about the major advantages anddisadvantages of going public, as well as the best time to do so. Their views are summarized here.While they present primarily a European viewpoint, there is remarkable agreement among respondentsfrom the various continents on the greatest risks and rewards of going public
Easier capital, more liquidity
The survey respondents had all traveled to the InternationalInstitute for Management Development in Lausanne, Switzerland, for a seminar entitled ÒLeading theFamily Business.Ó Of them, 12.5 percent had gone public, primarily to raise capital. Another 27.5percent had considered going public, but ended up not taking action because there was no financialneed for it or because the market was not ready. The remaining 60 percent had not considered theoption.
More of these owners will grapple with selling stock in the near future, however. A considerable 25percent said they would issue shares within the next 10 years, and another 43 percent indicated theymight issue shares.
Owners who had gone public or indicated they would issue shares cited considerable advantages. Oncestock is listed on a stock exchange owners have a vehicle for selling shares in order to raise capitalfor the company, or cash for themselves. Often owners sell shares in small, successive lots as needed,while retaining enough shares to continue to control overall management. The opportunity to financegrowth with equity rather than debt convinced many owners to offer stock to the public. The additionalworking capital enabled them to capture more market share, launch a new product, update technology, orovercome a recession.
There are two ways for a private company to go public. The first is to issue for sale a portion of theexisting stock already held by shareholders. This does not increase the companyÕs liquidity, but itdoes provide shareholders with cash, and gets stock out onto the market. The second method is to issueadditional shares, increasing the capital of the company by the amount outsiders pay for the newshares. This can bring a number of benefits.
Marketability of shares. Shares of stock held in a private company have limited marketability. Going public creates amarket in which those shares can be easily sold. Furthermore, because there is an outlet, banks andother lenders are much more willing to allow family members to use their stock as collateral for aloan. Respondents noted that creating a public market also gives family members who are not workingfor the company a way to convert their shares into cash, at a predictable price, from time to time.(Some owners drafted agreements that limit how many shares can be sold during a certain time period,so that family control and the stock price do not change too drastically.) Designing two differentclasses of stockÑvoting and nonvotingÑcan ensure that the family retains voting power over thecompany.
Solution for inheritance tax. Families rarely have the private wealth to pay estate taxes once an owner dies. The burdenusually falls to the company, and efforts to raise the money often drain the company treasury andimperil its future. By creating a public market, owners can raise the funds for estate taxes byselling shares at the right time.
Increasing the companyÕs value. Once stock is issued publicly, its price may increase remarkably. Outsideinvestors are much more willing to pay a higher price for the stock of a public company than for aprivate one because of the marketability of the shares, the credibility attributed to public firms,and the openness of a public companyÕs financial records.
Cheaper capital.Selling shares on the open market is the equivalent of borrowing money that does not have to be paidback immediately. This improves the companyÕs financial position. It may also enable the company toborrow money at more attractive interest rates. Moreover, respondents who had successful IPOsindicated they were able to raise additional capital in subsequent offerings under even more favorableconditions. The cycle enables a continued infusion of capital, an improved balance sheet, andincreased borrowing power. A public market also provides a way for owners to acquire companies; ownerscan sell shares to raise cash for a purchase, or offer stock directly to the owners of another companyin exchange for their firm.
Manager incentives. Stock incentives can be key to attracting and retaining top nonfamily managers. While sharesin a privately held company can engender a healthy sense of ownership in employees, there are usuallylimited opportunities to cash out. Creating a market for the shares makes the incentive much greater;it also eliminates pressure on family members and the company to buy back shares from departingexecutives. WhatÕs more, outsiders view companies with public shares as more willing to acceptnonfamily executives at senior levels.
Increased prestige. One of the advantages of going public that was widely recognized by respondents is greatercorporate visibility and prestige. If a family company is well run and compiles a record of success,going public will usually widen the name recognition of its products and services, as well as thepublicity they receive. Both customers and investors often prefer to do business with well-knowncompanies.
Many family companies have gone on to international fame after completing a public offering. Examplesinclude Benetton in Italy, Peugeot in France, BMW in Germany, Hoffmann-LaRoche in Switzerland,Kikkoman in Japan, and Marriott in the United States. These companies all went public to sustaingrowth and to give owners greater flexibility in their degree of involvement with the firm.
Less privacy and control
For all its potential benefits, going public involves severalpotential negatives.
Loss of privacy.Respondents indicated that the most disturbing change that occurs when a company sells stock is thelost privilege of being discreet. The companyÕs financial position, the identity of its shareholders,and the degree of confidentiality enjoyed by owners and shareholders will change significantly. Thesalaries, incentives, and perquisites for family executives will become public information. Documentsthat contain highly sensitive information, such as sales figures or the salaries of directors, willhave to be revealed to public shareholders and regulators as a matter of course, or upon request.
Possible takeovers. If a company issues too many shares, an investor, entrepreneur, or competitor can wrestcontrol from the owners. Family owners should retain enough shares so they can continue to elect thecompanyÕs directors and determine corporate actions. If more than 50 percent of the stock will bedistributed, the family can try to retain control by selling the shares widely in small lots, but thisentails risk; an investor can buy up shares and mount a takeover campaign. As an alternative, familyowners can issue only nonvoting stock for public purchase. However, these shares appeal somewhat lessto investors and therefore usually command a lower price.
Changes in board structure. If an investment banker takes a company public, he or she may expect a seat on the boardof directors. Although not law in Europe, it is usually required by the bank, which sees boardmembership as the best way to assure timely access to company information and to exert some controlover decisions. The practice is less prevalent in the United States. Although the family may view thisas an erosion of control, the bankerÕs expertise often contributes greatly to the firmÕs success.Having the person on the board generally advances the companyÕs new status as well.
Limitation of power. Simply put, the company will suddenly have outsiders who have a say in its operation.Shareholder meetings will be more formal and complicated. Approval of the board and consent ofshareholders will be needed on specific matters. Changes in ownership structure or policy, such as astock split or a decrease in dividends, will also have to be made public.
Perhaps the greatest risk, however, will come from shareholdersÕ desire for income. They willgenerally judge managementÕs performance in terms of dividends, profits, and stock price, and willapply pressure to increase dividends and earnings each quarter. If the family is not careful, this maycause management to emphasize short-term goals instead of long-term strategies.
Increased costs.The initial cost of going public is substantial. The underwriterÕs commission, legal fees, printingcosts, registration expenses, and audit expenditures can represent as much as 10 percent of theoffering price. Key executives noted that once the move was made, they had to devote a surprisingamount of time to informing shareholders and the public and to preparing reports, diverting theirattention from daily operations. It may also be necessary to update the companyÕs accounting system soit can produce financial information in a timely manner that is in keeping with the standards of thestock exchange and its regulators. If complex reporting requirements are not accurately fulfilled,executives could be subject to various legal liabilities, such as charges of creating false ormisleading reports.
Where and when to go public
Deciding to go public is one challenge. Actually doing it isanother. The two big questions are where to issue stock, and when.
It is much easier for large companies to go public than medium-sized ones. The legal formalities areless well designed for placing medium-sized family businesses on a stock exchange. Furthermore,taxation, regulations, and administrative requirements for admission to the biggest stock exchangeshave been drawn up for large companies; their complexities and costs are highly dissuasive formedium-sized firms. Medium-sized companies will do much better by first joining over-the-countermarkets or regional stock exchanges, both of which can be very productive.
Investors tend to look for companies with several years of strong, steady growth and rising profits.To them, these numbers indicate managementÕs ability to compete over the long run. An owner shouldissue stock only after the company has established such a track record, or the response will likely besmall. Some investors also will not consider investing in an IPO unless the company can anticipatevery significant growth over the next few years.
Even if a company satisfies these criteria, however, market conditions might not be propitious at thetime the company wants to place its offer. The market for initial public offerings has variedsignificantly, from the depressed levels of the mid-1970s to the record highs of the mid-1980s.Political developments, interest rates, the rate of inflation, and economic forecasts all influencethe mood of the investment community.
There is no sign of a slowdown in IPOs in the United States this year. Market analysts predict therewill be renewed interest in going public in Europe in the near future, particularly as inheritance andsuccession issues arise in family firms. Family businesses that have a success record and futurepotential, a need or desire for capital and liquidity, and a willingness to lose some privacy andcontrol might find it an optimum time to consider going public.
Monica Wagen is a research associate at the International Institute for Management Development inLausanne, Switzerland. She is a lawyer and holds an MBA and DBA.