In the past four months, the North American IPO market has shown some signs of a resurgence, at least in relation to the two years that came before. Given this potential rebound, this edition and the next couple of editions focus on the IPO legal process, together with certain legal aspects related to running a company after its shares are listed on a stock exchange. And while the focus will be on entrepreneurial businesses, much of this commentary applies equally to any type of business looking to go public. But before delving into legalities, first some thoughts on the all-important decision by the controlling shareholder(s): "Do you even want your company to go public?"
Why Go Public?
When a company "goes public" through an "initial public offering" (or IPO), it essentially sells some of its shares to retail and institutional investors, and those shares are then invariably listed on a public stock exchange, where the price for the shares floats up or down depending on a range of factors related both to the financial performance of the company and the state of the capital markets (and the broader economy) more generally. In order to become public, the company must go through a rigorous process of information disclosure centred around an extensive, written prospectus. Then, once public, it must adhere to a range of rules on timely legal and financial disclosure. Why would a business owner agree to jump through all these hoops?
Well, many do not! Particularly in the Canadian tech sector, many owners and managers of entrepreneurial businesses have a good long look at the costs and benefits of going public or staying private, and choose the latter. For example in the US, there are some significant private tech companies, such as SAS.
Moreover, if the owners of a private company want liquidity (that is, they want to turn the shares they hold in their private tech company into money), they can always sell the company outright to an interested buyer rather than sell a part of the company to public investors. And this is still the most common way shareholders of, for example, private Canadian tech companies achieve liquidity — by selling to typically non-Canadian-based larger public tech companies, such as IBM (though, usefully, companies like Constellation Software and Aastra Technologies are now acquirors as well). Indeed, there is by no means any shame in such an exit, particularly given that the founding entrepreneur of the sold company (and often several of his or her senior management), tends to reinvest much of the proceeds of their sale into new, start-up ventures (and the virtuous company cycle of establish, build, grow and sell will begin again).
Accessing Growth Capital
Often, however (and over the past few years with somewhat greater frequency than in the previous five years), Canadian entrepreneurs do not want to sell their companies, but rather want to stick around and build them. Moreover, they want to grow their companies, either by hiring additional staff with which to undertake the development or selling of new products or services, or by acquiring other companies with complementary or related products (in the tech industry, for example, the Constellation and Aastra Technologies models).
For an entrepreneurial business to either expand its current capabilities or buy a competitor, it requires serious investment dollars. Which brings us to perhaps the leading reason for a company going public — namely, to increase its access to capital. In a 2007 American survey of CEOs and CFOs of US companies (both tech and other) that had recently gone public, more than two-thirds (69 per cent) said their prime rationale for the IPO was to access capital (presumably at rates that were more favourable than the alternatives).
Minting Your Own Currency
This same survey found that 15 per cent of those questioned indicated that their main reason for going public was to be able to use the resulting public stock as a "currency" for acquisitions. That is, as a public company, you can buy other companies and exchange their shares for shares of your own company (or you can make it a combination of shares and cash — or, for that matter, all cash).
Accordingly, if you put together these two categories of respondents to the survey, fully 84 per cent of companies going public in 2007 (at least in the US), did so for financial reasons, and indirectly in order to grow the business. The same dynamics should hold true in Canada (and perhaps even more so in light of the recent credit crisis when access to private capital has been limited).
A Delayed Payday
There are several other good reasons companies go public. The survey noted above found that 31 per cent of senior executives wanted to do so in order that they, other managers who hold shares, and principal shareholders would be able to make some money by selling some (but not all) of their shares upon or soon after the IPO.
This is not surprising. A founder of a company, for instance, may have the bulk of his or her net worth tied up in the shares of his or her company. As a private company, there is no ready market for these shares. Now, of course, the founder could sell the whole company outright (as noted above). But the founder may believe that the company is unfairly undervalued, given the rather early state of development of the company (that is, it’s not a bad business, but "the best has yet to come"). The founder would be well-advised not to sell all of his or her shares at this premature juncture.
This is where an IPO might make good sense. Upon the IPO, the founder either sells very few — or none at all — of the founder’s shares, but waits until a market has truly evolved in the now-public company shares. Presumably the valuation of the company increases as the true potential of the company is realized. Then, from time to time, the founder can sell some shares, all the while working hard to increase the value of his or her remaining shares (the founder may also be subject to restricts on the sale of shares post-IPO imposed by either investment bankers or regulatory authorities, who will want to give the founder an incentive to unlock value).
In a similar vein, other employees of the public company can begin to cash out some of their shares once the company is public and there is a liquid market for the shares. Equally, the company can better recruit staff as a public company assuming they have a stock option plan or other equity based compensation plan of some sort that allows employees to purchase shares of the public company on some favourable basis.
Prestigious Public Companies
One reason popularly perceived as a very important one for going public is "publicity and prestige"; it is often thought, for example, that people would much rather work for a widely known public tech company, than for a relatively (or completely unknown) small, private one. In the event, however, the survey noted above found that only nine per cent of respondents cited publicity and prestige as the main drivers behind going public.
This is an extremely interesting insight (if indeed it is accurate). It tells us that, actually, fairly few founders and other shareholders are motivated principally by what others think, when it comes to the all-important "Go — No Go" decision on the IPO. Rather, the urge to build good companies through growth is the prime driver behind taking tech (and other) companies public. And this is how it should be.
So, assuming you are ready to go public (for all the right reasons), we will look at the legal process involved in doing so in the next edition of the TLQ.