SMALL BUSINESS FINANCE CHAPTER 17 Going Public: Past and Present Trends

1. Small Business Finance
Ch 17: Inherent Problems In Going
Public

2. INHERANT PROBLEMS IN GOING PUBLIC
In examining the question of whether or not to go
public, the owner of a small business should give
considerable thought to such a decision. A firm has to
face the following problems:-
 Time & Cost requirement
 Disclosure
 Reduction in flexibility in major decisions
 Formal Dividend Policy
 Liability of Directors & Officers
 An Unpredictable source of financing
Inherent Problem in Going Public

3. Time & Cost requirement
o The registration process carries with it a substantial
commitment on the part of management both in terms of
time and expense.
o In terms of time, management has to be prepared to allocate
a significant portion of its efforts to the task for some six
months preceding the actual sale.
o This estimate would not include the preliminary work and
thought required for at least two years prior to the first
offering.
o With respect to the issuing costs (legal, accounting,
underwriting, filing, fees, and printing) management will
expand a significant sum of money in completing the public
offering.
Inherent Problem in Going Public

4.  Disclosure
 As an aftermath of the public offering the principal
owner-manager is not in a position to administer the
operations in the personal manner typical of the small
closely held enterprise.
 Publications of many facets of the concerns activities
are required by the regulatory authorities, not only out
the outset of the issue but also on an annual basis.
 Such disclosures of inside transactions are not only
bothersome at times to the life-style of the small
owner but generally represent a significant cost of
reporting for the firm, both in effort and money.
Inherent Problem in Going Public

5. Reduction in flexibility in major decisions
 While most executives of small growth firms have
become accustomed to making decision quickly and
decisively with little though having to be given to the
opinion of others, going public can modify
significantly the decision making process.
 The decision will directly affect the stock price.
 It may take more time to make a sound decision.
Inherent Problem in Going Public

6. Formal Dividend Policy
Prior to the involvement of the public in a corporation,
the concern’s dividend decisions may be largely a
function of investment opportunities and tax
considerations.
For these reasons, the payments may occur irregularly.
However, the after effects of the public issue would
include the requirement for maintaining a more stable
dividend policy.
For the public firm, the omission of a dividend can have
a devastating impact upon the market price of the
company’s stock.
Inherent Problem in Going Public

7. Liability of Directors & Officers
The liability for directors and officers is
significantly increased when a corporation
becomes a public entity.
The strong tendency for individuals or groups to
sue corporation places the senior personnel and
directors of public firms in an uncertain situation.
Although insurance may be purchased to cover
this increased liability, the premiums are
expensive.
Inherent Problem in Going Public

8. An Unpredictable source of financing
 As a last item associated with going public, the public
market has to be recognized as being a relatively
unreliable source of funds.
 The market may be relatively bullish but may not be
receptive to the issue of a new and/or smaller
business.
Inherent Problem in Going Public

9. REASONS FOR GOING PUBLIC
There are following reasons due to which a firm goes
public.
 An Established Market for Future Financing
 No Cheap Source of funds
 Encouragement for Key Personnel
 Public Relations
 Diversification
 Collateral for Personal Credit
Inherent Problem in Going Public

10. An Established Market for Future Financing
Several benefits relating to future financing accrue to the
business organization.
a. When the securities in question become recognized by
the investment public, later issues should face a more
receptive market.
b. Creditors are typically more interested in lending money
to firms having a proven market for their common stock.
c. When a corporate entity is attempting to finalize a merger
or acquisition, a security having a tested value in the
market place becomes an invaluable instrument of
negotiation.
Inherent Problem in Going Public

11. No Cheap Source of funds
There have been periods during the past years when
the cost of equity funds obtained from initial public
offerings were considerably cheaper than funds
obtained from debt sources.
Inherent Problem in Going Public

12. Encouragement for Key Personnel
The employment of a stock option plan as an
encouragement to key personnel has received
considerable attention in the business literature.
However, the actual merit of such programs has to
be considered some what tenuous when a market
for the security is non existent.
Thus, for the concern utilizing stock option plans
going public should provide a more effective
employee incentive plan.
Inherent Problem in Going Public

13. Public Relations
o The broad distribution of a company’s stock among
the public is thought to afford favorable publicity.
o As shareholders of the company may be the users of
the company’s product, will enhance public relation.
Inherent Problem in Going Public

14. Diversification
• Often the owner of a closely held operation has
invested his life, both emotionally and materially, in the
company.
• However, if and when the company becomes
sufficiently large to justify external equity financing,
the owner may wish to diversify, thereby affording an
opportunity to broaden the financial base.
• Yet, such spreading of wealth is typically constrained by
the desire to maintain unquestioned control of the
business.
Inherent Problem in Going Public

15. Collateral for Personal Credit
In borrowing on a personal basis, the owner of a
firm is in a more favorable position by offering a
public security as collateral as opposed to a
stock having no public market activity.
Inherent Problem in Going Public

16. INVESTMENT BANK
An investment bank is a financial institution that
assists corporations and governments in raising
capital by underwriting and acting as the agent in
the issuance of securities.
They are experienced in carrying out projects
that, for most companies, take place very rarely,
but are critically important.
Inherent Problem in Going Public

17. Functions of The Investment Bank
Investment bank performs following functions.
Raising Capital
Mergers and Acquisitions
Sales and Trading
General Advisory Services
Research
Risk Management
Technology
Inherent Problem in Going Public

18. Raising Capital
o An investment bank can assist a firm in raising funds to
achieve a variety of objectives, such as to acquire another
company, reduce its debt load, expand existing operations, or
for specific project financing.
o Many people associate raising capital with public stock
offerings, a great deal of capital is actually raised through
private placements with institutions, specialized investment
funds, and private individuals.
o The investment bank will work with the client to structure the
transaction to meet specific objectives while being attractive
to investors.
Inherent Problem in Going Public

19. Mergers and Acquisitions
 Investment banks often represent firms in mergers,
acquisitions, and divestitures. Example projects
include the acquisition of a specific firm, the sale of a
company or a subsidiary of the company, and
assistance in identifying, structuring, and executing a
merger or joint venture.
 In each case, the investment bank should provide a
thorough analysis of the entity bought or sold, as
well as a valuation range and recommended
structure.
Inherent Problem in Going Public

20. Sales and Trading
• These services are primarily relevant only to publicly
traded firms, or firms which plan to go public in the
near future.
• Specific functions include making a market in a stock,
placing new offerings, and publishing research
reports.
Inherent Problem in Going Public

21. General Advisory Services
Advisory services include assignments such as
strategic planning, business valuations, assisting
in financial restructurings, and providing an
opinion as to the fairness of a proposed
transaction.
Inherent Problem in Going Public

22. Research
It involves reviewing companies and writing reports
about their prospects, with buy or sell rating.
Risk Management
o This involves analyzing the market and credit risk
which traders are taking onto the balance sheet
in conducting their daily trade.
o The bank also sets the limit on the amount of
capital to be invested.
Inherent Problem in Going Public

23. Technology
Almost all investment banks have in-house software
system that helps in telecommunication and
computer based support.
Inherent Problem in Going Public