Not long ago it was the dream of many a private company CEO to take their company public someday. During most of our lifetime, an initial public offering (IPO) was the preferred exit strategy for the successful entrepreneur. It not only provided liquidity for their shares but also demonstrated to customers, employees and suppliers that they had “arrived.” Being able to open the Wall Street Journal over a cup of coffee and see your company’s stock price listed in black and white was the equivalent of admission to an exclusive country club.
However, today most successful entrepreneurial businesses shun IPOs. The few initial public offerings that are coming to market are generally spin-offs of divisions of larger public companies seeking to become more focused or they are liquidity events for private equity firms who want to demonstrate that they have had a success in their portfolio. But it is rare for a high-growth business still owned by the founders to seek public status anymore.
Why is this? There are several downsides to being a public company that have always been there, plus a host of new ones that have cropped up since Enron, Tyco and WorldCom thumbed their noses at the regulators, triggering an avalanche of corporate governance reforms that have made running a public company much more challenging.
One of the most frequently mentioned downsides that deter business owners from offering their shares to the public is the need to disclose the compensation of senior executives to the world. But today, the SEC is considering rules that would allow shareholders to do a lot more than peek under the skirts of corporate executives; institutional investors will have real power. For the first time, the term “shareholder democracy” will not be an oxymoron.
The new rules under consideration would bestow true clout upon shareholders. Long-term shareholders, defined as a group that collectively has owned 5 percent of the shares for at least two years, could nominate up to three board candidates, depending on the size of the board. This represents a revolution in how companies are governed. Today, the options are to vote for the slate that is presented to the shareholders or to not vote for the internally chosen slate, comparable to the system Sadaam used.
The ability to propose shareholder nominees would be triggered in the future if 35 percent of the voting shareholders cast “withhold” votes for a company-nominated director. (The board at Disney must be quaking following this year’s vote, knowing this proposal may be enacted by next proxy season.) Alternatively, if a majority of the shareholders voted for a resolution authorizing an election contest, it would trigger the opportunity for shareholders to propose their own candidates.
What scares so many corporate executives about giving institutional investors direct access to the proxy statement is that the individuals who run these large funds are not members of the same fraternity of MBAs that run corporate America. In many cases, they represent the interests of a public pension fund or a labor union fund and they may have all sorts of agendas. After this year’s contentious proxy fight at Disney, six major pension funds arranged to meet with the board. Most of these funds were represented by a trustee whose day job is state controller, i.e., they are political officials who control millions of Disney votes.
Another knock on going public is that there has always been a considerable expense associated with not only executing the initial stock sale, but maintaining all the quarterly and annual filings with the SEC. When new SEC rules take effect August 23, 2004, public companies will have to report a lot more information, and report it sooner to the regulators. The are10 new events that will have to be reported to the SEC on form 8-K, all generally within four business days, as opposed to the five- to 15-day grace period that exists today.
Some of these events include the following:
Most observers would agree that corporate abuses in recent years have given the SEC a mandate to act. But the legal and administrative expenses of keeping up with these new reporting requirements add up to real money. Just complying with Sarbanes-Oxley regulations can cost a small fortune. Audit fees are up 20 percent to 30 percent for most companies. The average large company spent $5 million in audit fees last year. And officers and directors’ liability insurance premiums have shot through the roof since Sarbanes-Oxley was enacted. Peachtree City-based Crown Anderson recently announced it had enough of being a publicly traded company. The company is going private, largely to save what it estimates to be $250,000 to $400,000 a year.
One of the most compelling reasons to take a growth company public in the past was so the founders could share the wealth with the key executives who contributed to the success of the company. They could offer a cornucopia of stock options that were essentially free rewards to insiders. Now it appears those stock options are going to have to be reflected as an expense on the company’s income statement.
While the high-tech community is regurgitating over the expensing of options, in my view past practices are one gravy train for which there is no logical defense. If giving an employee a paycheck is an expense that reduces the earnings available to distribute to the owners, then giving them a stock option that dilutes the shareholders’ stake in the profits of the business also should be recorded on the books.
Ever since I was in charge of corporate governance policy for a previous president named Bush, I have supported most of the above governance changes, as they promote true accountability for public companies. In fact, I even proposed several similar reforms more than a decade ago. The recent push by the New York Stock Exchange to separate the role of chairman and CEO (how can you hold yourself accountable?); having only independent directors on the nominating and compensation committees and having a majority of directors that are not affiliated with the company are all ideas that were well debated in the 1980s and whose time have come. But it took the crises of Enron and others to inspire policy makers to act.
These reforms should accomplish their objective of enhancing corporate accountability. But while it is one thing to accept real accountability when stepping up to the helm of a public company that is already owned by public shareholders, it is quite another level of shock therapy to go from being private to becoming public in today’s environment. The days of issuing the public a different class of shares with little or no voting rights, stacking the board with your buddies from Augusta National and the Business Roundtable and burying all the bad news in a 10-K report, while blasting the good news around the world in press releases, are over.
Today, if you want access to the funds of the public to expand your business, you need to be prepared to accept your new owners as true partners rather than viewing them simply as a cookie jar. And since cookie jars are a lot more attractive than partners to many entrepreneurs, I wouldn’t expect to see a revitalization of the IPO market any time soon.