02 Feb Public Company Benefits to the Founding Entrepreneur(s)
If you ignore the capital flowing into the company coffers at the time of a public offering, going public also has a great deal of ancillary benefits to the founders and entrepreneurs in the business. What follows are a few of these benefits and how they can provide motivation for the founders and entrepreneurs in privately-held businesses seeking public status.
Non-marketable Stock is Made Liquid. We’re big advocates of using public offerings as a liquidity tool for investors and entrepreneurs. Once a private company engages in a public offering, the common stock is immediately sold on the open market, including at least some of shares of the founder owners/entrepreneurs. This means the stock that was once locked in a private business now be sold to both accredited and non-accredited investors alike. While there may be some restrictions on how much share volume can be sold (like the likely requirement for removal of the Rule 144 restriction), the stock is still more liquid post-public-offering than it ever was previously.
Price-to-Earnings Ratios. The accretion that occurs when a private company is taken to the public markets can send the private P/E ratio of a company through the roof in short order, especially if the company is solidly profitable with a good story for future growth. This means an investment or early stock interest in a company immediately jumps to a value much, much higher than it was as either a fledgling startup or viably-profitable private business. The value accretion to public companies is real and very helpful for an entrepreneur seeking to extract as much value as possible out of a deal.
Portfolio Diversification. Thanks to the first point made above, founding officers and managers are now better able to diversify their investments away from their company. For most founding entrepreneurs much of their life’s work and investment is often held in one single business. Until that company is either acquired or taken public, that founding member will have all his/her stock held in a single private entity. Going public helps to resolve this issue by allowing the stock to be sold on a public exchange or even directly exchanged for shares in other companies or funds, thus spreading and diversifying the risk held by the founder.
Not all major shareholders carry this diversification strategy as their mantra. Steve Ballmer is one high-profile example. After he recently stepped down as CEO of Microsoft, he claimed:
I hold more Microsoft shares than anyone other than index funds and love the mix of profits, investments and dividends returned in our stock. I expect to continue holding that position for the foreseeable future.
Any good investment manager or analyst would argue vehemently against such a strategy, but I guess when your net worth measures in the billions, it’s easier to be flippant about such things as diversification.
Repayment of Personal Loans. This also includes the dissolution of personal guarantees for loans taken out by the founders on behalf of the company. This can be a great relief of a burden on the founders who may be used to pledging such things as their home as collateral when obtaining financing from a bank for funding their business. In some cases, founders may have advanced money, delayed personal salaries or provided direct loans to the business. Being public can assist in righting all such personal sacrifices on behalf of the company.
Delay/Shift of Estate Taxes. Unlike private firms where estate taxes will likely need to come from the company funds, a public firm has an established stock value that can be used as an alternative source for paying inheritance tax if an inheritor wishes to do so. It’s an “in-kind” payment alternative that is pretty powerful at preserving family wealth.
Control of Timing for Capital Gains. The surety of death and taxes are unavoidable, but you can work to delay them as much as possible. With public company stock a founder can delay the timing of capital gains to when it suits his/her investment strategy. This occurs as the stock is slowly sold (in accordance with the timeline set forth by the firm’s broker-dealer) on the open market. In some cases, the gains can be offset by other losses outside the business as well such as other recognized losses from other businesses assets or real estate investments.
Easier to Secure Personal Loans. Because public stock offers a very acceptable form of collateral for a bank, it is much easier to secure financing for say a dream home or land investment against the value of publicly-traded stock shares. Some of the biggest CEOs on the Fortune 500 are able to jump into large land and real estate holdings because they own shares in public companies that can be used as personal collateral for securing the stock.
While there are both pros and cons associated with being a public company, the pros far outweigh any potential cons, unless the cons themselves are running the business. Then you’ve deeper issues with which to deal.