Why Going Public is Not a Good Liquidity Strategy
We receive regular requests from small business owners looking for alternative liquidity options for their private company shares. In many instances, a company owner reaches out with the idea that they will use the public markets to raise capital for growth, some type of recapitalization or a full sellout. In short, these owners would eventually like to sell their shares into the public markets as a way to create liquidity with an otherwise illiquid asset.
While I enjoy having these conversations, I often respectfully listen and then typically suggest alternatives to this strategy. Here’s why:
- Pubco insider and affiliate shares are restricted
- Private equity is as liquid as it has ever been
- Legal and admin costs of becoming and staying public are more burdensome than ever
- Here’s the rest of the list which we’ve discussed previously
Rule 144–Dribble the Shares
Company insiders and affiliates are significantly restricted on when and how much of their stock can be sold into the market at any given time. A company owner typical works directly with a broker-dealer to determine when a stock’s 144 legend can be removed and the stock can be sold to the general market.
Let’s also not forget the signal an insider gives when s/he decides to begin selling into the general market via this strategy. That alone can create immediate negative ripples that can impact the stock price and damage the company brand long term.
Today’s Private Equity Creates More Liquidity
There is more money in private equity than ever before. This does a couple of things for potential company sellers. First, it creates a more liquid market. Transactions between buyers and sellers are more fluid and private company valuations are higher than they have been in decades.
Secondly, the market is currently a seller’s market. Because of the tampered supply of companies willing and able to sell and the high level of liquidity in private equity, sellers often have the advantage, particularly when the business is put through a strategic auction process.
Cost & Liability
There are legal and direct financial impacts to the business when the shareholders decide to take it public. First, the upfront and on-going monetary cost of going and staying public can be substantial, particularly with the introduction of SOX rules.
We are not even including the potential costs to the company’s reputation, the cost of exposing all financial information and the legal cost and liability incurred by many a public company.
A Few Suggestions
I am never a big fan when someone says, “this strategy is just not a good idea,” but then no alternative solutions are given. From my perspective, this is how I typically would structure a smaller deal to ensure the company was able to advance to the desired outcome without going down the path of a public offering.
- Recapitalize the Company. Some investors are fine with minority stakes, others are interested in becoming the majority shareholder. Owners should be flexible, as many investors want to make sure they provide owners enough for taking some chips off the table while not incentivizing too much where they walk away completely.
- ESOP. I’m not necessarily a big fan of Employee Stock Ownership Plans, but they do have their place in the world. I would be remiss if I failed to list it as a potential option.
- Leveraged Buyout. Find a buyer, load the company up with as much debt as you can. Problem solved.
- Management Buyout. Almost all management buyouts include some leverage, but not all leveraged buyouts include some management. Often private equity plays a role in the financing component of a management buyout as well, layering on the debt after they put in a nice slice of equity.
- Full Sellout. Keep the door open as the company is shopped to strategic and financial investors. While many would love a piece, some may fall in love and may be willing to pay an attractive multiple. Even if a full sellout is not in the immediate cards, it is likely in the mid-term plans for creating liquidity in the market
While there is at least some liquidity on the microcap stocks, gone are the days when many brokers acted as market makers for smaller companies. The common broker, especially those on the lower end of the market, have been all but replaced by bots and other sophisticated fintech tools.
In some cases a public offering can create heretofore unforeseen opportunities. Regulation A+ has only reinvigorated this debate. However, there are often other more safe and viable options for private company owners looking for liquidity. Do not misunderstand, there still remains a place for smaller, public companies, but for most I feel like it is a huge disservice to a current and potential client to pitch them on the idea that equity crowdfunding; direct, alternative or initial public offering is a catchall to their liquidity and financing needs.
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