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Is Going Public Ever a Good Idea for a Company?

This article was written by in Economy. 12 comments.

Facebook recently went public. Mark Zuckerberg and the other owners might not have wanted to open the company up to a wide pool of investors, but the company had grown so large in terms of the number of private shareholders that it would have needed to release its financial statements publicly anyway. Through this process, a company that was founded as a social online hang-out and meeting place, not a money-making business, is forced under Wall Street pressure to have a better revenue strategy.

In Facebook’s case, it may be too soon to judge whether going public would have a positive effect on the company. Certainly, from a business perspective, additional pressure to generate revenue increases the value of the company, and that’s what shareholders, including the original owners who still have a large portion of shares, want. Users don’t notice when Facebook takes a percentage of every financial transaction in every game, but that isn’t generating the bulk of the company’s revenue. Other companies pay Facebook for advertising, and users generally notice advertising. And when under pressure to generate more revenue, Facebook will emphasize advertising further.

Peet's CoffeeRather than focusing on the core mission, Facebook engineers are developing more ways to take users’ money. Recently, the company has starting moving towards becoming a payment processor — accepting credit card transactions from users directly. This change in focus is typical when building a business, but is certainly more apparent when Wall Street analysts are breathing down the management’s neck. With 900 million users globally, Facebook doesn’t have much room to build its user base unless astrophysicists discover an intelligent extraterrestrial life form interested in socializing with Earthlings. The only solution is to grow revenue from each user, and depending on how aggressive the company is in answering Wall Street’s demands, users might be driven away to a competitor who isn’t digging in users’ pockets for lunch money.

Working with Wall Street means your business must answer to analysts — whose petty words can greatly affect the value of a company on paper, the capital that company has available for reinvesting in itself, and the company’s ability to borrow money at good rates — on a quarterly basis. Some companies, particularly those in a growing stage, need to be able to focus on a more distant horizon. Facebook may have passed the growing stage of its business many years ago, so perhaps the time is right for that company to face the music every three months.

When a company goes public, it’s like there are new people in charge, people who care about nothing other than impressive results every three months. They don’t want to hear excuses about poor investments or low consumer confidence, but if you pay attention to companies’ earnings reports, you’ll find they mostly follow a pattern: Unless a company had a widely publicized problem, public companies attribute any good financial results to their management and practices while they attribute bad financial results to external forces like the economy or government regulation.

I don’t see how this behavior is good for a business. It’s a waste of time of energy, it encourages creative accounting to make results look for favorable, it gives too much power to Wall Street analysts and takes that power from the company’s management, and it stifles serious long-term planning. The upside of going public is that it can raise a significant amount of money for a company to grow in ways the founders might have only dreamed of, but there’s a cost.

The management of Peet’s Coffee and Tea recently decided that the company would have better success if it operated outside of Wall Street, so it engineered a deal to go private, taking the company’s shares off the market. Shareholders were paid a premium over the stock price and thanked for their time. Rather than being owned by the public at large, a German conglomerate already deeply involved in the food sector will have the final say in the management and operation of Peet’s Coffee.

The drive for quarterly results can occasionally conflict with the need to build a meaningful business or a financially successful business in the long-term. Companies give up their flexibility in return for access to a significant amount of money through Wall Street. Not every company will find the trade-off worthwhile.

Photo: LWY

Published or updated July 25, 2012.

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About the author

Luke Landes is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 12 comments… read them below or add one }

avatar 1 Anonymous

Excellent post and I agree with much of what you said. An additional consideration in favor of going public is that this is a way for a company’s major shareholders and (as illustrated by Facebook) employees with signification numbers of shares to “monetize” their investment. Going back a number of years, there are a number of Microsoft millionaires out there, typically early employees who made tremendous gains on their stock during Microsoft’s heyday.

For many companies, the move to go private makes a lost of sense for the reasons you mention. Wall Street can be a harsh master with a very short-term focus.

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avatar 2 Anonymous

“but the company had grown so large that it would have needed to release its financial statements publicly anyway.”

I am not aware of any requirement that says financials must be public after a company reaches a certain size. Can you explain what you mean by this?

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avatar 3 Luke Landes

Size in terms of number of shareholders. The SEC requires that companies with 500 shareholders or more must go public (though there are calls for raising this threshold). I suppose size might have been an inaccurate way to describe it. I can edit and clarify.

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avatar 4 Anonymous

I did not know that. Thanks for the info.

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avatar 5 Anonymous

I think there are trade offs. If you have unlimited funds, stay private. Thee are some huge companies that are private and are very profitable. Going public allows you to expand faster and provides funds for that expansion.

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avatar 6 Anonymous

Seems to me that a company could just ignore the Wall Street analysts and do what they think is best for the company long term. Unfortunately thats not how the world works. But I don’t see why a company couldn’t do that if a company’s management decided to. Often times the analysts are just spouting their individual opinions and they may know little about the real operations and future of the company and know less about whats really best for the company.
Your stock can get beat up in the market because you ‘only’ made $2 a share earnings when the analysts average opinion was that you ought to make $2.2 a share. Its kinda silly how much weight people put in analysts.

I also think that being a private company doesn’t necessarily make you too much different. Looking at Facebook specifically, I assume they would do what they can to make money if they were private or not, as they are a for profit company and not a charity. Management is often only thinking short term whether they are public or private. Management will probably take credit for success and blame failures on someone/something else, Of course being private lets you ignore analysts and the fickle tastes of the stock market so that helps.

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avatar 7 William @ Drop Dead Money

Great Post!!!

There are outfits like KKR who do exactly what you propose – take public companies private and clean them up. And there are millions of private companies that stay private for this very reason.

However, the answer to the question (is going public ever a good idea) is: many times, yes. Take Amazon: their growth required more capital than existing owners could or wanted to front. So they raised more from the offering. And subsequent events proved that the capital was put to good use. Poster child for “the system.”

Facebook didn’t need any capital. They simply used the system as a way to benefit stockholders and investment bankers, rather than the company. It showed. But it’s not typical, though.

Overall, it comes down to the need for capital. If you need it, you pay the price, and transparency is part of that price. If you feel you can’t afford it, you always have the option to confine your growth to what internal cash flow can support.

But… pandering to the short term interests of casino investors does NOT need to be part of that cost. Warren Buffett is the arch-example. When Berkshire Hathaway bought stock in U.S. Airways (that shows my age, I know) his annual report said, in effect, “You would have done a lot better if your chairman didn’t screw this up.” He got applauded, rather than derided. Not too many managers have the huevos to say things like that publicly, though, and that’s too bad.

If you look at the vast majority of public corporations, 80-90% of them are reasonably well run and expectations are by and large reasonable. The companies I invest in certainly fall into that categorization. There are corporations which are mismanaged but the eco-system weeds them out over the long haul.

On a final note, I wouldn’t be too hard on managers who claim credit for what the economy gives them and blames the economy for bad results. We all do that to some degree. Quarterbacks do it in football. So do I: when I’m late for a meeting, I’ve been known to blame the traffic, and not the fact that I didn’t leave early enough. :) All I’m saying we shouldn’t be surprised when managers do that, too: if we do our own legwork, that kind of fluff is easy to tune out.

Analysts only have an impact in the short term in my experience and observation. After three or four quarters, results speak louder than opinions. There are more than enough value investors out there who look for undervalued companies. If a company focuses on its performance, it will show in the stock price sooner or later, analysts or no analysts, and the company’s stock price will regress to the mean if the performance is consistent. There are, unfortunately, enough incompetent and/or insecure managers who pander to analysts’ views to support your description, though. However, I believe they are the minority, not the majority. But hey, I’ve been wrong before! :)

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avatar 8 Anonymous

To me the only reason to go public is if you need cash to continue to grow your company and can’t get it any other way at a reasonable rate or for the big owners to be able to cash out their shares. I bet there were a lot of employees that wanted to turn their paper wealth into money wealth and that, along with the SEC rules forced them to go public.

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avatar 9 qixx

I worked for a company that was preparing to go public. At the last minute determined they added capital was unneeded (not sure if they got other funding instead or revised plans). Eventually they were just bought outright by another company. I’d expect a lot of businesses that don’t go the stock market route instead end up selling to another company.

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avatar 10 Anonymous

you pose an interesting question, and the answer would be different for each company. Going public will certainly change the culture and place a greater emphasis on making shareholders happy. But it can be an excellent way to raise capital for expansion and allow the company to grow far beyond what it could by staying private.

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avatar 11 Anonymous

“is forced under Wall Street pressure to have a better revenue strategy.”

Just using the FB example – if he owns majority which he does can’t he theoretically just ignore Wall Street since he can’t get displaced as CEO?

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avatar 12 Anonymous

The integrity and commitment of a company’s leadership does more than any analyst as far as preventing revenue “enhancements” from going too far. It wasn’t too long ago that almost all companies fell victim to the “Shareholder Equity” mentality and many drove themselves into bankruptcy. Enron being the poster child for placing too much emphasis on its stock price and not on its core businesses. Borrowing against the value of their stock and outright fraud sent them tumbling. The company I worked for went through a Shareholder Equity phase (classes and seminars) but soon realized that focusing too much on that aspect was hurting their ability to produce jets – fortunately they soon reversed course and focused on the business rather than the analyst calls. Many stockholders, particularily institutional ones, are far more comfortable with long term solidity rather than short-term gains.

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