Which owner or manager has never dreamt of taking his company public? IPOs (for initial public offering) have become synonymous with success and fortune. The business pages, especially with the recent .com mania, are filled with stories of spectacularly successful IPOs of high tech companies where insiders and venture capitalists become rich long before the company establishes its ability to even survive.

However, as many owners and managers of family businesses have discovered, going public may not be the best option to cash out their investment or develop their company. In fact, for most businesses, a sale or merger may be a more appropriate solution to meet the needs of the company and to provide liquidity to its owners.

INITIAL PUBLIC OFFERING (IPO)

Advantages

• Easier future financing
• Company image enhancement
• Stock-option plans
• Future stock acquisitions

Disadvantages

• Available only if requirements are met
• Out-of-pocket expenses
• Disruption of operations
• Disclosure of sensitive information
• Short-term orientation
• Insiders' stock "lock-up"
• Stock subject to market whims

Bursting the myth of IPOs

Is an IPO right for you? To ask the question is to assume that an opportunity exists for a company to go public. This means that the company has a history of successful operations in a growing market or is somehow perceived to have significant growth potential due, for instance, to the personality of the entrepreneur or the products that the company proposes to develop.

If such an opportunity exists, going public does offer many advantages. An IPO makes future financing quicker, easier, and less expensive. It enhances the image of the company and provides it with greater visibility among vendors, customers, and the investment community. It enables the company to establish stock-option plans and provide better incentives to its employees. Finally, an IPO gives the company a possibility to finance its future acquisitions with stock.

Going public, however, can also be a source of considerable trouble and expense. First of all, the IPO process is long and painful. The incurred out-of-pocket expenses will be considerable, and the process will disrupt the operations of the company for several months since a number of key personnel will be diverted from ordinary duties. Secondly, once the company is public, it will become subject to the reporting requirements of the federal securities laws. Previously secret information, such as the remuneration of management, will have to be disclosed. In addition, the managers of a public company typically become short-term oriented, that is, focused on the company's performance for each quarterly report rather than focused on a five-year plan. Thirdly, the liquidity of the insider's investment will not immediately be enhanced. Underwriters generally require a "lock-up" of existing shareholders' stock for a specified period (lasting anywhere from 3 months to a number of years) following an offering so that insiders do not appear as wanting to unload large portions of their stock. Finally, a public company's valuation is at the whim of the markets. The valuation could rise, but it could also fall abruptly for any number of reasons, some of which are independent from the performance of the company, such as a change in macroeconomic conditions or degradation of a specific sector.

While a few highfliers make the papers, the majority of companies that launched IPOs are performing poorly in the stock market. The myth that IPOs deliver money to the pockets of investors, owners, and employees just isn't true. According to Broadview Associates, of the 826 information technology companies that went public with amounts greater than $10 million between 1992 and 1998, only 49 percent are trading above their IPO price, and they are yielding a median annualized stock return of -5.4 percent. The best stock performance turned out to be within the first year of going public where the median annualized stock return was 13 percent. After five years, however, the stock has a compounded annual return of 0.5 percent for its public shareholders that invested at the IPO price.

Rising trend toward mergers and acquisitions

In contrast to the IPO market, 1998 was a record year for mergers and acquisitions (M&A). U.S. deals racked up a staggering $1.73 trillion, an 89% gain over 1997's record of $917.7 billion. (Mergers & Acquisitions Report, January 1999).

While some of these transactions were combinations of large public companies, the private M&A market also developed considerably over the last few years. This is due to the fact that M&A transactions constitute both a good exit strategy for the owners and a significant growth opportunity for the company.

As an exit strategy, selling the company, rather than taking it public, offers many advantages. First, it is faster than exiting through an IPO, since the process of selling the company is generally less time-consuming than the process of going public; in addition, the owner will not be subject to a "lock-up" agreement which will force him to hold on to his stock for months. Second, selling the company offers a higher degree of certainty: while the price of a newly-public company's stock can decline before the owner of the company has a chance to sell it, the cash purchase price offered for a company, absent any earn-out provision, is known on the day of signing of the purchase agreement. If the purchase consideration consists of equity in a seasoned public company, the price risk often can be mitigated by transaction structuring and/or hedging techniques. Third, unlike the disclosure requirements that come along with an IPO, companies involved in most merger or acquisition transactions are not required to file disclosure statements. Finally, selling a business is an option that is available to a wider range of owners than going public. If your company has erratic earnings, you may still be able to find a buyer, whereas you will never be able to convince an investment bank to underwrite your IPO.

ADVANTAGES OF A MERGER OR ACQUISITION

• Fast exit strategy
• Certainty of sale price
• Reduced disclosure requirements
• Benefits from merging with a larger company
• Synergies

For the company, a merger or an acquisition can represent a significant growth opportunity. Facing changing trends and customer preferences, many owners of smaller companies find it increasingly difficult to compete in the market; therefore, many sell to larger national companies that have the capabilities and access to capital to negotiate the changing market demands. The owner or management of the company may also choose to sell in order to benefit from the synergies created with a larger, more financially viable corporation. Possible sources of synergy include revenue enhancement and cost reduction. Revenue enhancement may come in the form of marketing gains from improvements in previously ineffective advertising efforts, a weak existing distribution network, and an unbalanced product mix. An acquisition may also offer strategic benefits to the seller in the form of a new product line or value-added services. In addition, by combining with a larger company, the seller may benefit from economies of scale, as well as new markets, technology transfers, and management expertise. For many family businesses, combining resources with other firms may provide the missing ingredient for continuous, long-term success.

Richard H. Witmer, Jr. and Lianne Lim are respectively partner and analyst at Brown Brothers Harriman & Co. "BBH&Co" assists private and closely-held public companies on important financial and strategic issues through advising on mergers or sales, or providing private equity. They may be reached at 59 Wall Street, New York, NY 10005 212.493.8403 www.bbhco.com/