Is Going Public Worth It Today

February 6, 2004
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GRAND RAPIDS — Everyone generally agrees that the cost of being a public company increased since the Sarbanes-Oxley Act was signed into law on July 30, 2002.

But are the costs associated with Sarbanes-Oxley compliance so burdensome that they’re driving small public companies back to private status?

A Securities Industry Association (SIA) research report released in August indicated that one year after implementation of Sarbanes-Oxley, from July 2002 to July 2003, 95 companies went from public to private, up nearly 30 percent from the year before.

As SIA Director of Research and Chief Economist Frank Fernandez noted in the report: “For small businesses, the cost of remaining a public company or of becoming a public company and hence availing yourself of the most efficient way of raising capital may have become prohibitive.

“Anecdotal evidence suggests that a not insignificant number of firms are either avoiding going public or going private to avoid the compliance cost imposed by new regulations.

“This is largely due to the high fixed cost of compliance with these measures that absorb a much larger share of a small firm’s revenue.”

Mike Lamfers, a partner in Deloitte’s Grand Rapids office, said there does seem to be some indication at the national level that smaller companies are migrating to private status after being public registrants.

“This is due to a number of factors, as each company has individual situations,” he noted. “Some may be tied to the attention small cap registrants have failed to garner over the years. Others may be due to no analyst coverage, industry issues and, most recently, the increase in cost and regulations as a registrant.”

Last October, Hastings Manufacturing Co. announced it was voluntarily delisting its common stock from the American Stock Exchange and terminating registration of its stock. The company subsequently began trading on the Pink Sheets.

At the time, Mark Johnson, chairman and chief executive officer, said Hastings’ board of directors felt deregistering the company’s stock was “a prudent course of action” for the company, its employees, customers, suppliers and shareholders.

“The board examined many factors in making this decision, including the nature of our shareholder base, recent trading history of our stock and, in particular, the rapidly rising costs associated with SEC reporting and compliance,” Johnson stated.

“The elimination of these expenses should have a positive impact on our bottom line and will allow us to focus our resources on growth initiatives.”

Robert Herr, managing executive of Crowe Chizek & Co. LLP in Grand Rapids, said he’s not aware of any public companies among his firm’s client base that are planning to go from public to private, nor is he hearing that kind of talk on the street.

“With smaller publicly owned companies there is certainly a cost of compliance element that you’ve got to weigh to the benefits of continuing to be public. But I don’t see a mass exodus from public status.” 

Regulation is expensive, and it’s an incremental cost, so more people are likely questioning whether being a public company is actually worth it, he said.

Public-to-private transitions are “a bit of a trend,” albeit the facts of the circumstances are limited to a certain segment of public companies, said Keith Burns, managing partner of Ernst & Young’s Grand Rapids office.

“I think the individual companies that are at least having a dialogue and a thought process around going back private have to do with what the investment banking community refers to as small caps or micro caps.”

Generally, those are companies with $50 million to $60 million in market capitalization or less. He thinks there are probably other companies in West Michigan that have smaller market capitalization that are now evaluating the benefits of public status.

“I do think that companies that are contemplating being public have additional factors to consider as to whether or not it is worth going public.

“They may choose not to or they may choose to find their financing in a different way rather than in the public equity markets.”

Joe Godwin, a Grand Valley State University accounting professor, said he hasn’t heard about any specific public companies considering a changeover, but he has heard rumors of some international companies talking about delisting in the United States, or staying in Europe just to avoid Sarbanes-Oxley compliance.

The cost of compliance can be “pretty healthy,” Godwin said, so a relatively small public company should weigh whether the cost is worth the access to the capital markets.

“The requirements can be costly to implement. If a company is not ready to go on that, they probably should just stay away.

“I keep hearing wide ranges of the cost to meet Sarbanes-Oxley. My guess is that it’s probably more than anticipated but less than people are reporting.”

But it’s not just about cost. Besides the increased compliance cost of auditing expenses, there are increased legal fees and increased insurance costs associated with directors and officers liability, on top of other insurance issues of being a public company, Burns explained.

“That’s part of the value equation, as well, as to whether the increased risk is worth the benefit of being a public company with respect to raising capital and having liquidity to be able to sell shares.”

Burns said the most significant downside of going from public to private is that shareholders lose the ability to sell shares on an open market, so they lose a little bit of personal investment in terms of liquidity.

What Herr is seeing is that some of the larger privately held companies are voluntarily adopting some of the new SEC rules and regulations, particularly corporate governance rules.

“I hear a lot of discussion about that. Private companies, I think, are looking at Sarbanes-Oxley and at what is good corporate governance, and are beginning to adopt some of that as policy within their own organization.

“From what I see, that’s more prevalent than public companies going private.”

Several private companies have evaluated the requirements of Sarbanes-Oxley and decided that elements of it just represent good governance practice and have voluntarily adopted those provisions or concepts, Burns said.

“The cost benefit equation makes sense to them,” he observed.

Burns sees a couple of additional trends emerging in the wake of Sarbanes-Oxley. He believes the next emerging area is going to be organizations that have tax-exempt public debt, such as health care organizations — perhaps even higher education — and other regulated industries like the insurance companies.

“We will see an emerging trend over the next two years that those organizations would also adopt, and are adopting, provisions and concepts of Sarbanes-Oxley.”    

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