Advantages and Disadvantages of Taking a Company Public

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The Sarbanes- Oxley Act of 2002

The Sarbanes- Oxley Act of 2002 is federal law that was sponsored by Paul Sarbanes and Michael Oxley to provide stringent financial rules to the federal securities. The Act came at time when there were several financial scandals that had led to the loss of billions of dollars of taxpayers' money (Gordon et al 2006). The scandals involved the following companies, WorldCom, Enron and Global Crossing. The Act became effective in 2006 and required all publicly traded companies to update and implement their internal accounting controls. It is enforced by the Securities and Exchange Commission (SEC). It provides guidelines that publicly traded companies should adhere to with the purpose of improving their reporting procedures. It provides that executives who approve and provide inaccurate financial reports are prone to face fines of up to $ 5 million and a jail time of up to 20 years.

Improving Accounting Standards

A company planning into publicly traded firm has to improve their accounting standards in compliance with the act. This is aimed at ensuring that accurate financial records are provided that present the real status of the company. The financial scandals of the early 2000s had been caused by executives presenting inaccurate financial records that were aimed at improving the company's outlook (Jenkinson & Ljungqvist, 2001). They used nonconventional accounting procures that reported future income before it was accrued leading to pumped up figures.

Advantages of Going Public

Going public involve the process of offering a company's stock for sale in an initial public offer. It involves the sale of a company's stock to external investors in a public trading facility. The initial public offering (IPO) presents a complex challenges to any executive with an interest of selling their company. There are stringent rules that a company should adhere to before offering itself for the public (Kim et al., 2008). It's very essential for the executive to determine the reason why they want to take their company public. This helps in evaluating the different options available when taking the company public. Growth and expansion often ranks as the main motivation for taking a company public. Before making a decision to turn a company public the executives of a company must weigh the advantages and the disadvantages that company is bound to gain following the decision.

Raising Capital

Taking a company public offer several advantages over private companies. An initial public offer raises capital form external investors which is necessary for further research and development. The raised capital can also be sued to pay debts and finance operations of a company. The capital raised through an initial public offering is relatively cheap compared to getting a loan from a bank (Bernstein, 2015). It is crucial to note that it's not mandatory for the company to payback the raised capital. The shareholders only enjoy dividends when the company makes some profits.

Increased Public Awareness

Initial public offerings generate necessary publicity through the mainstream media as well as the trading facilities. The publicity is essential for introducing the company's products and services to the general public and consumers. This greatly increases the market share of a company especially in sectors where competitors are not publicly traded (Jenkinson & Ljungqvist, 2001). Executive of small businesses who are thinking of expanding their business should therefore consider taking a company public due to the increased public awareness that an IPO creates. A publicly traded company further obtains prestige and visibility which are necessary for the progress of the company. Initial public offering offers exit strategies to founding executive who have invested in growth companies. The IPO presents an avenue for the founders to cash in on successful companies paving way for external investors.

Drawbacks of Going Public

However the process of taking a company public is sometimes tedious and hectic due to the stringent rules and laws that company has to meet. When a company turn public they must comply with all acts and regulations enforced by the Securities and Exchange Commission. Going public exposes a company to stringent scrutiny of its financial records in line with the law. It's a mandatory requirement for companies to completely disclose their financial records to the security and exchange commissions as well as investors (Gordon et al., 2006). The financial records are further closely monitored by the public to ensure they present a clear picture of the financial status of the company. The full disclosure may expose trading secrets and strategies to competitors who may utilize them to hurt a company's market share.

Compliance Costs

Compliance with the federal securities law is a major setback that many executive faces as they desire to take their companies public. Publicly traded companies must adhere to stringent laws such as the Sarbanes- Oxley Act. Compliance also comes with increase cost such as the creation of new departments such as the investor relations (Kim et al., 2008). For the success of the process companies must incur more costs of hiring experts who are well versed with securities regulation. This further pushes the costs of operations for the business.

Remaining Private

A company can however achieve expansion and growth by remaining private. The executives should consider engaging aggressive marketing of its products and services as to increase their market share (Bernstein, 2015). The costs in involved in achieving compliance can be used to increase a company's market share through further research and development and introduction of new products.

Financial Ratios for IPO

The analysis of financial ratios is essential in determining the success of an IPO for a company. The same ratios will be used by the investors to determine the viability a company for an investment. Ratios are necessary for comparisons with other companies' so as to chart the progress of a company.

Debt to Equity Ratios

Debt to Equity ratios shows how company is leveraged. For company to have a successful IPO it must ensure it maintains a low ratio to attract more investors. A high debt to equity ratios would make the company undesirable due to its uncertainties yin fulfilling its debts. Operations profits margins (OPM) is another rations that the company should be keen on when deciding to take company public (Bernstein, 2015). It represents the operational efficiency and pricing power of a company. Investors prefer company with a high ratio due to their ability to acquire raw materials cheaply and convert them into profits.

Return on Equity

Return on equity evaluates the return that shareholders are bound to get from their investments in a company. It is calculated by dividing the net income by the shareholder's company. The executive of a company planning to go public should evaluate the amount of shares they are willing to offer and calculate the probable return on equity. Current ratio is another important ratio that executive have to consider (Jenkinson & Ljungqvist, 2001). It evaluate the liquidity of a company and its ability to meets if financial obligations. The ratio is calculate by dividing the current assets with the current liabilities and should be above one.

Conclusion

In conclusion there are several considerations that accompany has to evaluate before taking a company public. The executive of company should evaluate the profitability of taking a company public in line with the compliance costs involved and decide whether they should remain private.

References

Bernstein, S. (2015). Does going public affect innovation?. The Journal of Finance, 70(4), 1365-1403.

Gordon, L. A., Loeb, M. P., Lucyshyn, W., & Sohail, T. (2006). The impact of the Sarbanes-Oxley Act on the corporate disclosures of information security activities. Journal of Accounting and Public Policy, 25(5), 503-530.

Jenkinson, T., & Ljungqvist, A. (2001). Going public: The theory and evidence on how companies raise equity finance. Oxford University Press on Demand.

Kim, N. Y., Robles, R. J., Cho, S. E., Lee, Y. S., & Kim, T. H. (2008, October). SOX act and IT security governance. In Ubiquitous Multimedia Computing, 2008. UMC'08. International Symposium on (pp. 218-221). IEEE.

October 30, 2023
Category:

Business Economics

Subcategory:

Corporations Finance

Subject area:

Company

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