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Should companies go public or stay private?

Traditional firms need capital injection to speed up growth through capacity expansion but the case for an IPO may be less compelling for the asset-light.

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With widening valuation gaps among different exchanges despite the same fundamental financials of an issuer, the attractiveness of the valuation in the target exchange market is exerting a larger influence on the issuer's choice of exchange.

GLOBAL IPO activity got off to a brisk start in the first quarter of 2017, led by market gains in the Asia-Pacific region and the US, the recent EY Global IPO Trends: Q1 2017 report revealed. A total of 369 IPOs raised US$33.7 billion worldwide, a 92 per cent year-over-year increase in the number of IPOs and a 146 per cent increase in global proceeds. Moreover, Q1 2017 was the most active first quarter by number of IPOs globally since Q1 2007.

This may be somewhat surprising, given that there has been a trend of public companies seeking to delist in some developed markets. It does look like public listing remains an attractive proposition in the capital markets.

There are many reasons why a public listing is desired. Traditionally, capital raising has been a key impetus. The ability to provide liquidity for existing shareholders or founders, clear and high valuations, attracting talent and raising the public profile of the company, are some of the reasons that drive the appetite for a listing.

For family businesses, listing the company may help the founding families to achieve a partial exit and liquidity. It can also provide a platform for succeeding generations to continue the business in a corporate structure that may not be possible in a private set-up, especially when extended families are involved in the operation of the company.

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SHORT VS LONG TERM

Corporatisation through listing is generally deemed to be beneficial to a traditional family business. However, the creation of the agency problem can have negative implications.

For example, the managers of the business may take short-term measures to maintain profitability and compromise the long-term strategic business objectives. The irony is that while these measures could benefit the managers, who are often also shareholders, and keep the activist investors happy in the short term, it could be detrimental to the overall sustainability of the business and shareholders' interest in the long run.

Some of the other concerns that companies have about a listing include: Is the cost of listing and subsequent compliance better invested elsewhere in the business? Is the business and management team fully ready for the scrutiny of regulators, minority shareholders, activist investors and the public?

All the above concerns are valid, and coupled with the fear of the unknown, may discourage private companies from going public.

ALTERNATIVES

At the same time, the options for capital raising do not stop at an IPO. Private companies are also considering alternative means of funding such as private equity funds, which are fast emerging as viable and credible options and may appeal to founders who do not wish to dilute their stake in the company.

In recent years, many private equity houses have been actively seeking investments locally, particularly in the consumer and technology sectors. Flushed with capital, some market observers believe that there is perhaps too much capital chasing too few targets.

While private equity houses are willing to invest, some business owners may be sceptical. Will the investors be too aggressive in their influence in the boardroom to reap unsustainable returns that give rise to increased risks? Thus, whether private equity could come at a "price" and is really cheaper than the cost of a listing remains debatable.

The type of company and the sector it is in may also influence whether a public listing or private equity funding is more appealing. Traditionally, brick-and-mortar businesses have a strong need for capital injection to accelerate growth through expansion in capacity. In these cases, the most logical route has been and continues to be to raise capital through an IPO.

In newer business models where the company is asset-light, the case for an IPO may be less compelling. In today's disruptive era, more and more companies are creating value through patents and other intangibles instead of hard tangible assets. These companies may prefer the option of private equity investors, who may be able to offer "smart capital" that combines both the benefits of liquidity and relevant experiences and connections from past investments.

For those that eventually opt for a public listing, the next important decision is where to list. With the capital markets increasingly global, options on where to execute an IPO are widening all the time. The costs, regulations, processes and expectations around an IPO can change from one market to the next.

For issuers, proximity to its target market is often seen as a strategic consideration. The selection of the listing exchange would thus typically reflect the market in which the company wishes to raise its profile.

However, given the trend of widening valuation gaps among different exchanges despite the same fundamental financials of an issuer, the attractiveness of the valuation in the target exchange market is increasingly exerting a larger influence on the issuer's choice of exchange. Between valuations and liquidity, and the need for market profiling, issuers will have to make a deliberate decision.

Clearly, going public or staying private requires extensive research and an honest evaluation of the interplay of factors that span the needs of the company and its shareholders, and what the market can offer in terms of valuation, liquidity and public profile.

It is a tough choice, but one that every growth company will have to face.

  • The authors are Max Loh, EY Asean and Singapore managing partner, and Adrian Koh, assurance partner and Singapore growth markets leader at Ernst & Young LLP.
  • The views in this article are those of the authors and do not necessarily reflect the views of the global EY organisation or its member firms.
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