Reading Financial Reports For Dummies. Lita Epstein

Companies don't take themselves public alone — they hire investment bankers to steer the process to completion. Investment bankers usually get multimillion-dollar fees or commissions for taking a company public. I talk more about the process in the upcoming section “Entering a Whole New World: How a Company Goes from Private to Public.”

      

GOING PUBLIC, LOSING JOBS

      Public company founders who don't keep their investors happy can find themselves out on the street and no longer involved in the company they started. Steve Jobs and Steve Wozniak, who started Apple Computer, found out the hard way that selling stock on the public market can ultimately take the company away from the founders.

      Jobs and Wozniak became multimillionaires after Apple Computer went public, but shareholders ousted them from their leadership roles in a management shake-up in 1984. Wozniak decided to leave Apple soon after the shake-up. Apple's new CEO announced that he couldn't find a role for Jobs in the company's operations in 1985.

      Interestingly, Jobs ended up as the head of Apple again in 1998, when the shareholders turned to him to rescue the company from failure. He engineered a comeback for Apple before his death in 2011.

      Examining the perks

      If a company goes public, its primary benefit is that it gains access to additional capital (more cash), which can be critical if it's a high-growth business that needs money to take advantage of its growth potential. A secondary benefit is that company owners can become millionaires, or even billionaires, overnight if the initial public offering (IPO) is successful.

      Being a public company has a number of other benefits:

       New corporate cash: At some point, a growing company usually maxes out its ability to borrow funds, and it must find people willing to invest in the business. Selling stock to the general public can be a great way for a company to raise cash without being obligated to pay interest on the money.

       Owner diversification: People who start a new business typically put a good chunk of their assets into starting the business and then reinvest most of the profits in the business in order to grow the company. Frequently, founders have a large share of their assets tied up in the company. Selling shares publicly allows owners to take out some of their investment and diversify their holdings in other investments, which reduces the risks to their personal portfolios.

       Increased liquidity: Liquidity is a company's ability to quickly turn an asset into cash (if it isn't already cash). People who own shares in a closely held private company may have a lot of assets but little chance to actually turn those assets into cash. Selling privately owned shares of stock is very difficult. Going public gives the stock a set market value and creates more potential buyers for the stock.

       Company value: Company owners benefit by knowing their firm's worth for a number of reasons. If one of the key owners dies, state and federal inheritance tax appraisers must set the company's value for estate tax purposes. Many times, these values are set too high for private companies, which can cause all kinds of problems for other owners and family members. Going public sets an absolute value for the shares held by all company shareholders and prevents problems with valuation. Also, businesses that want to offer shares of stock to their employees as incentives find that recruiting with this incentive is much easier when the stock is sold on the open market.

      Looking at the negative side

      Regardless of the many advantages of being a public company, a great many disadvantages also exist:

       Costs: Paying the costs of providing audited financial statements that meet the requirements of the SEC or state agencies can be very expensive — sometimes as high as $2 million annually. (I discuss the audit process in greater detail in Chapter 18.) Investor relations can also add significant costs in employee time, printing, and mailing expenses.

       Control: As stock sells on the open market, more shareholders enter the picture, giving each one the right to vote on key company decisions. The original owners and closed circle of investors no longer have absolute control of the company.

       Disclosure: A private company can hide difficulties it may be having, but a public company must report its problems, exposing any weaknesses to competitors, who can access detailed information about the company's operations by getting copies of the required financial reports. In addition, the net worth of a public company's owners is widely known because they must disclose their stock holdings as part of these reports.

       Cash control: In a private company, owners can decide their own salary and benefits, as well as the salary and benefits of any family member or friend involved in running the business. In a public company, the board of directors must approve and report any major cash withdrawals, whether for salary or loans, to shareholders.

       Lack of liquidity: When a company goes public, a constant flow of buyers for the stock isn't guaranteed. For a stock to be liquid, a shareholder must be able to convert that stock to cash. Small companies that don't have wide distribution of their stock can be hard to sell on the open market. The market price may even be lower than the actual value of the firm's assets because of a lack of competition for shares of the stock. When not enough competition exists, shareholders have a hard time selling the stock and converting it to cash, making the investment nonliquid.

A failed IPO or a failure to live up to shareholders’ expectations can change what may have been a good business for the founders into a bankrupt entity. Although founders may be willing to ride out the losses for a while, shareholders rarely are. Many IPOs that raised millions before the Internet stock crash in 2000 are now defunct companies.

Filing and More Filing: Government and Shareholder Reports

      Public companies must file an unending stream of reports with the SEC. They must file financial reports quarterly as well as annually. They also must file reports after specific events, such as bankruptcy or the sale of a company division.

      Quarterly reports

      Each quarter, public companies must file audited financial statements on Form 10Q, in addition to information about the company's market risk, controls and procedures, legal proceedings, and defaults on payments.

      Yearly report

      Each year, public companies must file an annual report with audited financial statements and information about

       Company history: How the company was started, who started it, and how it grew to its current level of operations

       Organizational structure: How the company is organized, who the key executives are, and who reports to whom

       Equity holdings: A list of the major shareholders and a summary of all outstanding stock

       Subsidiaries: Other businesses that the company owns wholly or partially

       Employee stock purchase and savings plans: Plans that allow employees to own stock by purchasing it or participating in a savings plan

       Incorporation: Information about where the company is incorporated

       Legal proceedings: Information about any ongoing legal matters that may be material to the company

       Changes or disagreements with accountants: Information about financial disclosures, controls and procedures, executive compensation, and accounting