Initial Public Offerings

            Initial public offerings or “IPOs” transition a company from being private to going public.  Most often companies go public to raise capital, but companies may also raise capital though other means such as a private offering.  Alternatively, some companies may be required to go public based on their size of the company and the number of shareholders such as Facebook.  Regardless of company size, entrepreneurs should consider whether going public is right for their companies.  Some advantages and disadvantages to going public are explained below.

Advantages

                Going public has several advantages from a capital raising and branding standpoint.  

                Raising Capital: An IPO may result in an increase in capital and access to a broader pool of investors than if the company remained private.  Private companies often raise capital through private offerings to friends, family and certain investors (angel investors and venture capitalists), but can be limited in the type of investor to solicit.  Conversely, in an IPO, the company can reach almost any type of investor without the same limitations as a private offering. 

           Employee Incentive: Public companies often use their stock as an equity incentive for employment.  Prior to going public, some companies issue stock to their key people to reward and retain these individuals after the IPO.

              Increase Liquidity: By going public, a company will have its shares listed on an exchange creating a market for those shares.  With a known value of the company’s shares, shareholders and employees may have an easier time selling publicly traded stock than privately held companies. 

              Retaining Control: With an IPO, a company may be able to retain some level of control of management as opposed to a company pursuing financing through venture capitalists who generally require some degree of control.  

            Brand Awareness and Prestige:  With an IPO can come a level of publicity, prestige and brand awareness.  The prestige of being an officer or board member of a public company has a certain appeal.  Also, brand awareness will increase after going public.  Millions of investors, investments analysis, and others will be able to access your company information and financials on the SEC’s database EDGAR.  

Disadvantages 

       While an IPO may bring access to capital and creditability, going public may be disadvantageous for some companies.  

             Expenses: An IPO can be a costly process to ensure that the IPO complies with all SEC rules and regulations.  This is an ongoing expense due to the periodic disclosures required by the SEC.

               SEC Filing and Reporting Requirements: Public companies are under more scrutiny than private companies because the barrier to becoming an investor/shareholder is relatively low.  Due to this low barrier, the SEC requires that public companies make certain periodic disclosures to keep shareholders informed about the company.  Public companies must report to all shareholders regarding management operations, executive compensation, legal obligations and financial statements.  A company may not want all of this information regarding the operations and financials of the company to be made public or potential competitors.

            Loss of Control:  Depending on the number of shareholders in the company, company management may lose some flexibility in managing company affairs when the shareholders must approve certain transactions.  

Phantom Equity Agreements

Most entrepreneurs are always looking for ways to incentivize and reward key management and top performing employees in order to keep them within the organization.  A common incentive is to offer ownership in the company to key employees through a stock plan.  While ownership may seem to be an attractive option, adding an owner to the business creates risks for the current and potential new owner.  Risk could arise from disagreement between new and old owners in leadership styles, the direction of the company and use of company funds.  Additionally, key employees may not have the financial capability of purchasing their shares of ownership or dealing with the consequential tax burden.

An alternative to offering key employees ownership is to set up a phantom equity plan.  Phantom equity is a promise by the company to pay key employees a bonus equivalent to the value of the company’s shares or the increase in the company’s shares over a period of time.   The key employees would receive this deferred bonus based on a particular vesting period.  Essentially, phantom equity allows key employees to participate in the upside of company as the company’s shares increase in value without the burdens of ownership.  

Phantom equity generally is non-taxable until the bonus is paid.  At that time, the employee recognizes income and the company may take a deduction.  Compared to offering ownership, the key employee does not have to purchase ownership or face an immediate tax burden upon introduction into the phantom plan.

Phantom equity plans may be an ideal incentive for employees; nonetheless, business owners should consult with legal counsel to make sure these plans comply with IRS regulations and avoid complex ERISA rules governing employee benefits.  If you have questions or are interested in implementing a phantom equity plan within your organization, we can assist you in implementing this plan.