Locate a recent story from The Wall Street Journal or other reputable news source about a company that has gone public through an Initial Public Offering (IPO) within the last year and rev

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JWI 531 (1202) Page 1 of 9

JWI 531: Financial Management II

Week Nine Lecture Notes

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JWI 531 (1202) Page 2 of 9

WELCOME TO WALL STREET What It Means Just as markets exist to sell food, cars, houses, and just about anything else you can think of, there are markets that bring together buyers and sellers of financial instruments. The most well-known are those that sell stocks, those that sell bonds and other debt instruments, and those that sell commodities such as oil, minerals, and foods. The equity (stock) markets typically get the most attention. These are the markets that specialize in the public exchange of shares representing equity in a company. Since anyone can participate in these markets, companies whose stock is available in these exchanges are referred to as “public companies.” Why It Matters

• As in investor, you will buy and sell stock through a stock exchange. While most exchanges will take place through a licensed broker and few investors interact directly with the exchange, you still need to know how they work.

• Companies seeking a large-scale infusion of capital to fund growth will eventually be faced with the decision about whether they should go public.

• These markets are the best way in which regular people can participate in the wealth-generating opportunities created by a capitalist economy. Just ask Warren Buffett.

“If a business does well, the stock eventually follows.”

Warren Buffett

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JWI 531 (1202) Page 3 of 9

THE CHALLENGE AND OPPORTUNITY FOR MANAGERS

Last week, we explored the advantages and disadvantages of funding growth through debt versus equity. We saw that each has merits, and, depending on the circumstances, either could be the preferred choice for the organization. This week, we turn our attention to the role that financial markets play in finance strategy. One of the most important distinctions that define the capital structure of a company is whether it is public or private. The other important distinction is whether it is for-profit or not-for-profit. While there are myriad different accounting and reporting requirements depending on whether the organization is for-profit or not- for-profit, the similarities in key areas are the same. As Jack has said, “non-profit does not mean non- performance.” Charitable organizations must still be good stewards of the money they manage. That means they must be efficient in distributing the highest percentage possible to the causes they support. They should also work to increase the contributions or revenue they take in. Some people would even say that, at the heart of it, the only difference between for-profit and not-for-profit organizations is that the former speak about profits and the latter speak about surplus. Our focus this week is on the advantages and disadvantages of public versus private companies. You can’t turn on the financial news without hearing about some company planning for an IPO (Initial Public Offering). These can be huge windfalls for the founders and equity holders of the company. In fact, they can turn even ordinary frontline workers into millionaires if those workers have been granted stock options at the right strike price. For many, going public is the ultimate goal and proof that the company has made it to the big leagues. With all this upside, why do many large and successful companies not go public? And why do some companies that are already public go private? This is something we will explore in our readings this week. One answer is that once a company is public, it faces a new level of scrutiny and reporting requirements. These requirements, while great for the investor, place significant burdens on the company and, because of the public nature of the required filings, result in revealing financial details to competitors that private companies can keep hidden. Also, public companies are subject to the ups and downs of the broader market which can impact share values for unwarranted reasons.

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JWI 531 (1202) Page 4 of 9

YOUR STARTING POINT

1. Can you explain the differences between a public and private company in terms of the ways

that ownership and exchange of shares are structured? What are the advantages and disadvantages of each type of capital structure?

2. You probably hear about IPOs all the time, but what steps take place behind the scenes before a company can go public?

3. What is the SEC, and what role does it play in the ongoing operations of a public company?

4. Why and how would a public company go back to being private? Can you find an example of a company that has done this? What was leadership’s rationale for this move?

5. What is a stock exchange? What are some of the major exchanges that exist, and why would a company be traded on one particular exchange and not on a different one?

6. How can understanding the advantages and disadvantages of a publicly traded company make you both an informed consumer of information and a better investor?

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JWI 531 (1202) Page 5 of 9

PUBLIC AND PRIVATE COMPANIES The Pros and Cons of Public versus Private It’s hard to overstate the prestige and financial rewards that can come from being the head of a successful public company. As Bragg writes,

“Many company owners and managers believe that taking a company public is the capstone of their careers, since being involved with a publicly-held company is considered to be not only prestigious, but also a superior way to raise capital. While such involvement may indeed be prestigious, it is also expensive, massively time-consuming, and quite possibly not such a superior way to raise capital.”

The CFO Guidebook, p. 259 For every potential benefit that comes from going public, there is a price to be paid. In many cases, the price, or the risk, is so significant that it outweighs the benefits; the owners then determine that remaining private is the better route to successful and stable growth. The reasons for and against going public are explored in chapter 15 of our readings for this week, but can be summarized as follows:

Benefits of Going Public Drawbacks of Going Public

ü It is easier to sell stock in the company ü It is easier to raise funds to operate the

business or fund an acquisition ü The lack of restrictions on selling shares

tends to raise prices ü Going public tends to reduce the

proportion of debt to equity ü Public status carries prestige ü Stock options are more easily exercised ü Management in public companies

generally makes more money

C It is expensive to pay for auditors, attorneys

and investor relations personnel C It takes management’s time away from running

the daily operations of the company C The required public disclosures allow

competitors to see more detail on the company’s financials

C Owner(s) could be forced out by an unfriendly takeover

C Investment banker fees can be very expensive

While the advantages are many, and going public is the best route to growth for many companies, Bragg doesn’t hide his cautions about the downsides:

“In short, there are a number of arguments both in favor of and against going public. Smaller companies will likely find that the cost of compliance with securities laws will erase a large part of their profits, and so may elect to remain private. A larger firm with more revenues will probably find that these costs only reduce profits by a relatively small amount, so that the overall benefits of being public outweigh those of being private.”

The CFO Guidebook, p. 260

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JWI 531 (1202) Page 6 of 9

Going Public Taking a company public is complex, expensive, and time-consuming. Bragg presents an overview of the key steps, people, and organizations that are involved in the process (pp. 260-263). We won’t recap those steps here, but you are encouraged to read this carefully, as it provides an excellent summary and sheds light on activities that most of us never think about when hearing about a new IPO. A few key terms worth noting include:

• Initial Public Offering (IPO) – the first offering of company stock to the public • Public Company – a company that has registered with the SEC and offers shares for sale to

anyone in the public who wishes to purchase equity in the company • Securities and Exchange Commission (SEC) – an independent agency of the federal

government responsible for regulating public markets and enforcing securities laws; this is the agency with whom financial reports must be filed to remain an active public company

• Registration Statement – a form mandated by the SEC that contains a detailed review of the company’s financial and operational conditions, risk factors, and any other items that it believes investors should be aware of before they buy the company’s stock

• Underwriters – investment banks that help the company go public; they provide a number of services, such as helping to set initial stock prices and buying a certain number of shares

• Road Show – a series of presentations typically over several weeks where senior management presents a summary of the company and its investment prospects to potential, and usually institutional, investors to raise awareness and excitement

• Reverse Merger – the purchase of an existing public company by a private company with the intention of using the public company as a vehicle to issue its shares

• Shell Company – a company that is no longer active but still public, typically purchased to leverage its public status in order to sidestep the initial SEC registration process

As you will learn when reading this chapter, it is extremely important when preparing for an IPO to have experienced legal, financial, and investor relations teams. While going public can be a fantastic way to raise capital and grow the business, it is not the right move for every company. It comes with capital structure and reporting requirements that can have a significant impact on the business. We will cover some of these ongoing requirements in greater detail next week but, to be certain, the IPO is just the beginning. There is a never-ending requirement to build a strong and effective investor relations capability, and to ensure that financial events are recorded and reported accurately, and paint a clear picture that enables investors to make informed decisions about how they invest in the company. In fact, the requirements can be so onerous, that Bragg offers the following advice:

“[B]efore committing to go public, take a very hard look at all other alternatives to see if it is possible to remain private for as long as possible. At a minimum, go public while keeping all options open for going private again if the rewards associated with being publicly-held do not materialize.”

The CFO Guidebook, p. 274

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JWI 531 (1202) Page 7 of 9

Stock Exchanges We hear about stock exchanges all the time in the financial news, but what exactly do they do?

“A stock exchange is a physical location or an electronic system, on which investors buy and sell securities. A stock exchange creates an orderly market, which makes it easier for transactions to be completed. They also impose listing requirements that keep the securities of less financially stable companies from being listed. Thus, investors use stock exchanges for their transactional efficiency and the supposition that the securities being traded come from issuing companies that have passed minimum financial benchmarks.”

The CFO Guidebook, p. 275 It is interesting to note that being listed on an exchange is not mandatory for a public company. Nevertheless, it is the normal path for most public companies because it helps to ensure that there is sufficient trading volume and price stability to make it easy to get into and out of a stock. This is especially important if a company intends to offer their stock – with or without additional cash – in exchange for ownership of another company during a merger. Bragg discusses the more well-known exchanges that exist. Each has its own list requirements which can range from very restrictive for the NYSE to more flexible for others.

• The New York Stock Exchange (NYSE) is the most prestigious exchange and has the most rigorous listing standards, making it the one that most companies aspire to

• The NYSE Market (formerly the American Stock Exchange) is designed to attract smaller companies that would not qualify for listing on the NYSE

• The NASDAQ is a computerized system that offers three different exchanges – Global Select, Global Market, and Capital Market – each with different listing standards ranging from most to least strict, allowing it to compete for a wider range of companies

• Non-US Exchanges – such as Toronto, London, and Tokyo – present opportunities to list in geographic areas where the company is headquartered or does most of its business

There are two other listings worth noting. One is the Over the Counter Bulletin Board. This is technically not an exchange, but rather a listing service. It shows real-time quotes and sales prices for companies that are not listed on an exchange, but are current in their SEC filings. The other is known as the Pink Sheets. This is a default listing where company shares are recorded when the company is no longer current in its SEC filings or has gone private. While it is not mandatory to be listed on any stock exchange, it presents a number of benefits.

“If a company is publicly held, then it should be listed on a stock exchange. Doing so confers the benefits of a higher volume of stock trading, though this comes at the cost of annual listing fees and some changes to the governance structure of a business. Once a company is listed on an exchange, the CFO should have an ongoing interest in advancing the business to an exchange that is used by a larger number of investors, thereby increasing the volume of trading in company stock.”

The CFO Guidebook, p. 284

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JWI 531 (1202) Page 8 of 9

SUCCEEDING BEYOND THE COURSE

As you read the materials and participate in class activities, stay focused on the key learning outcomes for the week and how they can be applied to your job.

• Explore the advantages and disadvantages of public and private companies If you work for a private company that is considering going public, this is a wonderful opportunity to see the process at work and to learn as much as you can about the rationale for the move. Many of us will work our entire careers and not find ourselves in such a situation. But you can still learn a lot by following financial news and listening to what is being said by the CEO, CFO, and investment bankers about why the company is going public, and how they are pricing the IPO.

• Examine the history and specialization of different stock exchanges

As an individual investor, you will not have any direct dealings with the actual exchanges. This will be handled through a brokerage firm licensed to buy or sell in the exchanges. Still, it is useful to understand the company sizes and financial profiles that different exchanges are tailored to. This is particularly relevant for companies launching IPOs. If you are in a position to guide financial strategy in your organization, you will need to understand the roles of different exchanges and which one can best support the growth of your company. It is also informative to take note of companies that move from one exchange to another. It can point to changes in the company’s finances and shed light on where business might be headed, depending on whether the company is moving to an exchange with more or less rigorous listing requirements.

• Understand the role of capital markets in investing and creating value

One of the important takeaways from this course is that you should learn more about financial markets and the instruments available to build wealth at both the personal and corporate levels. While it is true that stock investments can and do lose money, the overwhelming track record demonstrates that investing in the stock of well-managed, publicly traded companies far outstrips what can be earned through putting money in the fixed-return assets. If you do your research and can keep your emotions in check – not getting too excited when the market is up, or too fearful when it is down – there is no surer path to prosperity than to be a long-term investor focused on value.

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JWI 531 (1202) Page 9 of 9

ACTION PLAN To apply what I have learned this week in my course to my job, I will…

Action Item(s) Resources and Tools Needed (from this course and in my workplace) Timeline and Milestones Success Metrics