DebtFinancing and IPO
DebtFinancing and IPO
Forcredit is a medium-sized firm that desires to go public to raisehuge amounts of cash for numerous expansion projects. The CEO willhave the final decision on going public thus, it is imperative toidentify the benefits of going public as well as providingrecommendations and rationales for the process. Although the CEOunderstands that the company will incur costs accruing to more than$1.5 million in accounting expenses, underwriting fees, and legalexpenses among others, he also understands that by going public, thecompany will manage to initiate the identified projects ultimately.In this regards, the CEO identifies several benefits that the companywill accrue by going public as well provides the rationale for thosebenefits, provides the impacts of SOX compliance, and providesrecommendations whether to remain private or go public.
Benefits of Going Public
To identify the benefits of a small-sized company going public, itis essential to understand the meaning and processes involved ingoing public. Going public denotes the process in which a privatelyheld firm issues stock or shares to the public in an IPO (InitialPublic Offer) (Vernimmen, Quiry, Dallocchio, Le Fur, & Salvi,2014 Sun, Lan, & Ma, 2014). This is a significant phase in thedevelopment of numerous business since it provides the firms withaccess to the public capital market as well as enhances theircoverage and credibility. However, going public usually means thatthe management loses flexibility and control.
Going public will provide an immediate infusion of capital that doesnot encompass an interest charge to the company. By going public, thecompany will float shares of stock to the public through the stockmarket. According to Bova, Minutti‐Meza,Richardson, & Vyas (2014) a firm can access the capital once itmeets all the necessities of Security Stock and Exchange (SEC) andconforms to section 404 of SOX, which requires all CEOs to declareand report unrestrictedly the efficacy of internal mechanism over thebusiness or financial statements. In this regards, going public willprovide the required capital to the company without the IPO investorsrepaying the capital as they only seek an increase of theirinvestments and perhaps dividends. In addition, Bova et al. (2014)contend that by going public, a company may find it easier to accesscapital for future needs through offering new stock or offeringpublic debt. It is essential to note that after an IPO, a company canoffer new stock to the public, which helps the company to cash out onits early investment.
Cheng,Ioannou, & Serafeim (2014) assert that a companythat decides to go public will accrue the benefits of corporatesocial responsibility as going public will help it publicize itsinformation. In addition, the company will position ineffectivemarket-based solutions to SCR as well as enhance its profitabilityand business success factors. Publicizing the information gives acompany a stage to demonstrate its readiness to take intodeliberation the recompenses of all shareholders, which helps tointensify public confidence on the company (Cavusgil, Knight,Riesenberger, Rammal, & Rose, 2014). The enhanced publicconfidence will help the company to enhance its competitiveadvantage. Going public will provide a public valuation of the firm,which may help the company to enter into acquisitions and mergerseasily as well as attract better management talent.
Achieving the Benefits of Going Public by Staying Private
Going public provides numerous benefits to a company, but thecompany can still accrue the same benefits by staying private. Thecompany can still raise the required cash to initiate the projectsthrough ventures such as debt financing or selling equity. Debtfinancing requires collateral and one has to pay interest, but it isa good source of capital and fortunately provides numerous optionsthan equity financing. A company can use equipment, inventory,insurance policies, accounts receivables, and real estate ascollateral security to obtain debt from banks or can approach USSmall Business Administration (SBA) to serve as collateral (Bova etal., 2014 Cavusgil et al., 2014Cheng et al., 2014). In fact, debt financing willprovide fast capital as debt processing usually takes a small periodcompared to offering shares. In addition, the company can decide tosell ownership shares although this may not provide enough cash toinitiate the projects. By using debt financing to expand, the companycan still obtain public confidence by expanding rapidly and providingefficient customer care. The company can use also innovativecompensation approaches to attract and retain management talent. Thecompany can do so by advancing careers for employees, training,providing exciting opportunities, and rewarding success throughpromotions.
Evaluated Financial Ratios
By going public, a company raises external funds by offering sharesof stock to the public thus, selling these financial instruments tothe public depends on a set of factors such as return on asset,leverage of company, cash flow, and growth rate. In this regards, itis essential to evaluate financial ratios that will influence thedecision of the company to expand (Cavusgil et al., 2014 McLean &Zhao, 2014). Profitability ratios such as gross profit percentage ofsales, Return on Equity (ROE), Return on Assets (ROA), and net profithelp stakeholders monitor the selling price strategy of a company aswell as provides an analogous return on investment standards againstequity invested and assets employed. One of the most importantfinancial ratio is the gross profit margin as it offers informationrelating to the profit of the company to the public. The ratiomeasures the sum of profit that a firm is earning from its sales. Onthe other hand, ROA (Net Profit/Total Assets) looks at the sum ofasset investment utilized to obtain profit while ROE (Net Income/NetEquity) illustrates the earning power on stakeholder investment as itfocuses on the returns available to stakeholders.
Liquidity ratios such as current ratio and acid test ratio assistshareholders to determine the magnitude to which a firm has thecapital required for operations and processes (McLean & Zhao,2014). Current ratio (current assets/current liabilities) looks atthe magnitude to which assets predictable to be adapted into cashcover current liabilities. On the other hand, debt management ratiosassist shareholders evaluate the extent to which excessive debt canhave on liquidation risk thus, influencing on the profit of acompany. Debt management ratios include Times interest earned anddebt to equity ratio (ratio of total assets to equity funding).Companies with greater debt to equity ratio are at a greater risk ofbeing liquidated by external companies or parties. Market valueratios help shareholders to identify the present perception of themarket to the company concerning future profits and include ratiossuch as Price Earnings Ratio (PE) and dividend yield. PE identifiesthe market feeling regarding future profits where a ratio of 16 meansthat the market believes profits will increase while figure less than16 means that profits will fall. The results of the ratios wouldchange the decision to go public since the ratios show variousperception of the market to the firm.
Financial Impacts of SOX
The SOX act created numerous significant alterations for companieswishing to go public (Duarte, Kong, Siegel, & Young, 2014 Sun,Lan, & Ma, 2014). One of the significant benefit of SOX is thatthe act subjects a private firm with good governance and financialpractices and guidelines to little litigation and if litigated, sucha firm usually prevails since the benchmark any judgement is based onthe act. Furthermore, complying with SOX enhances the process ofraising of capital thus, compliance with SOX means that investorswill most likely risk their cash to invest. Although SOX improvesgood governance, it comes with increased costs to medium-sizedcompany. In this regards, Sun et al. (2014) and Duarte et al. (2014)contend that there is a high chance that a company will realizedecreased performance and earning if it decides to go public sincecomplying with SOX means that the firm will incur extra costs such asincreased audit, internal staffing costs, SOX consulting fees, andlegal fees.
As discussed above, going public may seem as the most viabledecision to take but increased costs and change of managementpriorities will impact on the company’s decision heavily to remainprivate. By choosing to go public, the company will incur more costsand ultimately attain poor returns on the increased investment. SOXdiminish the value of medium-sized companies due to increasedexpenses as well as diversion of attention from significantmanagement oversight and decision-making. Although the company maytake advantage of good governance and raise capital, the enhancedgood governance diverts administration from the management and theincreased investment realized from equity financing does not offergood returns (Sun et al., 2014). For example, if the company wishesto raise $16 million, it will incur in excess of $1.5 million interms of underwriting fees, legal fees, printing costs, and othercosts, which mean that firm, must have the $1.5 million in order togo public. In this regards, it is better to remain private or lookfor mergers or acquisitions.
Recommendations and conclusion
Vernimmen et al. (2014) assert that going public opens newprospects to employees as well as enhances public confidence.However, the company is still medium-sized and still lacks thewherewithal to comply fully with SOX. Although the CEO understandsthat going public will infuse large amounts of capital at nointerest, he also understands that the company can still raise thesame cash through debt financing. In fact, debt financing providesthe most viable chance for medium-sized companies to raise cash as itless costly. In addition, debt financing is less time costly thanequity financing, which usually takes more than 6 months. Althoughboth sources of capital provide the required capital, the CEO doesnot wish to lose or divert management priorities as it happens incases with equity financing thus, the firm should remain private.
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