Going Public

Should your company turn the corner from private to public ownership? Here’s a look at the positives and the potholes of putting your business on Wall Street.

Although the scrap industry has long been dominated by privately held family firms, there have also been some notable exceptions to that rule. Commercial Metals Co. (Dallas), Imco Recycling Inc. (Irving, Texas), and Schnitzer Steel Industries Inc. (Portland, Ore.) are just three examples of publicly owned scrap companies with considerable clout in the industry. And, of course, the current wave of consolidation is being driven primarily by three publicly held entities.

With more acquisitions almost certainly ahead, even firms that want nothing to do with Wall Street must at least consider the possibility of ending up there. So whether going public is the answer to your company’s prayers—or the worst nightmare you can imagine—it certainly pays to consider the issue’s pros, cons, and costs.

A Capital Idea

Sooner or later, every successful family business reaches the point where it needs additional capital. The company may be in a growth phase and need access to acquisition capital. Or maybe its owner wants to retire and needs to convert his equity in the company into cash to secure his future.

These are two of the most common reasons that make scrap company owners consider taking their company public. “Going public is one way of providing for immediate capital needs while maintaining a low debt ratio, and it offers some additional benefits as well that are worth considering,” says Walter Wright, a partner with the law firm of Mitchell, Williams, Selig, Gates & Woodyard P.L.L.C. (Little Rock, Ark.).

“A company that goes public has two things going for it—value and liquidity,” he says. “When you establish a market price for your stock, your company has value. That makes it easier for a founder to turn all or a portion of his stock into cash.”

The liquidity of securities compared with that of tangible assets also is an advantage for beneficiaries who must pay estate taxes. In a private company, a beneficiary may be forced to liquidate a portion of the company and its tangible assets to cover estate taxes. When the company is public, a beneficiary should be able to sell enough stock to cover the estate taxes, while keeping the company’s assets intact.

There’s also a certain credibility that comes with being a publicly traded company that may have some strategic advantages, says Wright. “For example, being in the market already may allow a company easier access for a second public offering. Or growth companies may find themselves able to trade their stock with another company as part of an acquisition agreement.”

For companies that want their story told, “going public can be a tremendous opportunity to let the world know about your business,” says Danny Rifkin, president and COO of Omni-Source Corp. (Fort Wayne, Ind.). Public companies, particularly new issues, attract investor attention, and that kind of exposure may have some market value. 

The officers of OmniSource, a third-generation, privately held company founded by Rifkin’s grandfather, “have taken the matter under serious consideration,” adds Rifkin. “At the moment, however, we enjoy sufficient access to the debt markets to manage our growth and achieve superior results without going public.”

Similarly, David J. Joseph Co. (Cincinnati) is another large, private company that has been able to achieve its goals without resorting to public capital. Joseph Co. is owned by SHV Energy N.V. (Utrecht, Netherlands), a holding company with diverse interests in many industries.

“We haven’t needed to go public, so why would we?” asks Stephen W. Wulff, vice president of planning for Joseph Co.’s ferrous division. “Because of the size and strength of our parent company, access to capital isn’t a problem.”

Both OmniSource and Joseph Co. are proof that going public isn’t always essential for attaining significant size and market share. OmniSource is currently at a run rate of more than $800 million in sales for 1998, while Joseph Co.’s annual sales exceed $2 billion.

Conducting Business in a Fishbowl

More than anything, issues of privacy and control are what make privately held companies of all sizes, in all industries, balk at the thought of going public. “From the minute a company announces its intent to sell shares on the public market, all of the officers and family members are living in a fishbowl. That makes many people uncomfortable,” says Wright.

Companies that desire to float an initial public offering (IPO) are immediately caught up in complex legal situations governed by the rules and regulations of the Securities and Exchange Commission (SEC). The SEC requires that public companies disclose certain information before stock is issued and regularly thereafter.

A partial list of the information that must be disclosed includes officers’ compensation, the company’s net worth, pending agreements, environmental concerns that may affect the business, prior arrangements with vendors, affiliate agreements made with family members, and details of contracts with key suppliers.

Public companies, Rifkin points out, are required to lay open to public scrutiny not only their financials, but also their growth strategy, competitive analysis, and lending arrangements. “It’s not that a private company has anything to hide, but rather the perception that there can be competitive and strategic advantages to keeping this type of information confidential,” he says.

Family members who will continue as shareholders in the public company must be prepared to be in the public view themselves and have everything they do related to the business subjected to scrutiny. That includes the perks they might be used to, such as cars, travel expenses, or cell phones. Family members may have to give up these benefits—unless the company plans to treat all shareholders to the same perks. Information disclosure requirements don’t end with the IPO. The decision to float an IPO is the beginning of a cycle of information collecting and reporting that will be repeated regularly throughout the company’s life.

It’s the price of being public, says Paul Dufour, CFO of Imco Recycling. “Along with access to public capital comes a lot of reporting requirements and obligations to the investing public. Keeping up with the requirements takes time and money.”

Scrap companies tend to be closely held, family businesses where shareholder control is synonymous with family control. If the family plans to use the capital raised to make its exit en masse, then control is not an issue. “But many times some family members want to stay on, and then control becomes a big issue,” says Drew Mendoza, director of the Loyola University of Chicago Family Business Center and a principal in the Family Business Consulting Group. “For the CEO used to heading up the family business, being an officer in a public company is an entirely different way of doing business. And they often don’t like it.”

All officers in a public company, including the founder and his or her family, are subject to having their actions and decisions questioned and their performance examined. The board that used to be all family members now will include nonfamily members—outsiders, in the family’s view—who have every right to ask questions and expect answers. Even if the family retains majority ownership of company stock, outsiders now have the legal right to participate in decisions affecting the company.

The scrap industry’s tradition of privacy, personal control, and involvement in the business may limit the number of recycling companies that even consider going public. “In my experience,” notes Mendoza, “families rarely anticipate the public exposure and the lack of control they have to deal with on a daily basis when they go public.”

Heads of family businesses are similarly unprepared for the different business philosophy that guides public companies. To the former head of a closely held company, the new, public board of directors often seems totally without vision, and this difference in outlook can cause conflicts, says Mendoza.

“A family business is driven by dreams. Shareholders take a long-term view of the company, the use of capital and return on capital,” he says. “That’s in direct conflict with the public company that operates based solely on one focus: what the quarterly earnings report will look like.”

Public Spending

But before the founder starts worrying about the changes going public will bring, he or she would be wise to take a serious look at the financial commitment involved to determine if floating an IPO is even feasible for his or her company. “Generally, 5 to 10 percent of funds raised from an IPO will go toward expenses,” says Wright. “Unless a company is trying to raise $15 million to $20 million, the effort usually isn’t worth the costs.”

A significant portion of the costs are in hard money, mostly related to compliance with federal regulations governing the issuance and sale of securities. These costs include fees that the company must pay for registration and professional consultation with securities and legal experts.

The biggest outlay is for underwriters’ fees—the money paid to the investment bank that acts as the adviser and actually raises capital in the market by distributing the securities. As an example, for a company that wants to raise $15 million—considered a fairly modest IPO—underwriters’ fees would run between $900,000 and $1.5 million.

Any company hoping to float an IPO must have its books examined by an outside accounting firm. For that hypothetical company with the $15 million IPO, accounting fees would run about $60,000 to $70,000. Add in another $125,000 to $175,000 for legal fees, plus up to $10,000 for expenses such as travel, photocopies, long distance phone calls, meals, and other expenses the various consultants will incur and for which they’ll bill the client. 

Printing and mailing costs are hefty expenses that companies often underestimate or overlook. They are proportional to the size of the offering, but printing and mailing a prospectus easily can run $100,000. The company also is responsible for printing the registration statement and underwriting agreement for distribution.

The government collects its share of fees as well. The SEC charges a fee for registering the securities, and each state charges a fee for registering securities under their Blue Sky laws. Individual state fees can range anywhere from $10,000 to $50,000 or more. 

Time and Management

Other costs related to going public are harder to estimate, says Wright. “The officers and key executives must know up front that the process and the commitments on their time will be extensive. Even before the offering is made, their time will be taken up collecting information, preparing reports, and going to meetings.”

The time demands on officers and key executives escalate dramatically about one month prior to the date set for the IPO. “They must take their show on the road to drum up interest from institutional investors,” says Charles J. Kaplan, president of Equity Analytics, a Long Island, N.Y., IPO consulting firm.

“Officers must be willing to make the time commitment to travel to several cities within a short time period and be ready and willing to withstand rigorous questioning about the company from experts,” he says.

The purpose of this “road show,” as Kaplan calls it, is to demonstrate the company’s management strength and competence to institutional and retail buyers and brokers. 

“The road show is very important. Ultimately, how well the management team portrays the company at these sessions can affect the stock’s performance in the aftermarket when it actually begins trading,” he says. “The other part of these meetings is to see how well the management team holds up under intense questioning by seasoned professionals. Analysts consider top management to be one of the most crucial aspects of any company.”

When is the right time for a company to go public? “That question has an easy answer: When they’ve conceptualized the plan they’ll use the money for,” Kaplan says. “When the company has identified in what products or markets it wants to expand, what acquisitions it wants to make or equipment it wants to purchase—that’s the right time.”

Some experts say that a company needs to have reached a certain level in sales volume—around $100 million is the figure usually quoted—before it will attract serious investors or promoters. Kaplan disagrees and points to biotechnology companies that have gone public while recording losses. “The more important question is whether the securities will be a viable offering for investors. They want to know what kind of growth the company is experiencing and whether it is getting better over time,” he says. For a smaller company, year-on-year growth of 30 to 50 percent is a good indicator of future prospects and returns.

The value of the company—and how much the family will get out of it—depends on what investors are willing to pay for each share. Investment bankers use $10 to $20 a share as a rule of thumb in pricing IPOs, and a million shares is considered the minimum amount that should be issued.

The investment bank sets the share price based on the composite picture of the company they develop from examining its cash flow, profits, management, future prospects, and potential dividends to be paid.

Overall, for a company to look attractive to investors, it must compare favorably with other recycling companies of similar size.

“There’s a tug-of-war going on,” says Kaplan. “Investors want as large a return as possible for the IPO while the company wants to maximize its return from the offering.” The investment bank has the challenge of balancing both sides.

Timing of the IPO can make a big difference in how the tug-of-war turns out. “Keeping in mind that IPOs generally are underpriced, they are less underpriced in a bear market,” says Kaplan. Under those conditions, he notes, the market is soft, the amount of funds available is limited, and usually only the best companies can do an offering.

In a raging bull market, “issues are likely to be overpriced and still underpriced,” he says. “Valuation reflects the conditions of the market. The multiples—such as price/earnings—are higher in a bull market, and that’s the same for IPOs. But the IPO will generate a lower initial multiple relative to competitors. In a bear market, the IPO price more closely reflects true market value as measured by investor returns.”

The company that can wait out a bear market for a bull market will realize a figure closer to the hoped-for proceeds from the IPO.

Patience Required

Companies that are considering an IPO and trying to time it right need to keep in mind that this is a long, slow process, says Wright. Offering a comparison, he notes, “once the decision to raise capital is made, getting a bank loan is a quick process. If your credit is good, you can have a loan in a few days. Expect a six-to nine-month time frame for the IPO process.”

Victor Winkler, president of MetroMetals Northwest Inc. (Portland, Ore.), believes his company could float a successful IPO in a year, if that was necessary or desirable. For now, at least, it’s neither, says Winkler. “That’s not to say we never will, but there’s no need to at the present time,” he says. “We’re a young company, ready to grow. Right now, the banks are willing to lend money to scrap companies. As long as we can sustain our growth and stay private, that’s what we prefer.”

That attitude seems to permeate the recycling industry, despite a brief flurry of IPOs last year.

“We saw a handful of companies going public to gear up for consolidation,” says Rifkin. “That seemed to indicate that the industry was moving toward rapid consolidation and the public environment. Acquisition prices gave target companies the idea that they could get more value out of their company than they ever dreamed possible, while escalating stock prices provided consolidators with a currency with which they could make accretive acquisitions. These dynamic conditions were setting the pace for consolidation in 1997.”

Since then, however, the market has backed off, especially in steel and scrap-   related stocks, and the interest in IPOs and consolidation seems to have temporarily waned, he says.

Still, going public is only a matter of time for the industry, says Harry Kletter, CEO of the publicly held Industrial Services of America Inc. (Louisville, Ky.). To him, “public ownership means companies backed by adequate capital to expand in response to changing customer needs, larger yards, and consistent volume and availability that lets the yards set prices.”

He believes that the recycling industry must go public to sustain the necessary growth and allow company owners to liquidate their assets. Kletter envisions a fourth generation of publicly held scrap companies, born from third-generation private companies. “Consolidation is good. Smaller companies need to sell out and go regionally public,” he says. “Sellers currently want those high prices, and the market can’t support them, so we’re in a stalemate.”

The Small Company Offering Registration (SCOR) process is another alternative for smaller companies seeking to raise $1 million or less in capital. This simplified version of securities law is available in more than 30 states. It is designed to make it easier for a company to raise smaller amounts of capital, without requiring federal registration for an IPO.

SCOR isn’t often used, but it can be a good vehicle for small companies that can’t attract the interest of professional investors and investment banks. A corporate attorney can determine if a particular company is a candidate for SCOR.

But regardless of whether a company’s owners decide to go public or stay private, the fact that they’re considering the issue indicates that they’ve reached a crossroads. Clearly, they must step wisely as they contemplate a walk down Wall Street. •