AMMAN, 5 July 2004 — Choosing between taking a company public by floating shares on the local stock exchange or staying a privately held company is not an easy decision. It is based on an assessment of whether the extra opportunities that an initial public offering (IPO) would provide exceeds the disadvantages of being exposed to more regulations, higher cost of compliance and the fact that the enterprise would lose control to shareholders that it cannot choose.
The main driver in favor of going public is the desire to tap outside sources of equity for expansion. By selling shares in the local or regional capital markets, a private company would be able to raise the funds required for the swift growth of the business. Furthermore, banks may be far more willing to lend money to a public company than to a relatively unregulated and less transparent private institution.
Going public through issuing IPOs is a feasible option for privately owned businesses who want to realize the value of their companies. Instead of having 100 percent ownership, listing on the local stock exchange will enhance the profile of the company in the market place and will allow the owners to share the risk with other smaller investors, without necessarily losing the identity of the firm. The additional capital raised will reduce the company’s dependence on bank borrowing and would facilitate expansion while maintaining the firm’s “optimal” financial structure in terms of debt to equity ratio. An increase in available capital is not the only advantage associated with the transition from a private firm to a public one, there is also the advantage of having to put in place a more transparent reporting system as usually required from publicly listed companies besides drawing on more experienced and professional management.
In the Arab region, for a family company or a privately held one to go public carries a social stigma. It is seen in the same light as a company facing financial or managerial difficulties since it is assumed that the family in is incapable of running its business. Furthermore, the idea of going public raises concerns in the area of disclosure and control. It is feared that greater corporate disclosure might reveal considerable private wealth that has so far been hidden. Another concern is that going public would reduce the influence of the family controlling the business and will make it more difficult for future generations to re-establish their family identity if the company is owned by “faceless” investors. There is also the worry that an old rival, or some local or international giant could take over with little or no concern for the family’s name or values.
In a publicly owned shareholding company the main goal of management is to maximize shareholders’ value. With family businesses, there are other objectives to achieve beyond shareholders value that include attaining long-term growth targets, maintaining certain family traditions, staying away from businesses that require excessive disclosure and financial transparency, getting into new lines of business that meet the requirements of one of the siblings, etc. Family members feel they are only entrusted to take care of the business before handing it over to the next generation hopefully in a better shape. In a typical family firm, progress is measured in small, regular steps. Management is usually conservative in nature, have longer time horizons and lower appetite for borrowing. Following the recent corporate scandals in the US, Europe and the region there has been a return to the kind of values prevalent in family owned companies, including taking a long-term view rather than live or die by quarterly results and earnings per share.
A shortage of risk capital in the past has motivated the formation of publicly owned companies. As banks, manufacturing and services companies requiring substantially more capital than individuals could or would provide began to emerge, the need for new means of raising funds and spreading the associated risks arose. However capital is no longer scarce nor is it as risk averse as it used to be before. When faced with the challenge of how to finance growth in the business, privately held companies may raise capital through retained earnings or drawing on the financial strength of the owners. Low interest rates have made debt financing, especially through issuance of long term bonds at fixed rates, an attractive option. However, to do that, privately held limited liability companies need to convert into private shareholding companies and follow more stringent reporting requirements. There is also the private equity market that is still in its early stages of development in the region. There are few private equity funds active at the local and regional levels and several others are currently being established that can provide patient capital to businesses to finance their long-term growth.
The difficulties faced by privately held companies upon going public have led some of the currently listed firms to think about delisting. The presence of strict corporate governance regulations, the lack of liquidity in their stocks and the rising cost of listing and auditing have lead several companies in the US and Europe to feel that they will be better off going back to being private entities. A record number of US companies are expected to go private this year, topping last year’s number of 86, and 55 three years ago. Even after a sharp rise in small-cap stocks over the past two years in the US, the small and midsize companies making up the Russell 2000 index are still trading at just 2 times their book value, suggesting that investors are not giving much attention to small companies. Furthermore, there was very little equity research cover for those companies. By contrast, the large companies in the Dow Jones Industrial Average are trading at 3.5 times their book value. Until 1998, there was hardly any difference between the two.
Privately held Arab companies may decide not to go public if they perceive the cost of doing that outweighs the potential benefit. Many of them have other options that they can draw upon to raise capital. The regulatory authorities should make it conducive for firms to consider going public by lowering the cost of listing and other associated fees. Standards of regulations should continuously be upgraded but without making them prohibitively restrictive. Investment banking institutions in the region are called upon to educate companies on the importance of going public and provide such services as valuation, underwriting and market placement of IPOs. They should also issue equity research reports on newly listed companies to raise investors interests and boost liquidity in the traded shares of these companies.
(Henry T. Azzam is the chief executive officer Jordinvest)
