Accounting & Tax

Same Straw, Smaller Back

New regulatory burdens fall heavily on small public companies. One way to lighten the load: Go private.
Ed ZwirnFebruary 1, 2003

“We’re too small to bear the expense of being a public company,” says John Clary, CEO of Monrovia, California-based Clary Corp., which employs 40 to 50 people and generates $6 million to $8 million in annual revenue. “Every year the regulations get more complex.”

“The federal government and the State of California both seem hell-bent on making sure everything’s manufactured somewhere else,” adds Clary, whose family-run company produces uninterruptable-power-supply equipment. In a December filing with the Securities and Exchange Commission, Clary Corp. announced its intention to go private in a management-led transaction. In part, says Clary, the reason was to avoid the additional audit costs imposed by Sarbanes-Oxley.

Statistics may be hard to come by at this point, but anecdotal evidence seems to indicate that many more small public firms will go private this year. The SEC, which must approve all going-private transactions, maintains that it doesn’t keep count. But Mike Starr, the U.S. managing partner for strategic services at accountancy Grant Thornton, confirms that “certainly, we’ve had discussions with smaller companies about going private.” Many attorneys, consultants, and other industry professionals are also seeing increasing numbers of companies with going-private deals in the pipeline or under consideration.

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Typically, the “stock [in these companies] is not widely held,” says Starr. In addition, going private will be “more prevalent among companies not listed on a major exchange.” Starr adds that considering the relative obscurity of many of these companies and the time required to close a going-private transaction, and allowing for a six-month deal pipeline, the full extent of this trend will not be apparent until later in the year.

“Many smaller firms are going to rationalize whether the cost of being public” is justified, concurs James Haddad, chairman of the Association of Financial Professionals financial reporting committee and vice president of corporate finance at Cadence Design Systems in San Jose, California. “They’re looking at whether they need to stay public, particularly with valuations the way they are.” (For more on how this may affect the client base of the Group B accounting firms, read “The Second Six: Ready to Step Up?“)

Small domestic companies are not alone in voicing their concerns about staying public — or going public — in the United States. In Germany, the source of some of the loudest complaints, automaker Porsche decided against a U.S. IPO because under German law, supervisory boards and audit committees must include employee representatives — who, by definition, aren’t “independent” under Sarbanes-Oxley. In Japan, Daiwa Securities Group and Fuji Photo Film Co. of Japan recently delayed planned U.S. listings, citing similar conflicts.

If money could be made hand over fist in the U.S. equity markets, many more companies would willingly jump through the regulatory hoops. But “companies are not having revenue growth of 30 to 40 percent” to compensate for increased costs, especially new audit costs, says William Travers, managing partner at accountancy McGladrey & Pullen. At the same time, their shares “are not trading and not getting the attention of the mutual funds,” he adds. Given the present market psychology, “public isn’t the place to be unless you have that rocket-ship opportunity.”

“When the market goes up,” says Grant Thornton’s Starr, “I don’t think this will be a significant factor.” But that’s no comfort to John Clary today. Says Clary, “We reached a time when [going private] looked reasonable for everybody.” Clary Corp. shareholders, including the approximately 40 percent who were not family members, officially accepted the tender offer for their Pacific Exchange-listed stock in late January. None of these outsiders, says Clary, has reason to complain about the $2-per-share offer: “Our stock’s been in the doldrums; it’s been about $1 or $1.25 for four years, and that would vary a great deal, based upon whether someone was trying to buy or sell.”

“In such an illiquid market, there is no advantage to anybody,” adds Clary. “Small companies shouldn’t be on the market.”