Capital Markets

When Going Public Can Spawn a Merger

Strategists at more and more private corporations are choosing to explore two plans at the same time: issuing an IPO and selling the company.
Helen ShawJuly 7, 2005

Facing an unpredictable IPO market and the high regulatory hurdles of going public, executives at an increasing number of private companies are taking a “dual track” route toward changing the nature of the company’s ownership: pursuing an independent public offering, but also remaining open to the chance that it might be acquired.

Under those circumstances, for instance, a company might file for an IPO, prompting interest from strategic buyers. Then the company could talk with potential acquirers to learn whether going public would provide the best value.

Previously, most private corporations looking to change their status have chosen to go public before even considering a merger. “Now, more companies are looking at a sale potential along with an IPO, particularly small-cap and mid-cap companies,” says Cole Bader, a partner in the mergers-and-acquisitions group at Thomas Weisel Partners. “The trend is strong in the technology and consumer sectors, where a lot of smaller companies are going public.”

Sometimes executives consciously pursue a dual-track strategy, to be sure. But sometimes they just stumble on it. Sybari Software, a message-security provider, had completed a roadshow and was set to launch an IPO when, suddenly, Microsoft expressed interest in the company. Discussions with a potential suitor after a roadshow are rare, notes Walter Kortschak, a managing partner at private equity firm Summit Partners, which had invested in Sybari. However, Sybari began talks with Microsoft and reached a definitive agreement within one week.

“We, the Sybari Board, consulted with the management team and their perspective was that there was a lot of strategic merit in combining with Microsoft,” says Kortschak. “They felt they would have been an excellent public company and would have done well, but they could do even better as part of a larger entity with Microsoft.”

Announced on February 8, the 100 percent cash transaction for an undisclosed sum was completed on June 21. Microsoft management has reportedly said that the purchase adds “a critical security component” to its offering.

Investors note that the dual-track approach, although never uncommon, is rising in frequency. “In the old days, the focus was on getting a company public and then, with a market price, a company could think about a merger [or about being acquired] because it established a fair price,” observes Mark Perry, a general partner at New Enterprise Associates, a bi-coastal venture capital firm. “But [going public] is harder to do now; therefore, looking at things in parallel can be attractive.”

Among the challenges to a private company in trying to successfully transform itself into a publicly owned one are the increased level of compliance required under the Sarbanes-Oxley Act, an erratic IPO market, and the possibility of a stock-price decline, bankers and financial investors say.

The new regulatory environment tops that list. “Sarbanes-Oxley is so cost-prohibitive, particularly for small, new public companies, that I think it will be harder for small companies to justify going public,” says Gregory Case, a general partner at Apax Partners, a private-equity firm. “They are dealing with increased liability in a post-SOX world.”

Indeed, the cost of compliance can have a powerful influence on the decision to become a public company. “Sarbanes-Oxley is a confidence tax imposed on companies,” says Robert Kitts, director of M&A and co-director of investment banking at Thomas Weisel. “The cost differential sometimes affects the decision. If it is a tie to sell or go public, the confidence tax is a big swing factor.”

Another swing factor, especially for smaller private companies, is the uncertain nature of the IPO market. On a single day last month, the shares of two new public issuers closed a good deal higher than expected, while the shares of two other IPOs suffered the opposite fate.

In such a market, the dual-track approach can help private companies hedge the risks of self-transformation. Even if a company abandons its hopes for an IPO, the IPO process can raise the company’s profile and increase its allure as a potential target. Indeed, the process of interviewing investment bankers to select a group of managers for the IPO makes a company more visible, said Brian Conway, a managing director at TA Associates, a private-equity firm.

Others add that a private company’s ability to attract the support of an investment bank in a public offering validates the merits of the private company. “There is an element of endorsement [by the bank] that can make a company more valuable and legitimate,” says Perry.

At the same time, issuing an IPO requires preparation for compliance with Sarbanes-Oxley, which can be valuable for a company even if it doesn’t become a free-standing, publicly held outfit. “Preparation for SOX compliance is not wasted,” said Case. “With that in place, it makes the buyer more comfortable.”

Would-be acquisition targets can also use an IPO as a credible negotiation hammer, notes Kitts. A company could use a high expected IPO price range as a threat to walk away from the negotiating table, go public, and possibly develop into competition for the would-be acquirer. “The flip side is: Be careful. The worst outcome is, if you file for an IPO but [really] want to sell and an acquirer does not come along,” he adds.

As is the case preceding any merger, managers of companies pursuing two tracks face a possible conflict between pursuing shareholder value and their own career enhancement. Senior level executives — especially finance chiefs — could end up losing their jobs if they choose to sell the company, for instance. A CFO may be part of an integration team for a few months, but usually does not remain with the resulting company in the long-term. “CFOs might favor an IPO in which their worth to the organization goes up because of increased responsibility and investor-relations responsibilities,” says Conway.

At the same time, going public is a costly proposition. Still, a parallel track approach can be cheaper than pursuing an IPO or an acquisition at different times, notes Case. If there’s a lapse of time between the public offering and the merger, the deal would require a second round of due diligence — and added costs.

The real cost, however, is best gauged in terms of management effort, according to Conway. The time frame of four to six weeks between filing for an IPO and launching the offering leaves little time for managers to ponder bids from suitors.

In any case, the choices they make about whether to consider both tracks and, then, which one to choose are sure to be prompted by the current IPO market and the regulatory climate. “Before the stock-market bubble burst, being CEO was the end goal for many executives,” says Kitts. “The bloom has worn off because of the downside of being public.”

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