Choosing Between An Initial Public Offering And An Outright Sale

Tuesday, August 19, 2008

Prof. Annette Poulsen and Prof. Mike Stegemoller University of Georgia (AP); Texas Tech University (, Financial Management Association, University of South Florida, College of Business Administration, http://

Abstracted from: Moving From Private To Public Ownership:
Selling Out To Public Firms Versus Initial Public Offerings

Financial Management - Vol. 37, No. 1, Pgs. 81-101

Making a choice
Entrepreneurs often consider either an initial public offering or a sale to a public company when they are ready to harvest their company's value. Given the very different outcomes of the two exit routes, making the optimal decision is critical. The IPO leaves the entrepreneur with a significant ownership stake and often still in control. Selling out, while typically less costly and complex than an IPO, requires the business owner to cede ownership give up control. Although entrepreneurs prefer IPOs, a significant number end up selling out to a public firm. By examining 1,074 IPOs and 735 sellouts between 1995 and 2004, finance professors Annette Poulsen and Mike Stegemoller pinpoint the underlying characteristics of companies that may guide the decision toward one outcome over the other.

Higher growth rates, higher valuations
Companies that go public differ in a number of respects from those that sell out to public companies, the authors find, and these characteristics play an important role in choosing the exit route. Most notably, IPO issuers tend to have higher growth rates. In the year preceding the offering, sales at the IPO companies grew at a median rate of 44.6%, versus 26.2% for the sellout group. Median asset growth clocked in at a robust 49.2%, compared to 18.8% for the sellout group, while the median ratio of market value to book value for the IPO group was higher. These results suggest that the investors place great value on the higher growth prospects for the IPO firms. Firms with venture capital backing have more generous valuations than those that do not, regardless of whether they have been taken public through an IPO or a sale. Of the IPO issuers, 55% had some venture capital backing. Given the perceived preference of venture capitalists for exiting by taking a company public, it is surprising that over 41% of the sellout group had such backing as well.

Fueling growth
Over the period studied by the authors, capital expenditures grew at a rate of 49.3% for the IPO firms, but just 16.3% for the companies that eventually sold out. The desire for growth­or the need for capital to fuel it­appears to be a driving force in the decision to go public. During the year before shifting from private to public ownership, the sellout firms incurred much more debt (both short- and long-term) taken as a percentage of assets, than the IPO issuers. Yet, despite their lower debt levels, the IPOs have greater cash constraints and a more limited ability to service debt, suggesting the need for equity financing to fill the gap. The companies that sold out show a higher level of intangibles (such as goodwill and patents), underscoring their ability to communicate such features to a small group of investors with greater effectiveness than they might with a larger, more diverse shareholder group.

Abstracted from Financial Management, published by Financial Management Association, University of South Florida, College of Business Administration, 4202 East Fowler Avenue, Tampa, FL 33620-5500.

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