Disadvantages of Going Public

Sharing the Profit—If the firm is sitting on a highly successful venture, future success (and profit) has to be shared with the shareholders.

Confidentiality—Public companies experience less confidentiality than their private counterparts.

Ongoing Filings—U.S. Public companies must continuously file reports with the SEC and the exchange they list on. They must comply with certain state securities laws (“blue sky”), FINRA and exchange guidelines. This disclosure costs money and provides information to competitors.

Liability—The company, its management, and other participants may be subject to liability for false or misleading statements and omissions in the registration documents or in the reports filed by the company after it becomes public. In addition management may be subject to law suits by the stockholders for breaches of fiduciary duty, self dealing and other claims, whether or not true.

Sarbanes-Oxley—This is a big one.  Two separate studies, one conducted by a group of executives and academics, and another by McKinsey and Co. for New York Mayor Michael Bloomberg and New York Senator Charles Schumer, both reached the same conclusion; excessive regulation has made the U.S. stock exchanges a less-than-favorable place to go public, and singles out the Sarbanes-Oxley Act, as the main reason.

So what is the Sarbanes-Oxley Act, and why is it making such a negative impact on U.S. public companies? Sarbanes-Oxley was enacted in 2002 in response to the failures of several large companies like Enron and WorldCom. It’s intent was to protect investors. Basically, the act requires full disclosure on just about everything and most believe that the requirements went way overboard. It comes down to expense. To adhere to the requirements of Sarbanes-Oxley is extremely costly. So costly, that, since passage of the Sarbanes-Oxley Act, many U.S. companies have found the ongoing expense to be reason enough not to be listed on the OTCBB or Pink Sheets (or any other US Stock Exchange)

Short Sellers—Some critics blame short sales as a major cause of market downturns, such as the crash in 1987 and 2008. In fact, two years after the 1987 crash, the U.S. government held a House subcommittee hearing on short selling. They wanted to examine the effects short sellers had on small companies and the need for regulation after allegations of widespread manipulation by short sellers of over-the-counter stocks. SEC officials reassured the public that manipulations hadn’t been uncovered and more rules would be put in place. Short selling is still a wide-spread problem for OTCBB and Pink Sheet and even Nasdaq listed stocks today. And these days short sellers in the U.S. leave almost no stock unturned. This is why you see so many stocks trading in the sub-pennies on the OTCBB and Pink Sheets, which at one time were a much, much higher price.

Short selling has an even darker side because of a percentage of short sellers who are not above using unethical tactics to make a profit. Sometimes referred to as the “short and distort,” this occurs when short sellers manipulate stock prices, usually in the OTCBB and Pink Sheet by taking short positions (where they sell the stock without actually owning it) and then using a smear campaign on chat rooms to drive down the target stocks, where they then buy the stock at a big price differential from where they sold it short. [This is the mirror version of the pump and dump, where crooks buy stock (take a long position) and issue false information that causes the target stock’s price to increase]. Short selling abuses like this have grown along with internet trading and the growing trend of small investors and online trading. Short selling is a tremendous problem on the OTCBB and the Pink Sheets, and one that doesn’t seem to have a good solution.

No Public Offering Without an Underwriter—Many people that we speak with are under the illusion that once a company goes public, they can raise money by selling the company’s stock to the public. This is absolutely false. In fact, once you are public, you cannot offer to more than 35 non-accredited investors and you can only solicit to people that you have a pre-existing relationship with. Moreover, not only can you not advertise the offering, but you cannot even put an offering document on your website. The fact is, the same exact private offering restrictions apply when you are a public company or a private company. There is no difference. The only way to offer stock ‘publicly’ like most people think they can do, is to become approved for a public offering with an underwriter. And as you probably already know, conventional IPOs are out of favor, and simply will not happen unless the company is extremely established and typically must have revenues of a minimum of $50MM per year. And even then, it is next to impossible to find an underwriter willing to underwrite a conventional offering.