Here’s a good tip for all private middle market business owners looking to improve the value of their business: Act like a public company.
According to Robert Slee, author of Private Capital Markets: Valuation, Capitalization and Transfer of Private Business Interests, private companies that structure themselves and act like public companies reap tremendous advantages regardless of whether they ever become a public company:
Here’s why: When performing a market valuation of a private company for new financing or other reasons, analysts tend to use public “comps” of like public company transactions. In most cases this is the only available data in the market. However, comparing a public company to a private company is not very accurate—there are far too many inconsistencies and variances between the two. Public companies by design and for SEC requirements must have in place transparent financial, managerial, and organizational structures that enable investors to accurately measure and compare profitability, strategy, and performance before making an investment in a publicly traded stock. Private companies, on the other hand, are not held to the same standards, hence making any deep comparison difficult.
What Slee found in his book is that there is a significant difference between private companies that look and act like public companies when compared with private companies that remain insular. Private companies that could be public but chose not to be can easily have:
• A higher valuation
• A lower risk profile and lower cost of capital
• A greater number of investors interested in funding growth
• An easier and less costly transfer of ownership (future sale or IPO)
Many private companies consider public company structures and SEC reporting requirements as too burdensome, overwhelming, and even unnecessary. They prefer not to worry about these requirements, believing they know what’s best for the bottom line. While this attitude reduces compliance costs, it can raise financing costs or result in a lower valuation because it forces investors to seek higher risk premiums and senior lenders to seek higher risk interest rates on loans. That’s because the lack of transparency requires guesswork in order to judge future earnings performance of these insular private companies.
So what should you do as a private business owner to provide more accurate information on your company’s future earnings performance?
My advice is simple. Find a successful publicly traded company that compares to yours. Review and compare your company structures side by side, and begin a company reporting process review similar to the public company. This is not a process that can be accomplished overnight, but over time the results can achieve many of the same benefits of being public without the associated costs of compliance.
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About The Guest Author: Rick Andrade is a Los Angeles-based investment banker focusing on helping small businesses and middle market companies in finance, mergers and acquisitions. Rick has more than 25 years’ experience as a finance executive and business advisor, advising hundreds of company executives at every level on how best to maximize the value of their capital resources and improve the value of their company.