The November issue of Business 2.0 has an article by Stanford’s Jeffrey Pfeffer on Why It Pays to Be Private describing how more and more companies are opting to go or stay private. Bill has blogged about how lean companies, especially those working on leading edge concepts like lean accounting, seem to be predominantly privately held. Pfeffer’s article reinforces what Bill noted, with some other aspects.
Pfeffer references comments by Berkshire Partners’ partner Kevin Callaghan who believes there are three main factors pushing companies to "go private":
The ability to run a business more effectively
This is what Bill has been talking about, and what many companies in the lean world experience. Public companies are beholdened to the quarterly numbers, with access to capital, cost of capital, and often management compensation tied directly to how Wall Street perceives the short-term financial metrics. Some public companies, such as Toyota, have the clout to ignore demands for short-term success, but most don’t. Private companies can focus on the long-term, keep strategies under wraps instead of effectively disclosing them to competitors on analyst conference calls, and compensate executives based on fundamental results.
As Pfeffer points out,
"When I teach executive courses on why companies don’t implement what they know they should be doing, executives invariably tell me that the markets won’t let them do the right thing. If that’s true – and private companies are starting to enjoy some inherent advantage just from being private – then natural selection will take over, and more companies will follow the same path."
The hassle factor
Most notably the increased costs in time and attention to comply with Sarbanes-Oxley, but also including the higher risk of shareholder lawsuits and dealing with boards, Wall Street analysts, investment conferences, and the like.
As with all regulatory efforts, the more regulations, the more attempts to find loopholes, and the more complex then the more loopholes that will be found. Exhibit 1 is of course the U.S. tax code, with 60,000 pages that waste 6.2 billion hours and costs the equivalent of the GDP of some small countries to enforce… imagine the value that those hours and dollars could create with any of the far simpler tax methods… flat or VAT or whatever. But this is a subject for another day.
Like it or not, we already live in a global market. A heavy regulatory environment in France is causing companies to flee that country, leading to even greater unemployment. Similarly single-payer "universal" care in Canada creates very long waits for even critical care, with the wealthier already going to the U.S. for faster treatment, leading to a two-class healthcare system. It’s like a balloon… constrain a free market in one direction, and a secondary result (or "opportunity") will pop out some place else.
The same exists for capital markets… and we now also have the "outsourcing of capital." There are many companies that still go from private to public. Startups and other private companies that desire access to public capital are starting to avoid U.S. markets in order to avoid the "hassle factor." Many U.S.-based companies are now choosing to go public on foreign exchanges, which speaks to the competitive viability of American capital markets.
The money factor
Private firms can operate in a more leveraged capital structure and thereby increase the potential returns to equity investors. Compensation structures become much more flexible. The trend of going private, in effect "insourcing capital," is accelerating. Since 2003 more than 40 companies worth over $400 million each have completed privatization. During the first half of 2006 leveraged-buyout activity acocunted for 11 percent of all M&A deals, a 50 percent jump from 2005. Over 2,000 companies are now controlled by U.S. private equity firms, 254 of which firms have assets greater than $500 million.
Perhaps the trend toward privatization will help create companies with better long-term fundamentals. However the reduced access to large capital markets, and especially technology companies that effectively become foreign owned by accessing overseas capital markets, should also be a concern.