members. Going public sets an absolute value for the shares held by all company shareholders and prevents problems with valuation. Also, businesses that want to offer shares of stock to their employees as incentives find that recruiting with this incentive is much easier when the stock is sold on the open market.
Looking at the negative side
Regardless of the many advantages of being a public company, a great many disadvantages also exist:
Costs: Paying the costs of providing audited financial statements that meet the requirements of the SEC or state agencies can be very expensive — sometimes as high as $2 million annually. (I discuss the audit process in greater detail in Chapter 18.) Investor relations can also add significant costs in employee time, printing, and mailing expenses.
Control: As stock sells on the open market, more shareholders enter the picture, giving each one the right to vote on key company decisions. The original owners and closed circle of investors no longer have absolute control of the company.
Disclosure: A private company can hide difficulties it may be having, but a public company must report its problems, exposing any weaknesses to competitors, who can access detailed information about the company's operations by getting copies of the required financial reports. In addition, the net worth of a public company's owners is widely known because they must disclose their stock holdings as part of these reports.
Cash control: In a private company, owners can decide their own salary and benefits, as well as the salary and benefits of any family member or friend involved in running the business. In a public company, the board of directors must approve and report any major cash withdrawals, whether for salary or loans, to shareholders.
Lack of liquidity: When a company goes public, a constant flow of buyers for the stock isn't guaranteed. For a stock to be liquid, a shareholder must be able to convert that stock to cash. Small companies that don't have wide distribution of their stock can be hard to sell on the open market. The market price may even be lower than the actual value of the firm's assets because of a lack of competition for shares of the stock. When not enough competition exists, shareholders have a hard time selling the stock and converting it to cash, making the investment nonliquid.
Filing and More Filing: Government and Shareholder Reports
Public companies must file an unending stream of reports with the SEC. They must file financial reports quarterly as well as annually. They also must file reports after specific events, such as bankruptcy or the sale of a company division.
Quarterly reports
Each quarter, public companies must file audited financial statements on Form 10Q, in addition to information about the company's market risk, controls and procedures, legal proceedings, and defaults on payments.
Yearly report
Each year, public companies must file an annual report with audited financial statements and information about
Company history: How the company was started, who started it, and how it grew to its current level of operations
Organizational structure: How the company is organized, who the key executives are, and who reports to whom
Equity holdings: A list of the major shareholders and a summary of all outstanding stock
Subsidiaries: Other businesses that the company owns wholly or partially
Employee stock purchase and savings plans: Plans that allow employees to own stock by purchasing it or participating in a savings plan
Incorporation: Information about where the company is incorporated
Legal proceedings: Information about any ongoing legal matters that may be material to the company
Changes or disagreements with accountants: Information about financial disclosures, controls and procedures, executive compensation, and accounting fees and services
The rules of the Sarbanes-Oxley Act
All the scandals about public companies that emerged in the early 2000s have made this entire reporting process riskier and more costly for company owners. In 2002, Congress passed a bill called the Sarbanes-Oxley Act to try to correct some of the problems in financial reporting. This bill passed as details emerged about how corporate officials from companies like Enron, MCI, and Tyco hid information from the SEC.
New SEC rules issued after the Sarbanes-Oxley Act passed require CEOs and CFOs to certify financial and other information contained in their quarterly and annual reports. They must certify that
They've established, maintained, and regularly evaluated effective disclosure controls and procedures.
They've made disclosures to the auditors and audit committee of the board of directors about internal controls.
They've included information in the quarterly and annual reports about their evaluation of the controls in place, as well as about any significant changes in their internal controls or any other factors that could significantly affect controls after the initial evaluation.
The Sarbanes-Oxley Act has added significant costs to the entire process of completing financial reports, affecting the following components:
Documentation: Companies must document and develop policies and procedures relating to their internal controls over financial reporting. Although an outside accounting firm can assist
