going public - google

The Transition from Private to Public Ownership, With a Concentration on the Transition of Google, Inc. By Brian Love Abstract Growing a small to mid-sized business in the U.S. often requires the transition from private to public ownership in order to obtain additional capital to sustain corporate growth. After deciding to take the business public there are legal preparation that must be undertaken, including the preparation and filing of the registration statement and prospectus, as well as, negotiating the share price and number of shares to be offered via the underwriters. The Initial Public Offering is then made, in which the underwriters pay the corporation the net proceeds from the IPO in exchange for the stock. The transition from private to public ownership takes time and money, but can be rewarding to a growing company, like Google Inc.; which on August 19th, 2004 offered 19,605,052 shares of class A common stock raising $1.67 billion from investors (1). Advantages of Public Ownership However, before a business decides to allow public ownership in the corporation, the pros and cons of public ownership should be reviewed. The advantage of public ownership is stock compensation, improved financial position, public awareness, market liquidity, acquisition ability, and ultimately the unrestricted use of large amounts capital. Stock compensation allows corporations to attract highly skilled and efficient managers, by offering stock compensation and tying compensation to performance on the job (2). This allows companies to attract a good quality workforce without incurring a large cash expense, for a sign-on bonus, or an exorbitant salary. Most importantly it keeps management interested in the efficiency of the firm, in order to maximize the value of their stock, and therefore minimizing the agency effect. Greater public awareness is another advantage that allows the firm to have wider access to financing through both equity and debt (3). An example of this is the sale of stock, or ownership in the organization, which increases the financial position of the firm because of the increase in both the owner’s equity and the cash, or assets, of the firm. Because of the increase in the assets and owner’s equity the overall book value of the firm will also increase, giving the firm greater leverage to incur more debt financing and thus lowering the cost of capital. Market liquidity is established when the market demand for the securities remains after the IPO, allowing investors to liquidate their securities. One more advantage of a corporate transition to public ownership is that the company can use the stock to buy-out a competitor by offering them stock instead of cash, thus using your stock as a form of currency (2). Lastly, and most importantly, public ownership allows the corporation to use the proceeds of the stock sale for whatever the firm sees fit. These intended uses of capital generated are included in the prospectus statement to inform prospective investors as to what their potential investments may be used for. However, in the end, the firm is allowed to use the money for any purposes that it’s owners, or Board of Director’s, see fit. -1- Most companies use the capital earned through public offerings to finance large growth, purchasing new property, facilities, technology, etc… Disadvantages of Public Ownership Some disadvantages to public ownership include: the impact of stock price and shareholder wealth on management decisions, public scrutiny, potential substantial loss of control over the strategy and direction of the company, and time and costs incurred in an Initial Public Offering. First and foremost, the stock price and shareholder value will consistently have weight in a decision faced by directors, officers, and management; which can have a positive and, more often, a negative impact. When management is focused on the short-term value of their shareholder and not on the long-term efficiency, performance, and competitiveness of the firm; management will often make poor judgments to satisfy the short-term projections and wants of the market, thus boosting or keep the sale-price of a share constant in the short run (2). Secondly, a public company faces increased scrutiny by the public, as they are now required disclose information that was previously closely held inside the corporation. Some of this information includes: key management and officer’s salaries and compensations (including any fringe benefits received), management transactions, consolidated financial statements, insider trading information, and significant vendors and customers. The increased public disclosure can have an impact on management’s decisions of benefits or salaries. The disclosures also compel companies to reveal information to the public, including competitors, that could damage the competitive advantage the firm may have over it’s competitors (3). After becoming a publicly owned company, management will now have to inform or get approval from shareholders when making key strategic decisions, merger, elections of the board of directors, and other important decisions as stated in the articles of incorporation or the corporation’s bylaws, that may require a vote by the stockholders (2). The owners of the firm before going public had the ability to exercise complete and direct control over the operations and strategy of the business. After the public offering of stock in the company, the owners may lose their controlling interest in the company if their shares are diluted enough (3). In order to prevent this, Google Inc. adopted a dual-class voting structure, allowing the original owners to maintain control and influence over the corporation (6). Lastly, there is a cost of capital associated with an Initial Public Offering, as well as those fees incurred to offer public ownership in the corporation, such as: the registration fee, legal fees, accounting and auditing fees, filing fees, printing expenses. The main cost is the underwriter’s commission, which is a percentage or fixed amount of the stock’s initial offering price sold to investors. There are also ongoing legal and accounting fees incurred for maintaining status as a publicly held corporation including: annual reports, proxy solicitations, and management’s time that must be devoted to these functions (3). It is important to keep in mind that time is money, since it will keep employees busy and not working on normal operations and they are being paid for their time. The process of an Initial Public Offering take a long time, up to a year or more, requiring time and effort from officers and key management, as well as the accounting and finance departments within the organization. These advantages and disadvantage exemplify the complex decision that owners and managers of an organization face when considering an Initial Public Offering. -2- Registration Statement When going public, a company must first select and hire one or more underwriters. The underwriters are an investment-banking firm that purchases the securities from the company, and sells them either directly to investors or through other underwriters to investors. The underwriters work with the company to determine the number of shares that will be offered in the initial public offering, and the price per share that the investors will pay, which includes the commission established for the underwriters. Once the firm has hired an underwriter and they have decided the number of shares to sell, the firm must file a registration statement with the Securities and Exchange Commission, or SEC. The registration statement is an official document notifying the SEC of the firm’s intent to become a publicly owned corporation through the issuance of stock in an initial public offering, and can be amended if need be, at a later date (5). The registration statement consists of two main parts, the prospectus and additional information that might be “necessary to make the required statements, in the light of the circumstances under which they are made, not misleading” as stated by Regulation C §230.408 (5). This information can include risk factors faced by prospective investors, including industry trend and economic conditions and “dependence upon key personnel” or officers of the business. In the case of Google, Inc., the registration statement states that the investors are placing a large bet on the performance and abilities of the three key officers (Mr. Larry Page, Dr. Sergey Brin, and Dr. Eric E. Schmidt Ph.D.) of the corporation, which have significant control over the strategy and operations of the firm (6). All companies can use form S-1, the basic registration form provided by the SEC, while those firms considered to be a “small business issuer” can file a simplified registration statement on form SB-1 or SB-2. Form SB-1 is used by companies raising less than $10 million securities in a 12-month period. Whereas, form SB-2 is used by companies that are raising any amount of money, and is less demanding than Form S-1. An example of how form SB-2 is less demanding of companies than form SB-1 is that the financial statements required is only for the past 2 years and is not required to meet the high standards set forth by the SEC. It also requires less insider information disclosed, “particularly in the descriptions of [the] business and the [disclosing] of executive compensation” (4). In order to file either forms SB-1 or SB-2, the entity must be considered a “small business issuer”. A small business issuer is a firm that is not an investment company, has revenues of less that $25 million, is a U.S. or Canadian issuer, and if the firm is a “majority owned subsidiary, the parent corporation is also a small business issuer” (5). If a company is not considered a “small business issuer” then the firm must file form S-1 with the SEC. Form S-1 is much more complex, and requires much more of the corporation. Form S-1 contains: an outline of the firm’s business, properties, competition, officers and directors (and their compensation and transactions), any legal proceedings before the corporation or any of it’s officers or directors, a plan for distributing the securities and the intended use of the source of funds, and consolidated financial statements that have been audited by a certified public accountant (5). -3- Prospectus The prospectus usually consists of: the prospectus summary, the offering, the risk factors, forward-looking statements, use of proceeds, stock price for IPO, Dividend policy, Cash and capitalization, dilution, selected consolidated financial data, and management’s discussion and analysis of financial condition and results of operations, the business of the company, management, certain relationships and related party transactions, principal and selling stockholders, description of capital stock, rescission offer, shares eligible for future sale, underwriting, legal matters, experts, and where you can find additional information. Some prospectus statements may contain other sections or information. In the case of Google, Inc., the founder’s felt it necessary to have a letter from the founder’s section in which they lay out their goals and reasoning for Google going public and an explanation of the structure and strategy of the company, and more (6). Examining the elements of the prospectus further: first, the prospectus summary is a brief overview of the company and its history to give investors some basic information about the company. Second, the Offering describes the number of shares of stock that will be offered and the price per share that investors will pay. Some companies, like Google, decide to allow the market to establish the price per share for the initial offering. Google went with awkward and complex open auction process, in which the prospective investors, with an account at one of the firms that is an underwriter for the IPO, can bid to purchase a number of shares at the price they are willing and able to purchase. Those investors with the highest bid price for the number of shares bid, up to the number of shares being offered, are be able to purchase those shares at the lowest price bid for the stock (within the number of shares available). The maximum share allocation was established using an algorithm determining the maximum number of shares per individual, with the intent that “successful bidders with smaller bid sizes would receive share allocations for their entire bid amounts, while successful bidders with larger bid sizes would receive no more than a maximum share allocation” (6). Risk factors section of the prospectus outline the challenges and obstacles that management must face in both the short-term and long-term, potential volatility of the stock price and revenues, competitors, and factors the business relies upon or against, including regulations, technologies, markets, etc. Forward looking statements use historical data to forecast trends or possible cash inflows and outflows, and are based heavily upon assumptions and expectations in the future as agreed upon by management. The Use of proceeds section reveals where most of the money from the offering is intended to be spent, including future or potential projects. The Dividend policy explains the benefits or potential cash dividends that might be paid out; which is usually uncertain at the point of an IPO and most IPO investors are not concerned with the dividend policy. The cash and capitalization section gives a brief outline of the change in the balance sheet due to the public offering of the companies stock, although the price per share and number of stocks to be offered are often unknown at the time the prospectus is distributed to investors, and therefore, investors often have to estimate these figures. The Dilution section of the prospectus provides the investor with the estimated change in the book value per share of stock for existing stockholder’s when the offering takes place, and the additional shares of stock are issued to the marketplace. The selected consolidated financial data and management’s discussion and analysis help investors to understand the financial position -4- of the firm. The selected consolidated financial data section often contains 3 to 5 years of historical data found on the statement of operations and balance sheet, figures from the most recent quarter, and management’s perspective on the most recent results. The overview in management’s discussion and analysis of financial condition and results of operations contains a summary of the firm’s business model, how they operate, and how they stay in business or generate revenues (6). This section also contains information to explain the financial position to potential investors, outlining the source of revenues as well as costs and expenses. The Business section of the prospectus is where management outlines the plan for the future of the business, and is able to really sell the plan to the investor, hoping to convince the investor that it is a worthwhile plan whose potential future returns is matched to the risk. It also contains the mission of the business, where the opportunities lie for the business and how it plans on taking advantage of those opportunities, along with products and services that fulfill those opportunities. The management section lists the executive officers and directors, their ages, and the positions they hold in the company, along with a brief biography and the contributions to the company, and their compensation. Certain relationship and related party transactions outlines financial transaction between the corporation, its owners, and key management. The principal and selling stockholders section lists those persons who have shares beneficially owned prior to the public offering, the voting power of those shareholders, and the number of shares they are offering in the public offering. Google’s prospectus contains a description of capital stock which specifies the different classes of common stock, along with preferred stock (if any), along with each type’s voting rights, dividends, and liquidation. The common stock for Google is divided into two classes, class A and class B common stock. The main difference is that class B common stock has 10 votes to 1 vote per share of class A common stock, and when transferred, the class B stock is converted to class A (except between the two founders, Larry and Sergey, and themselves or their subsidiaries) (6). As soon as the registration statement is completed and filed with the SEC, the preliminary prospectus, called the “Red Herring” is delivered to the underwriters to in turn distribute to potential investors, which bid or notify their broker of their interest to purchase the stock. After the SEC receives the registration statement, it is reviewed and any comments pertaining to “incomplete or inaccurate information” are reported back to the firm, which is then allowed to correct or clarify with an amendment to the registration statement as necessary. One the statement is approved by the SEC, the firm’s legal counsel will file a request for effectiveness acceleration, which allows the SEC to declare the registration statement effective “once the company has satisfied the disclosure requirements”, allowing the company to immediately go to market with the shares of stock (4). Initial Public Offering of Google, Inc. Google Inc. decided it was time for the business to become a public corporation on October 25, 2003 and was approved by the SEC on August 18, 2004 (1) in order to become more competitive in the industry. Google was also being required to disclose information publicly, similar to a public corporation, and due to their growth in size. The initial public offering of Google was a long road with several bumps and turns along the -5- way; including the raising of the number of shares available, then lowering, the auction process, and others (1). Google expected to receive over $2.7 billion in the sale of the class A common stock, when in the end they only received $1.6 billion. This was due to the “demand being less than expected” and some insiders with “large stakes in the business and [directors] decided to cut the number of shares they planned to sell” (8) forcing Google to slash the offering price down to $85 from the previous price estimate of $108 to $135 (9). Because the initial price was much higher than the final offering price many small investors and individuals could not bid for the number of share they could have potentially purchased if the price was lower. Many investors and underwriters bowed out due to these complications and Google’s insiders who “reduced the number of shares to be sold to 19.6 million from 25.7 million” (10). Many individual investors were not given the “same opportunity to reduce their share sales”, as were a few insiders, and were forced into selling or buying the shares at the new price set. One reason for the reduction in the number of shares being sold by the company was because of lack of investors and the need to sell the shares to avoid delaying the closing of the offering. This left Google with “400,000 additional shares” because of investors dropping out of the IPO due to the complications and the awkward modified dutch auction process used to determine price per share (8). Google was forced to convince other investors to “make larger share sales in the over allotment”, which some proved to be harder than others, in part due to the now lower offering price of $85 (8). Another bump along Google’s road to an IPO included the SEC investigating their lack of registering “23 million shares and 5.6 million options” that had been issued to employees and “consultants” before the IPO (9). When Google was still private, it issued these stocks “without compliance with Rule 701 or any other exemption from registration” (12). Section 5 of the Securities Act 1934 specifies that companies, like Google, that are private and have over $5 million in outstanding award are required to “provide specified information to optionees including summary financial information” (12). Lastly, Google faced another filing by the SEC in which it "requested additional information concerning the publication" of an interview with the founder’s of Google in the pop magazine Playboy (10). According to Regulation C, it is a violation to talk to anyone about any information not included in the prospectus or registration statement regarding the upcoming IPO (5). Eventually, the stock was sold on August 19, 2004 at the set price of $85 with 19,605,052 shares sold at the IPO (1). The obvious winners in the IPO were insiders and key officers of Google, as well the initial investors of Google’s IPO; who profited from the rise in price to over $100 per share the first day of trading, and currently trading at $348.65 as of the close on 10/24/05 (11). In conclusion, It is important for a company to allocate considerable effort to the decision as to allow public ownership in a company, and the effect this can have on management, current shareholders, workers, stakeholders, and the firm. When it makes sense for a company to make the costly and time-consuming transition from private to public ownership, it can be a large source of financing that can provide the capital needed to stimulate future rapid growth. -6- Works Cited 1. 2. Google IPO Central, http://www.google-ipo.com Catalyst Law - Advantages & Disadvantages of Going Public http://www.catalystlaw.com/document/18 FindLaw: What are the advantages to a company of "going public"? What are the disadvantages? http://cobrands.business.findlaw.com/banking_financing/source/faqs/faq452.html?finance/ny SEC Registration statements, http://www.smallbusinessnotes.com/financing/secregis.html Regulation C – Registration, United States Securities and Exchange Commission, Washington D.C., http://www.sec.gov/divisions/corpfin/forms/regc.htm Form S-1, Registration Statement under the Securities Act of 1933, Google Inc., http://www.sec.gov/Archives/edgar/data/1288776/000119312504073639/ds1/htm Kawamoto, Dawn. Want in on Google’s IPO? ZDNet News, http://news.zdnet.com/21003513_22-5202120.html Delaney, Kevin. Google IPO Revisited: Insiders Got Choice Other Sellers Didn’t. September 16, 2005. The Wall Street Journal. http://online.wsj.com/article/0,,SB112682702496942327,00.html Fordahl, Matthew. SEC opens inquiry into Google stock issue. August 17, 2004. Associated Press.http://www.boston.com/business/technology/articles/2004/08/17/sec_opens_inquiry_into_go ogle_stock_issue/ 3. 4. 5. 6. 7. 8. 9. 10. Fordahl, Matthew. Google price set at $85, at low end of company’s expectations. Associated Press. http://www.sfgate.com/cgibin/article.cgi?file=/news/archive/2004/08/18/financial2112EDT0223.DTL&type=business 11. Yahoo! Finance. Summary for Google, GOOG. September 26, 2005. http://finance.yahoo.com/q?d=t&s=GOOG 12. Keller, Stanley. Searching Google for Meaning: Equity Compensation Pitfalls and a Changed Climate for Lawyer Responsibility. Insights; the Corporate & Securities Law Advisor. Englewood Cliffs: Aug 2005. Vol. 19, Issue 8; pg. 2, 7 pgs. -7-