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Entrepreneurs generally make more profits choosing IPO vs. acquisition, says BYU study

Considering whether to go public, stay private or sell your company to the highest bidder? If your objective is to maximize your profits, better stick with an initial public offering, according to a new Brigham Young University study, which also provides recommendations on how to best position a company for an IPO or friendly takeover.

With the dearth of IPOs during the last few years, many entrepreneurs are opting to be purchased by larger, publicly traded businesses as a quick payoff. But James C. Brau, assistant professor of finance in BYU's Marriott School of Management, says business owners who are willing to assume additional risks associated with an IPO are, in the long run, typically compensated accordingly.

"The IPO takes a lot more effort, there's a lot more risk involved -- if I'm an entrepreneur, I can't sell all my stock after going public because that sends the wrong message to stockholders," said Brau. "If I'm willing to incur the risks involved with an IPO -- hanging onto the company, running it -- by the study's measures I'll get a bigger payoff in the end than if I sell off immediately."

Published in the December issue of the "Journal of Business," the study examined the determining factors that led more than 9,500 U.S. privately held firms from 1984 to 1998 to go public or be acquired by a publicly traded firm.

Furthermore, the study provides insight into the primary characteristics of companies ripe for acquisition versus those headed for an IPO. The following factors increase the probability of a company choosing an IPO:

  • Inclusion in an industry that is composed of only a few, big players, which tends to be less conducive to corporate combinations because antitrust concerns make takeovers more difficult.

  • Affiliation with the high-tech industry. Investors' attraction to high-tech IPOs may encourage IPO activity.

  • A high cost of debt in the current market – higher costs make IPOs more attractive as takeovers become harder to fund and as equity is relatively cheaper.

  • How hot the IPO market is.

  • Large firm size – the smaller the firm, the less likely it can afford the costs of going public and survive on its own.

  • Owners who wish to maintain control prefer IPOs. Conversely, the following factors show a company's stronger likelihood for takeover:

  • Inclusion in industries where market values are relatively higher than the value of equity reported in their financial records. With the industry's overvaluation, owners may choose attractive premiums over continued ownership of the company.

  • Inclusion in industries with a lot of debt, where a takeover tends to be a more conservative restructuring path than an IPO.

  • Inclusion in the financial service sector – recent governmental deregulation of such a fragmented industry makes consolidation more feasible.

  • Deals that give insiders greater opportunities to readily convert the company's value into cash. The attractiveness of greater liquidity may be an effective cash-out strategy. "Some of the factors are fairly apparent, and your average entrepreneur will say, 'Of course it makes sense that if the IPO market is hot, then my chances of doing an IPO are higher,'" said Brau. "But some of the others aren't so obvious, and the real benefit of our study is that we can say which factors are economically and statistically significant."

    That said, Brau cautions against business owners using the factors like an infallible formula for positioning their companies for takeover or an IPO.

    "This isn't some kind of highly specific cookbook that tells you if a company is going to do an IPO or be acquired," says Brau, the Goldman Sachs Faculty Fellow at BYU. "But if I'm an entrepreneur, a business owner, I can do my best to make my company look like a takeover target or an IPO by structuring my company according to these characteristics. The study gives me a general idea and feel how to position myself, depending on what I ultimately want out of the experience."

    Brau is joined on the study by University of South Florida finance professors Bill Francis and Ninon Kohers.

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