Private companies go public in order to generate capital to help further their growth, reduce debt, or fund other business operations. Going from a private company to a public one, known as an initial public offering (IPO), comes with both advantages and disadvantages and may not be the right move for every company. The price of raising capital can be high.
An initial public offering (IPO) is a milestone event for any company. It marks the transition from a private company to a public company by offering shares to the general public for the first time. But why would a successful private company want to take this leap and go public? There are several key reasons that motivate companies to pursue IPOs:
Access to Capital
One of the biggest reasons companies pursue IPOs is to raise capital. An IPO provides a large infusion of cash that the company can use to fund growth initiatives, pay down debt, acquire other companies, and more.
For example, when Facebook went public in 2012, it raised over $16 billion in its IPO. This provided Facebook with a huge war chest to continue its growth and expansion in the years following
Many private companies reach a stage where private fundraising rounds are no longer sufficient to support their growth plans. An IPO enables them to tap into the vastly larger public markets for capital.
Liquidity for Early Investors
An IPO provides liquidity for a company’s early investors and employees. Many early investors tie up capital for years before a company eventually goes public. Similarly employees often accumulate significant equity stakes in the form of stock options.
An IPO enables these stakeholders to translate some or all of their equity into cash, Early investors can cash out a portion of their stake to lock in returns, Employees can exercise stock options and sell shares to generate funds
Providing liquidity for early backers is often a key incentive for founders and management teams to take their companies public. It rewards stakeholders who took early risks on the business.
Prestige and Visibility
Pursuing an IPO instantly boosts a company’s public profile. Listing on a major stock exchange like the NYSE or Nasdaq provides prestige and visibility that can benefit the business strategically.
The extensive media coverage surrounding an IPO also raises the company’s brand awareness among potential customers. B2C brands can leverage this attention to drive sales.
Additionally, being a public company lends credibility with business partners, suppliers, and clients. The transparency and oversight required of public companies provides assurances for stakeholders.
Currency for M&A
Once public, a company’s stock can be used as acquisition currency for mergers and acquisitions. Many companies pursue IPOs specifically to build up a war chest that can be used to acquire other companies.
Having publicly traded shares enables acquisitive companies to structure deals that swap stock rather than cash. This conserves capital for future deals.
For example, Facebook and other tech giants have routinely used stock as consideration in acquisitions of smaller startups and competitors.
Alignment with Strategy
Some companies simply reach a stage where being public makes strategic sense based on their goals and business model.
A retail company looking to rapidly expand may tap public markets to fund growth. A software business with a recurring subscription model may pursue an IPO to access larger pools of capital for product development.
In these cases, an IPO aligns with the company’s broader strategic vision and helps enable the next phase of growth. The benefits outweigh the costs of operating as a public company.
Wealth Creation Opportunities
Founders, employees, and investors can generate significant wealth through an IPO. Selling even a portion of their equity stakes during or after the IPO can provide outsized returns.
For example, Amazon founder Jeff Bezos’ 20% stake in the company was worth over $30 billion after Amazon’s 1997 IPO. Early employees at companies like Microsoft, Apple, and Meta have reaped billions from company stock.
The wealth creation potential of an IPO is a key incentive for insiders at private companies to pursue a public listing. However, this must be balanced with the company’s overall readiness for life as a public entity.
Transition Ownership
Some founders and early investors look to cash out the majority of their holdings during or after an IPO. An IPO can represent the culmination of decades spent building the company.
founders may aim to gradually transfer ownership to public shareholders as they reduce their equity stakes over time. This enables them to realize returns while entrusting the company’s next phase to new leadership.
Mark Zuckerberg and early Facebook investors like Peter Thiel and Jim Breyer gradually sold billions in stock but maintained control post-IPO.
Risks and Downsides
Despite the potential benefits, the decision to go public is not without risks. Companies must weigh several downsides and challenges:
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Significant costs – The direct costs of an IPO, including underwriting, legal, and accounting fees, can total 4-7% of capital raised. The ongoing costs of regulatory compliance are also higher for public companies.
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Increased scrutiny – Public companies face much higher transparency standards and scrutiny of their financials and business practices. Some private companies may wish to avoid this heightened oversight.
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Disclosure requirements – Public companies must disclose sensitive information around finances, executive compensation, operations, and material events/risks in regular SEC filings.
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Short-term focus – Being public often encourages a short-term focus on quarterly earnings results rather than long-term value creation. This may alter strategy and decision-making.
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Loss of control – Founders and executives of public companies have less autonomy and control than in a private setting. They become accountable to a broad base of new shareholders.
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Market volatility – Fluctuations in stock price based on market sentiment rather than fundamentals can be distracting for management teams.
Weighing these pros and cons enables private companies to determine if an IPO is the right strategic move versus remaining private or pursuing an alternative such as a direct listing. There is no one-size-fits-all answer, and each company must evaluate its own specific situation and objectives.
The IPO Process
As covered in the article, pursuing an IPO is a complex, multifaceted process that requires careful planning and preparation. Here is an overview of the key steps:
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Select investment banks – The company chooses underwriter(s) to manage the offering. Large IPOs can have multiple banks in a syndicate.
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Perform due diligence – The underwriters conduct due diligence on the company’s business model, financials, management team, industry dynamics, etc.
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File registration statement – The company files an S-1 registration statement with the SEC providing detailed disclosure of its business, risks, financial statements, etc. This includes the “red herring” prospectus.
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Marketing – Management conducts an investor roadshow to market the IPO to potential investors. This typically involves presentations to institutional investors across major cities.
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Price the offering – Company leadership and underwriters determine the price range and finalize the IPO price typically the day before trading starts.
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Allocate shares – Underwriters allocate IPO shares to institutional and retail investors based on indications of interest and demand.
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First day of trading – The company’s shares begin trading on the public exchange on the predetermined date. The stock price often rises significantly above the IPO price on heavy volume.
Each step along the path from private to public requires careful execution. With proper planning and advisors, companies can maximize the outcome while minimizing risks.
Pursuing an initial public offering represents a milestone event for a private company. By offering shares to the public, the company can gain access to capital, liquidity, prestige, M&A currency and other benefits. However, the decision requires weighing these incentives against the costs, disclosure requirements and loss of control that come with being publicly traded. Each company must determine if an IPO aligns with its strategic goals or if remaining private would better serve its interests. With proper planning and execution, an IPO can help propel a company into its next phase of growth and success.
The Disadvantages
Going public can also come with several disadvantages. One of the biggest factors that puts companies off going public is the need for added disclosure for investors. When companies go public, they are required to regularly keep the public updated about their activities and financial performance and do so in a certain way. These obligations are costly and can create public scrutiny.
Public companies are regulated by the Securities Exchange Act of 1934 in regard to periodic financial reporting, which may be difficult for newer public companies. They must also meet other rules and regulations that are monitored by the Securities and Exchange Commission (SEC).
The cost of complying with regulatory requirements can be very high, and as rules to protect investors continue to be added, these costs keep increasing. Some of the additional costs include the generation of financial reporting documents, audit fees, investor relation departments, and accounting oversight committees.
Advantages and Disadvantages of Going Public
Before deciding whether or not to go public, companies must evaluate all of the potential advantages and disadvantages that are involved. This usually happens during the underwriting process as the company works with an investment bank to weigh the pros and cons of a public offering and determine if it is in the best interest of the company for that time period.
Here are some of the main pros and cons they have to consider.
What is an IPO? | CNBC Explains
What is an initial public offering (IPO)?
An initial public offering (IPO) is when a private company sells shares of its stock for the first time to the public and becomes a public company. When a company makes this transition, it is no longer in the hands of the private owners and investors but is now under public ownership.
Why would a company want to go public?
There are many reasons why a company might want to go public. Selling shares to the public provides companies with additional capital, which can then be used to fund key business initiatives. Venture capital firms and other investors typically invest in private companies with a plan to cash out through a liquidity event, such as an IPO.
What happens if a company goes public?
If the company succeeds and eventually goes public, theoretically everyone should win. A stock that was worth nothing the day before the IPO will now have value . However, because their shares don’t trade on an open market, those private owners’ stakes in the company are hard to value.
Should a company go public in an IPO?
Going public in an IPO can provide companies with a huge amount of publicity. Companies may want the standing and gravitas that often come with being a public company, which may also help them secure better terms from lenders. While going public might make it easier or cheaper for a company to raise capital, it complicates plenty of other matters.
