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.
Key Takeaways
- In order to become an IPO, a company must be able to pay for the generation of financial reporting documents, audit fees, investor relations departments, and accounting oversight committees.
- IPOs often generate publicity by making their products known to a wider potential swath of customers, but taking a company public is a huge risk.
- Smaller businesses may find it difficult to afford the time and money it takes to become an IPO.
- Privately held companies have more autonomy than public ones.
Advantages and Disadvantages of Going Public
As said earlier, the financial benefit in the form of raising capital is the most distinct advantage. Capital can be used to fund research and development (R&D), fund capital expenditure, or pay off existing debt.
Another advantage is an increased public awareness of the company because IPOs often generate publicity by making their products known to a new group of potential customers.Subsequently, this may lead to an increase in market share for the company.
An IPO also may be used by founding individuals as an exit strategy. Many venture capitalists have used IPOs to cash in on successful companies that they helped start up.
If a company wants to raise more capital sometime after an IPO, it can do a secondary public offering; offering new shares to investors.
Even with the benefits of an IPO, public companies often face several disadvantages that may make them think twice about going public. One of the most important changes is the need for added disclosure for investors.
In addition, 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).
More importantly, especially for smaller companies, is that the cost of complying with regulatory requirements can be very high. These costs have only increased with the advent of the Sarbanes-Oxley Act. Some of the additional costs include the generation of financial reporting documents, audit fees, investor relation departments, and accounting oversight committees.
Special Considerations
Public companies also are faced with the added pressure of the market which may cause them to focus more on short-term results rather than long-term growth. The actions of the company's management also become increasingly scrutinized as investors constantly look for rising profits. This may lead management to use somewhat questionable practices in order to boost earnings.
Before deciding whether or not to go public, companies must evaluate all of the potential advantages and disadvantages that will arise. 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.
Real-World Example
One high-profile company that plunged following its IPO is Snap Inc (SNAP), best known for its flagship product Snapchat. The company raised $3.4 billion in March 2017.
Despite aninitial surge above its $17 IPO price, the stock struggled to hold onto those gains. In its first quarterly report as a public company, Snap reported disappointing user growth figures. In May 2017, investors sued, alleging the company had made "materially false and misleading" statements regarding user growth. Snap settled for $187.5 million in January 2020.
Why Would a Company Not Want to Go Public?
A company may choose not to go public for many reasons. These reasons include the tedious and costly task of an IPO, the founders having to give up total control, and the need for more stringent reporting to comply with SEC rules.
When a Company Goes Public, Who Gets the Money?
When a company goes public, the company initially gets all of the money raised through the IPO. When the shares trade on a stock exchange after the IPO, the company does not get any of that money. That is money that is exchanged between investors through the buying and selling of shares on the exchange.
Is It Better for a Company to Be Public or Private?
Whether it is better for a company to be public or private will depend on the specific company and the goals of its founders. Remaining private allows the founders to run the company as they wish and not have to meet the many regulatory requirements of being a public company. Going public allows a company to raise significant capital and grow the business. At the end of the day, the best decision is that which is best for the founders and their vision of the company.
The Bottom Line
Taking a private company public raises capital so that a business can fund its growth or use the money for other business needs. It is a common step for many companies that grow out of the start-up phase.
Though taking a company does bring in more capital, there are also significant drawbacks. These include the time-consuming process of an IPO, ensuring the company meets strict regulatory rules, giving up complete ownership and total control, and being under the scrutiny of the public and investors.
It's important to weigh the pros and cons and have a vision for what the founders want the company to be before deciding to go public.
Greetings, enthusiasts of corporate finance and strategic business decisions. I am deeply entrenched in the world of financial markets, with a comprehensive understanding of the dynamics surrounding private and public companies. My expertise spans financial reporting, regulatory compliance, IPO processes, and the intricate balance between autonomy and capital infusion in the corporate landscape.
Now, let's delve into the rich tapestry of concepts interwoven in the article you've provided:
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Initial Public Offering (IPO):
- Definition: An IPO is the process by which a private company becomes publicly traded by offering its shares to the public on a stock exchange.
- Significance: This transition allows the company to raise capital from a broader investor base.
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Advantages of Going Public:
- Capital Infusion: The primary advantage is the ability to raise capital, which can be utilized for research and development, capital expenditure, or debt repayment.
- Increased Public Awareness: IPOs garner publicity, expanding the company's reach and potentially increasing market share.
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Disadvantages of Going Public:
- Disclosure Requirements: Public companies face increased disclosure obligations, necessitating transparency in financial reporting.
- Regulatory Compliance: Compliance with regulations such as the Securities Exchange Act of 1934 and Sarbanes-Oxley Act adds complexity and costs.
- Short-Term Focus: Public companies may experience pressure from the market, leading to a focus on short-term results over long-term growth.
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Special Considerations:
- Market Pressure: Public companies are subject to market pressures, which may influence management decisions and practices.
- Regulatory Costs: Compliance costs, including financial reporting, audit fees, and oversight committees, can be especially burdensome for smaller companies.
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Real-World Example: Snap Inc (SNAP):
- Case Overview: Snap Inc's IPO in March 2017 raised $3.4 billion, but subsequent challenges, including disappointing user growth and legal issues, impacted its stock performance.
- Lesson Learned: The example highlights the volatility and risks associated with going public.
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Reasons a Company Might Avoid Going Public:
- Tedious and Costly Process: The IPO process is time-consuming and expensive.
- Loss of Control: Founders may be reluctant to relinquish control over the company.
- Stringent Reporting: Compliance with SEC rules requires stringent reporting, which some companies may find burdensome.
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Distribution of IPO Proceeds:
- Initial Capital: The company receives the money raised during the IPO.
- Post-IPO Trading: Subsequent trading of shares on the stock exchange involves transactions between investors, and the company does not receive any further proceeds.
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Public vs. Private Dilemma:
- Autonomy vs. Capital: The decision to remain private or go public hinges on the balance between retaining autonomy and accessing capital for growth.
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The Bottom Line:
- Capital Infusion vs. Drawbacks: Going public provides capital but entails drawbacks such as loss of control and heightened scrutiny.
- Founders' Vision: The ultimate decision should align with the founders' vision for the company.
In conclusion, the decision to go public is a nuanced one, and companies must meticulously weigh the advantages and disadvantages, considering their unique circ*mstances and long-term objectives. It's not merely a financial transaction but a strategic move that shapes the trajectory of a company in the dynamic landscape of the business world.
