Initial Public Offering
What is an Initial Public Offering – IPO
The process of offering shares in a private corporation to the public for the first time is called an initial public offering (IPO). Growing companies that need capitalwill frequently use IPOs to raise money, while more established firms may use an IPO to allow the owners to exit some or all their ownership by selling shares to the public. In an initial public offering, the issuer, or company raising capital, brings in underwriting firms or investment banks to help determine the best type of securityto issue, offering price, amount of shares and time frame for the market offering.
BREAKING DOWN Initial Public Offering – IPO
Some people refer to an IPO as a public offering or “going public.” There are other ways to go public like a direct listing or direct public offering. When a company starts the IPO process, a specific set of events occurs. The chosen underwriters facilitate these steps.
- An external initial public offering team is formed, comprising underwriters, lawyers, certified public accountants and Securities and Exchange Commission (SEC) experts.
- Information regarding the company is compiled, including financial performance and expected future operations. This becomes part of the company prospectus, which is circulated for review after it has been prepared.
- The financial statements are audited, and an opinion is generated.
- The company files its prospectus and required forms with the SEC and sets a date for the offering.
Advantages of an IPO
The primary objective of an IPO is usually to raise capital for a business. However, a public offering has other benefits as well.
- A public company can raise additional funds in the future through secondary offerings because it already has access to the public markets through the IPO.
- Many companies will compensate executives or other employees through stock compensation. Stock in a public company is more attractive to potential employees because shares can be sold more easily. Being a public company may help a company recruit better talent.
- Merger and acquisition activity may be easier for a public company that can use its shares to acquire another firm. Similarly, it is easier to establish the value of an acquisition target if it has publicly listed shares.
Some companies will conduct an IPO because of the prestige and credibility it imbues. This may be a factor for future lenders who might be more willing to make loans at more favorable terms if they know the company has a diversified shareholder base and is accountable to the SEC for accurate financial reporting. However, the real value of intangible advantages like prestige are difficult to measure.
Disadvantages of an IPO
An IPO is expensive, and the costs of maintaining a public company are ongoing and usually unrelated to the other costs of doing business. There are other disadvantages of an IPO as well.
- Fluctuations in a company’s share price can be a distraction for management, which may be compensated and evaluated based on stock performance rather than real financial results.
- Strategies used to inflate the value of a public company’s shares, such as using excessive debt to buy back stock, can increase the risk and instability in the firm.
- A public company must file reports with the SEC that may reveal secrets and business methods that could help competitors.
- Rigid leadership and governance by the board of directors can make it more difficult to retain good managers willing to take risks.
Having public shares available requires significant effort and expense that does not end after the IPO has completed. Public companies are also at risk of lawsuits and legal actions related to their public shares that can be expensive and distracting.