INTRODUCTION
An initial public offering (IPO) is the first sale of stock by a company. Small companies looking to further the growth of their company often use an IPO as a way to generate the capital needed to expand. Although further expansion is a benefit to the company, there are both advantages and disadvantages that arise when a company goes public.
Before deciding whether or not to go public, companies must evaluate all of the potential advantages and disadvantages that will arise. This usually will happen 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.
ADVANTAGES
There are many advantages for a company 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, fund capital expenditure or even used to 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
A "reverse merger" is a method by which a private company goes public. In a reverse merger, a private company merges with a public company with no assets or liabilities. The publicly traded corporation is called a "public shell"
since all that exists is its corporate structure. By merging into such an entity, a private company becomes public.
The Private company merges into a public company and obtains the majority of its stock (usually 90% or more). The private company normally will change the name of the public corporation (often to its own name) and will appoint and elect its management and board directors.
The advantages of public trading status, which are outlined in greater detail below, include the possibility of commanding a higher price for a later offering of the company's securities. Going public through either a reverse merger or a registered spin-off (described below) allows a private company to go public, typically at a lesser cost and with less stock dilution than through an initial public offering (IPO).
In an IPO, the process of going public and raising capital is combined. In a registered spin-off or reverse merger, these two functions are unbundled - a company can go public without raising additional captial. Through this unbundling operation, the process of going public is simplified greatly.
The Private Company which has gone public obtains the benefits of public trading of its securities, namely:
Increased liquidity of the ownership shares of the company.
Higher share price and thus higher company valuation.
Greater access to the capital markets through the possibility of future stock offerings.
The ability of the company to make acquisitions of other companies using the company's stock.
The ability to use stock incentive plans to attract and retain key employees.
Going public can be a part of a retirement strategy for business owners.
Simply by merging into a public company, a private corporation can increase its value by three to five times. .
The newly created value can become part of an estate providing value not only for the founders, but for generations to come.
It is essential that public companies, especially newly public companies, actively maintain and manage a financial communications program.
A newly formed public company would be well-advised to invest in consulting services, to plan and execute a strategy for building and maintaining an active interest in your company within the financial community.
Consultants are available to assist the public corporation in providing corporate relations services intended to increase awareness of your company on Wall Street.
For most people, recapitalization and stock value appreciation would seem reasons enough to be publicly owned, but there are other advantages that a company can gain. A public company has a broader equity base, thus increasing it's opportunities for obtaining financing for future projects. Increasing the bottom line net worth of a company, as well as its debt to equity ratio, enables it to borrow at lower interest rates from traditional institutions.
DISADVANTAGES
Profit-sharing
If the firm is sitting on a highly successful venture, future success (and profit) has to be shared with outsiders. After the typical IPO, about 40% of the
company remains with insiders, but this can vary from 1% to 88%, with 20% to 60% being comfortably normal.
Loss of Confidentiality
A major reason for firms to resist going public is the loss of confidentiality in company operations and policies. For example, a company could be destroyed if the company were to disclose its technology or profitability to its competitors.
Reporting and Fiduciary Responsibilities
Public companies must continuously file reports with the SEC and the exchange they list on. They must comply with certain state securities laws ("blue sky"), NASD and exchange guidelines. This disclosure costs money and provides information to competitors.
Loss of Control
Outsiders are often in a position to take control of corporate management and might even fire the entrepreneur/company founder. While there are effective anti-takeover measures, investors are not willing to pay a high price for a company in which poor management could not be replaced.
IPO Expenses
An IPO is a costly undertaking. A typical firm may spend about 15-25% of the money raised on direct expenses. Even more resources are spent indirectly (management time, disruption of business).
Immediate Cash-out usually not permitted
Typically, IPO entrepreneurs face various restrictions that do not permit them to cash out for many months after the IPO.
Liability
The company, its management, and other participants may be subject to liability for false or misleading statements and omissions in the registration documents or in the reports filed by the company after it becomes public. In addition management may be subject to law suits by the stockholders for breaches of fiduciary duty, self dealing and other claims, whether or not true.
FAILURE COMPANIES IN IPO