What Are The Pros And Cons Of An IPO?

An IPO is an initial public offering (IPO), which is the first limited public stock sale by a private company. IPOs are a strategy often used by smaller businesses to raise capital from public investors in order to facilitate expansion and growth. Once public, the company can be traded on the open market. There are both upsides and downsides to taking a company public. 

What are the Pros?

Increased Financial Benefits: 

• Because an IPO raises capital from investors, it offers significant financial benefits. The money raised can fund research & development and capital expenditures. It can also help to pay off existing debt. Raising capital is more challenging for private companies because it locks in investors. But in a public company, investors can choose to enter or exit the investment at their discretion. 

More Public Awareness:

• An IPO draws increased media coverage, which increases the public’s awareness of a company, which can help to boost market share and attract new customers. Publicly listed companies are also sometimes viewed with more respect and are often thought to have a better reputation. 

Higher Share Valuation:

• Stock shares traded on a public stock exchange have more liquidity than privately held shares. Also, when a company’s shares are listed on the stock exchange, investors can compete to invest in them. This competition drives the price of the shares higher. 

M&A Funding:

• Higher valuations mean the company’s stock can be used for M&A transactions. This can be done using cash proceeds raised or the exchange of fewer shares. M&A transactions, when properly executed, have the potential to generate growth and increase revenue for a company.

 Reduction of Corporate Debt:

• An IPO can allow a company to retire debt, reduce interest costs, improve cash flow, and improve the debt-to-equity ratio. 

Attracting Talent:

• Public companies have a lower risk tolerance with stock option plans, which can be more attractive to certain employees who prefer to work for larger, publicly held companies over smaller, private firms or startups. 

An Effective Exit Strategy:

• IPOs can be very effective exit strategies for founders and owners looking to cash out and either retire or move on to the next big thing. Learn more about the importance of professional exit planning here. 

What are the Cons?

A Time-Consuming Process:

• Small businesses may find it frustrating to go public simply because it can take a great deal of time to complete the process. An IPO can take years to be finalized. 

Distraction from the Day-to-Day:

• The time-consuming process of going public can act as a distraction for the leadership of a company, diverting attention from daily operations and other growth opportunities. The long-term vision for the company becomes sidelined while management focuses on short-term revenue and profits. 

Added Disclosure: 

• An IPO means more disclosure for investors. This includes disclosing information to competitors and having less privacy regarding operational strategies, which can result in losing a competitive edge. 

SEC Regulation:

• When a company goes public, it faces rules, regulations, and monitoring by the SEC for financial reporting. This will almost always certainly draw a higher degree of scrutiny for the business. 

Added Expenses: 

• Compliance with regulatory requirements can be quite costly because of quarterly audit fees, percentage-based underwriting fees, legal fees, investor relations, and the need for committees to oversee accounting practices to ensure adherence. Because of this, it can be difficult for some companies to afford it.

Less Autonomy:

• Public companies do not enjoy the same level of autonomy as private companies. Decisions that were once unilateral now need to be approved by a certain number of shareholders.  

Pressure to Perform:

• Going public puts serious pressure on a company to perform because the financials are reported every quarter. The stock market is not forgiving when it comes to declining performance. This scenario can cause the company to become shortsighted just to keep investors happy.

Loss of Company Culture:

If your business has a strong culture, going public puts this culture at risk, which puts the company at risk for losing key talent. A strong culture may be more beneficial for you in an M&A transaction. 

Higher Weighted Average Cost of Capital (WACC):

• The cost of equity is more than the cost of debt. Raising equity will raise the company’s WACC. Read more about WACC and how to value a business. 

 

What is Right for You?

Companies need to assess all of the potential pros and cons before deciding whether or not to go public. It may or may not be the best option for you. Alternatives to an IPO include a merger, acquisition, direct listing or direct public offering (DPO), special purpose acquisition company (SPAC), refinancing, strategic alliance, private placement, reverse merger takeover, alternative public offering (APO), crowdfunding, asset sale, or simply holding off until the time is better for a major move. But if you are thinking of waiting, you may want to take a minute to learn about why 2022 is a seller’s M&A market.