Key advantages and disadvantages of a company going public
A company going public is a colossally significant move. Taking a business public comes with numerous benefits, as the company shares are being sold to the common public.
However, it does take an extreme amount of preparation. The arrangements would involve presenting your company as an attractive investment opportunity to the public shareholders, also making sure that the company strictly abides by all legal guidelines set by the government.
The discussion of taking a company public is done by many people online and offline but there isn’t much conversation or guidance about the preparations that need to be done beforehand for the same.
Here is everything you need to know about a company going public.
What does company going public mean?
For a company to go public, it needs to meet certain public reporting obligations ordained by the Securities and Exchange Commission (SEC).
The obligations include the sales of shares that the company holds privately into the public market through various methods like an IPO, fulfilling the base trigger requirements of the SEC’s investors for public reporting, or voluntarily registering with the SEC to reveal certain business and financial data for the public.
When a company goes public through a share distribution, the privately owned stocks of the business are traded in the public investors market for initial public offering and then the company ceases to be privately owned.
This sale of private stocks gives companies the opportunity to raise money which can then be reinvested in the business.
In the trade process when the company gets capital, the owner or founder of the company gives up a percentage of their ownership in the business.
Taking a business public, through any mode is a big decision that requires a colossal amount of preparation.
After the business is public, it has to follow strict reporting requirements laid down by the regulators, as well as all the scrutiny that comes from all the shareholders, now because they are owners of some part of the company.
Public company reporting requirements include:
• Financial statements to be released every quarterly and annually.
• Essential events that the shareholders should be aware of.
• Proxy statements for the shareholders to vote on.
• Complete disclosure on any mergers, acquisitions, and any other arrangements.
When should company go public?
Taking a company public is every entrepreneur's dream. It is one of the ultimate marks of success which comes with a huge payout.
However, before you even discuss the idea of an IPO, your company must fulfill all the below-mentioned requirements set by the underwriters.
Your company must have a foreseeable and continuous revenue system. It is said to be a damaging impression if a company loses some earnings or has difficulties predicting its future.
This clearly means that the business must be mature enough that its future revenue and profits can be reliably forecasted.
The business must always have extra capital (cash) to fund the IPO process.
Make a careful note that going public is not cheap, there are numerous expenses that occur way before the actual IPO happens.
Moreover, the money you raise from taking your business public cannot be necessarily used to pay off those before IPO costs.
The company mist still has the potential and scope to grow in the business industry. No public investors would put their money in a company that has no further scope of development.
People will invest in a company that has reliable earnings today and also has the bandwidth and potential to grow in the future.
The company must be among the top players in its industry. During the initial public offering time, public investors would compare your organization to other similar ones in the market before putting in any money.
The business must have a strong existing management team.
All public companies must have all their audited financial statements.
Your business should have a firm functioning process. Even if a company is private, its operations must be strong. But the focus on the processes increases more when a company goes public. It is crucial.
Before a company goes public, it must ensure that its debt-to-equity ratio is low. This ratio plays a vital role in deciding whether your IPO will be successful or not.
Check this out - When should a company go public - Everything you need to know
7 steps to take the company into public
1. Hire a team of underwriter or an investment bank
To start the IPO process, a company tends to seek advice and guidance from a group of underwriters or investment banks.
Many times companies tend to hire services from more than one bank.
The task of this team is to study and analyze the financial position of the company, evaluate the assets and liabilities and then make a plan to fund the future financial requirements.
An underwriting agreement is signed which contains all the precise details of the IPO like the amount which will be raised from the sale of the stocks, the securities that will be used for the process, etc.
The underwriters can tell you the capital that will be raised, but still, no promises can be made.
None of them shoulder the risk involved in getting the money.
2: Register with the SEC
The company going public and the underwriters, conjointly file a registration statement, which has the details of all the financial records and the business plan of the organization.
This statement will have to specify how the company is planning to utilize the funds raised from the Initial Public Offering and the public investment securities.
If this registration statement is viable with all the guidelines of the SEC, which ensure that all the important information that a potential investor must know is disclosed, then the company gets a go-ahead.
If not, the statement is sent back with comments, which then requires the company to work on those and then register again.
3: Verification (Red Herring Document)
A document with all the details of the procedure is shared with the people involved with the IPO.
This initial prospectus contains the expected price estimate per share and the other IPO details.
This document is known as a Red Herring Document, this is because the first page of the prospectus displays a warning that clearly mentions that this is not the final deal.
This is like a pre-testing of the IPO between the investors.
4: IPO roadshow
This is the phase that comes two weeks before the IPO goes public.
The executives and senior members of the company go all around the world to advertise and market the forthcoming IPO for potential public investors.
This marketing is basically a presentation of the facts and figures, which warm up the investors to show a positive interest.
5: Pricing of IPO
Whether a company chooses to go for a Book Building Issue or a Fixed price IPO, the price band and the price will always be fixed.
A book building IPO issue will consist of a price band but a fixed price IPO as the name suggests will state a fixed price in the order document through which investors make their bid.
The number of shares the company will sell is also decided. The company also has to make the decision of the stock exchange in which the shares would be listed.
Then only the business can ask SEC to release the registration statement so that people can start purchasing.
6: Available to the public
A date is set on which the registrations and the applications forms are released live for the public investors, both online and offline.
The form can be accessed from any designated bank or firm. Once the form is filled with all the details, the potential investors submit them with a cheque or the option to submit online is also available.
The SEBI sets s fixed availability period of on IPO for the public, which is generally known to be 5 days.
7: Going live with the IPO
Once the price of the IPO is finalized, the underwriters and stakeholders get together to decide how many shares each investor would get.
Until oversubscribed, investors usually get complete securities. These shares are then credited to their Demat account.
After the securities are distributed and designated, the stock market then starts trading the company’s IPO.
Advantages of a company going public with an IPO
Increasing capital
Companies that go public, raise huge amounts of capital and subsequent funding rounds which are used for normal corporate operations, development opportunities, marketing, capital expenditures, R&D.
Gaining higher market valuation
Shares that are traded on a public stock exchange like Shanghai Stock Exchange, Nasdaq, New York Stock Exchange (NYSE) usually have more liquidity than the shares which are held privately.
Declining corporate debt
Public companies get a chance to retire from the debt by going through the IPO or selling the subsequent shares.
This reduces the interest costs and also increases the cash flow and the best-to-equity ratio.
Maintaining corporate identity and becoming better known
When a company chooses an IPO as an exit strategy instead of a merger or any other company acquisition, it keeps its business name and status.
A company going public is more widely known and gains the major attention of many potential customers and investing partners through media coverages and press releases.
Public companies are obviously more transparent than any private company as they are legally mandated to disclose all business information publicly like financial statements.
Attractive and beneficial for employees
After a company goes public, it starts attracting employees with lower risk tolerance and public stock options.
The existing employees will also be entitled to new stocks and discounted stock purchases.
Disadvantages of a company going public with an IPO
Disturbance in business processes and overlooked opportunities
During the pre-IPO process, the whole company has numerous projects and meetings to hold, which subsequently increases the workload of the employees way beyond the usual job descriptions and responsibilities.
Some tasks would be delayed, some mistakes will be made here and there.
In the Initial Public Offering process, it is possible that a company may lose many growth opportunities.
Cost of issuing shares
The team of underwriters and investment bankers usually get paid a lot as an underwriting fee for the sale of shares in the IPO.
The major amount of the money raised through the IPO however mitigates this disadvantage as the underwriting fee is eligible to be deducted from the IPO gross proceeds.
Managing for positive quarterly results instead of long term gain
Public companies should have strong plans and strategies which can be implemented to meet the short-term profits expectations, instead of channeling energies towards long-term business plans.
The company stock price can significantly drop due to any missing financial estimates.
This short-term planning can be burdensome from the company management's point of view.
Public information scrutiny
If a company is private, they tend to keep their business information confidential, especially financial records.
But when a company goes public it needs to prepare itself to disclose all business data, especially financial reports with the public, which also include competitor companies.
Higher weighted average cost of capital
During the IPO preparation process, the cost of equity is generally higher than the cost of debt, using the Capital Asset Pricing Model (CAPM).
Raising new public equity means that the company’s Weighted Average Cost of Capital (WACC), increases.
This in turn becomes a roadblock in the decision-making process to assess the capital expenditure projects which would be a part of the company’s future growth.