An initial public offering (IPO) is the process a private corporation goes through so it can sell shares to investors on a stock exchange. This puts ownership of the company in the hands of the public. If a company chooses to remain private, ownership remains in the hands of private owners, though it can also issue stock to shareholders. Companies go through the IPO process or stay private for many different reasons, whether it’s to raise capital or to keep expenses down while saving time.
KEY TAKEAWAYS
- An initial public offering means a company can sell its shares on the public market.
- Staying private keeps ownership in the hands of private owners.
- IPOs give companies access to capital while staying private gives companies the freedom to operate without having to answer to external shareholders.
- Going public can be more expensive and rigorous, but staying private limits the amount of liquidity in a company.
IPO
As mentioned above, an initial public offering is a process a private company needs to go through in order to sell its shares to the public, usually on a stock exchange. Private companies normally have to go through a period of growth before they make the decision to go public through an IPO.
One of the main reasons why a private corporation goes public is financial. This gives the company access to cash — usually in large amounts. This influx of capital can be used to pay off debt, increase research and development (R&D), or other ventures. It also allows companies to shore up their balance sheets and secure financing in the future.
There is also a perceived legitimacy in being a public company because it tends to make potential investors and business partners feel more at ease working with the company since information is filed with the Securities and Exchange Commission (SEC) and available for all to see.
Cons
While prestige and cash are tempting reasons, there is a huge risk associated with undertaking an initial public offering. What if the IPO fails? Or there’s not enough interest from the public? Then there’s the fact that it’s an expensive and time-consuming process. The requirements for holding an IPO and being publicly traded are significant drawbacks.
“Going public, even under the reduced reporting requirements of the JOBS Act, can be an expensive exercise,” says Helen Adams, San Diego-area managing partner of Haskell & White, one of the largest independently owned accounting, auditing, and tax consulting firms in Southern California. “There are specific SEC financial statement filing requirements on a quarterly and annual basis, and many periodic legal reporting requirements, including those for material transactions and for stock trading by senior executives and board members.”
Companies end up spending more money as a public company than a private one. Larger companies can afford to pay these costs but small ones may find it affects their bottom lines without careful consideration.
While both can issue stock to shareholders, public companies sell them on a public exchange, while shares in private companies remain in the hands of private shareholders.
Staying Private
Going public may help private business owners grow their balance sheets, smooth business transactions, make it easier to take over competitors, and make them stand up a little straighter, but there are many pros to remaining private. Private companies report to a finite group of investors. While the pool of potential investors is smaller since they have to be accredited, the amount of capital that’s usually poured into early-stage companies is incredible.
Staying private gives a company more freedom to choose its investors and to retain its focus or strategy, rather than having to meet Wall Street’s expectations. And since there’s a risk involved in going public, the benefit of staying private is saving the company from that risk.
Cons
With a private company, you may not be able to attract top talent through benefits like stock incentives, according to Mike Ser, an active trader, trading coach, and entrepreneur with more than 16 years of trading experience. He is the co-founder of Ser Man Traders, a training program for professional traders. Another con, he says, is that as a private company, you can’t use your stock as currency to acquire your competitors or other companies. “If you’re a private company, it’s more of a challenge as you either have to have cash or borrow debt to acquire companies.”
Staying private also limits liquidity for existing investors. They can’t easily sell their stake in the company by going to a public exchange. It may not be so hard to find a buyer for a well-known, top-performing, venture capital-backed company, but in the case of a lesser-known company, the only potential buyers might be other existing owners. Selling shares in the secondary market is often challenging, especially since prospective buyers have to be accredited.
Investors may hold a significant stake in a company and be vocal about how they think a business should be run. Relying on private investors may not allow the company to raise the funding it needs, and it may not be able to find enough private investors interested in the business.
Source: Investopedia
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