Why Do Companies Go Public? An Inside Look at IPOs

Have you ever watched a company skyrocket in value overnight and wondered what magic caused it? The answer often lies in three simple letters: IPO. 

When a privately held company decides to step into the broader financial arena, it usually takes the route of an Initial Public Offering or IPO. 

But why would a company choose to expose itself to the scrutiny and volatility of the public market? 

Join me as I take a closer look at IPOs in this article. 

Understanding what is IPO

An IPO, or Initial Public Offering, marks a significant phase in a company's journey. It's when a previously privately held company starts selling its shares to the public for the first time. This transition allows the company to raise capital from a wider pool of investors, but it also comes with its own set of responsibilities and regulations.

The IPO process involves the company collaborating with investment banks. These banks help determine the initial price of the shares and handle their sale to the public. 

The Securities and Exchange Commission (SEC) plays a key oversight role, ensuring that all required disclosures are made and that investors are provided with truthful information about the company.

After the IPO, the company's shares are traded on public stock exchanges, like the NYSE or NASDAQ. This not only boosts its financial resources but also enhances its visibility and credibility in the market. 

For many companies, going public is seen as a testament to their growth and success, though it does come with increased scrutiny and expectations from shareholders and analysts.

What are the reasons behind companies going public with an IPO?

While IPOs might seem dominated by financial jargon and complex processes, at its heart lies a series of strategic decisions made by the company's leadership. Let's read into the primary reasons why a company would choose this path, illuminating the benefits and motivations behind such a significant move.

Capital influx

An IPO allows companies to secure a significant amount of capital. Unlike borrowing or seeking individual investors, an IPO often brings in more substantial funds. This capital is instrumental in reinvesting in business operations or settling existing debts, positioning the company for future growth.

Rewarding early investors and employees

Initial investors and employees who received stock options stand to gain considerably from an IPO. By going public, these stakeholders can profit by selling their stocks, thereby realizing tangible benefits from their early faith and contributions to the company.

Enhanced publicity and attention

IPOs usually attract media attention, promoting the company to a broader audience. This increased visibility can be instrumental in capturing market interest, fostering trust, and attracting potential customers.

IPO as a transition phase

An IPO marks a transition in a company's journey. It concludes one phase where early investors, like those from friends and family rounds or angel investors, seek an exit. It simultaneously heralds a new phase where the general public can invest. 

Alternative to other capital sources

Companies might find other avenues like venture capitalists, private investors, or bank loans expensive or restrictive. In such scenarios, an IPO emerges as a more viable way to raise necessary funds without incurring hefty interest or diluting control excessively.

Boosting the company's public profile

Going public elevates a company's status. It's not just about the financial influx; being a publicly traded company often brings with it a level of prestige and credibility. This enhanced reputation can assist in negotiations, securing better terms from lenders, or establishing partnerships.

What are the reasons companies choose not to do an IPO?

Before jumping on the IPO, many firms evaluate the inherent challenges and weigh them against the potential benefits. Let's explore some of the primary reasons companies might opt to keep their operations private.

Loss of control

One of the primary concerns for companies, especially for CEOs who might also be the founders, is the potential loss of control over the firm's direction. When a company remains private, its leadership can steer its course with minimal external interference. 

However, after going public, the company's leaders are accountable to a broader base of shareholders, potentially influencing major decisions.

Unfavorable market conditions

The financial market's health plays a crucial role in the decision to go public. If the market is down or unstable, the shares' value might be diminished during the IPO, resulting in less capital raised and a potential undervaluation of the company. 

In such situations, companies might decide to delay or abandon their IPO plans.

Increased regulatory scrutiny

Going public invites more oversight from government regulatory bodies. This augmented regulation can be both time-consuming and expensive, deterring companies from taking the leap.

High compliance costs

For smaller companies, in particular, the cost of adhering to regulatory demands can be prohibitive. 

With regulations like the Sarbanes-Oxley Act in place, companies face rising costs associated with financial reporting, audit fees, establishing investor relations departments, and setting up accounting oversight committees. 

The desire for privacy and confidentiality 

Many companies cherish the luxury of operating without the constant public eye. Staying private allows firms to maintain discretion over sensitive information, such as their financials, strategic plans, or proprietary processes. 

Going public necessitates the disclosure of numerous details that might otherwise remain confidential. Such openness can be a double-edged sword. 

While transparency might bolster credibility with investors, it can also expose potential vulnerabilities to competitors and give them insights that could be leveraged against the company.

Potential for increased short-term pressures 

Once a company is publicly traded, there's often an intensified focus on quarterly results and short-term performance metrics. 

The pressure to meet or exceed quarterly projections can sometimes skew decision-making towards short-term gains, potentially at the expense of long-term progress and vision. 

CEOs and leadership teams might find themselves swayed by the short-term desires of vocal shareholders, rather than sticking to their foundational long-term strategies.

How to invest in an IPO? 

Initial Public Offering (IPO) is undeniably magnetic. This critical juncture in a company's growth trajectory can offer lucrative opportunities for both the company and potential investors. However, understanding the intricacies of the IPO process and knowing when and how to invest is crucial for those looking to tap into this market segment.

The underpinnings of an IPO

An IPO is a strategic decision made by companies to optimize returns, often driven by a vision of accelerated growth and an ambition to amass significant capital. 

These offerings are especially tempting for public investors, as shares during an IPO usually come with the promise of high growth potential. 

The pricing strategy for an IPO is an intricate dance led mainly by underwriters. They deploy rigorous methods to determine an apt price for the IPO. 

This process, known as pre-marketing, revolves largely around comprehensive company valuations. Among the various techniques employed, the discounted cash flow method stands out. 

This method endeavors to provide an estimation of the company's future monetary value by evaluating its prospective cash flows. 

When setting the IPO price, underwriters don't merely look at demand. They strategically price the shares to ensure that the offering is not only competitive but guarantees a successful IPO.

Navigating the IPO investment process

For potential investors, dissecting an IPO and determining its viability can be daunting. While staying updated with news related to the IPO is beneficial, the real treasure trove of information is the prospectus, which becomes available after the company files its S-1 Registration. 

This document is a goldmine, presenting deep insights into the company's overarching strategy, the specifics of the deal, and details about the banks backing the IPO. 

These elements are often pivotal in identifying IPOs that have a strong foundation and a higher probability of success.

However, simply having the knowledge isn't enough. The pathway to investing in an IPO is multi-faceted. 

During the pre-marketing phase, institutional investors play a dominant role, often shaping the trajectory the IPO will take during its initial trading days. 

But when the final offering day arrives, it's open season for all interested investors.

Summary of what we learned

The transition of a company from private to public status via an Initial Public Offering (IPO) is one of the most intriguing financial events in the business landscape. As we've seen, there's a blend of strategic planning, economic calculation, and ambition behind a company's decision to go public. 

On the flip side, the concerns of losing control, navigating an unfavorable market, and grappling with increased regulations might keep some companies in the private arena.

For investors, the allure of IPOs is undeniable, offering the potential for significant returns. Yet, diving into the IPO pool requires meticulous research, timely information, and strategic decision-making. 

Armed with the right knowledge, tools, and insights, investors can maximize their chances of capitalizing on these lucrative opportunities.

Seize the moment, and let your investment journey begin!

Check out this interesting article: How to trade CFDs: a beginner's guide

  “When considering initial public offering (IPO) for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss. Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.”