In an Initial Public Offering (“IPO”),
a private company sells its stock to the public. Companies usually use an IPO to raise capital so they can
expand or to become a publicly traded company. As a public company, its stock can be traded via a stock
exchange. One effect of this is
that publicly traded companies often have many shareholders, whereas private
companies might have only a few.
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The
primary advantage of becoming a publicly traded company is the ability to raise
capital. An initial public
offering can raise millions of dollars for a company if it fetches a 100% or
500% increase on its stock offering price (e.g., if the company prices the
stock at $7 per share, and it later sells for $50 per share). Also, as the stock’s value increases,
it becomes more “liquid,” enabling the investors to use it more like currency,
in turn decreasing the need to use cash to obtain needed assets. Going public will also create publicity
for the company.
Further, offering shares to the public
allows the owners to retain the same management, whereas if the company sold
securities to another business, that business might want to place some of its
personnel on the board of directors.
Thus, issuing an IPO can enable the company to retain decision making
authority over its business.
But
public companies are not more advantageous than privately held companies in
every way. Public companies must
file quarterly and annual financial statements with the Securities and Exchange
Commission. The SEC in turn uses
this information to ensure that the company is not defrauding or misleading
investors into believing the company is worth more than it is in fact.
Going
public requires companies to comply with many legal rules and can cost a large
sum of money. First, the company
has to register with the SEC and await the SEC’s approval of its registration. Completing a registration statement requires
the company to compile many records, including bylaws, information about any
litigation involving the company, board meeting records, and an array of
personnel information. It will
then need to market itself to investors.
The company must employ underwriters to price its stock accurately so
that the price will be high enough to raise money for the owners but low enough
so traders will purchase it. The
legal, accounting, and underwriting costs, in addition to SEC filing fees, make
the entire process quite expensive.
In 2007, for example, the average overall cost to complete an IPO
totaled an average of $2.85 million.
The
company might have to hire additional employees to ensure that it complies with
the legal rules that govern public companies. Laws require the company to report certain transactions, management practices, and executive compensation, among
other matters. Further, this
effort will require the company to keep better records, and in the process, the
company’s operation will lose some flexibility.
Finally,
the extensive disclosure of business operation information can benefit
competitors by providing information that allows other businesses to infer the
company’s business strategies and the business’s strengths and weaknesses.
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