What is an IPO: Why Companies Go Public

There are as many glorified tales of triumphant IPOs as there are devastating ones about companies whose entry into the public markets proved their ultimate undoing. Not surprisingly, the logistics behind issuing an Initial Public Offering are supremely complicated — in both making the decision to go there and in actually getting there.

An IPO can be a great strategy for a business to grow, but it’s not for everyone. Indeed, the fact that fewer than 1,000 businesses a year are successful at IPOs (says the Small Business Administration) is reason enough to give the consideration pause. Here’s some counsel to help understand the nature of the beast.

What is an IPO?

An IPO is the first offer of a company’s stock on the public market. “Going public” thus is the sought-after destination of many emerging companies. Here, organizations are compelled to assemble various detailed public disclosures — with the assistance of a lawyer — that they present to an investment bank who handles the underwriting. This procedure involves setting a price for the stock, and arranging participation of large institutional investors.

After that, company execs and the underwriter participate in a road show, wherein they meet with potentially interested parties and look to drum up public interest in the their firm. Traditionally, the IPO has been used as a financing vehicle. Today, it’s a little more complex than that. After all, going public is an expensive proposition. An IPO can cost hundreds of thousands of dollars — and there’s no guarantee it’ll even become a reality.

Why Companies Go Public

When you’re a fuzzy and bootstrapping startup, you’re the darling of the business world. People admire your tenacity and speak glowingly about your selfless efforts. But when you’re a public entity, there’s considerably less sympathy on offer. More than that, such a move exposes all kinds of vulnerabilities. For one, it subjects a company to new rules and regulations by various governing bodies. For another, it opens it up to the risk of takeover. A public company’s shares can be snapped up by anyone — even its competitors.

While the IPO’s primary reason for existing is to provide liquidity to investors and employees (with some companies forced into it as a means to pay back investors), an IPO also furnishes a company with some collateral that can later be traded upon for future purchases or mergers. Before anything else, though, the execs of a would-be public entity need to be clear on what they’re trying to achieve before taking a step in this direction. Importantly, the objective cannot solely be to make money, a caveat Mark Zuckerberg clearly understood when he said in his letter to Facebook investors upon its IPO filing, “We don’t build services to make money; we make money to build better services.”

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When is the Right Time?

This is the heart of the matter. Undertaking an IPO too early can have catastrophic effects on the future health of a business; waiting too long might allow a competitor to steal their thunder.

Its not a foregone conclusion that a company will always issue an IPO. Such a venture requires founders who have a plan that includes a defence of the company and a financial spreadsheet that’s tight and within the grip of strict controls. The public markets need to be able to trust an operation’s ability to make — and keep making — money. Investors aren’t fans of weaknesses in an IPO prospectus.

Going public involves selling your vision and future results to others. That’s where the storytelling pitch comes into play. Critical to that is the piece that describes how your business is different from — and superior to — the competition. Here’s where you need to fasten on a sustainable competitive advantage that’s definitively yours. Some questions to consider when pondering whether you’re in a position to go public:

  • Does the business have processes built into the business plan that defines a path for growth while accounting for possible change?
  • Are they delivering at least $60-$100 million in annual revenue (or $15-$25 million in quarterly revenue) — the commonly accepted benchmark for this move?
  • Can they demonstrate cash flow profitability?
  • Can the business point to a track record of accurate business-result forecasting? Knowing with reasonable precision what next quarter, or even next year, is going to look like, you’re golden.
  • Is the business reasonably invulnerable? (In other words, do they have a couple of very large customers and a dominant supplier or distributor, or are they beholden to a single platform, technology or regulatory regime?)

Wrapping it Up

There are many advantages to a company going public, including the acquisition of capital to invest in R&D or pay off debt as well as increased public awareness. But there are downsides, too, the requirement of added disclosure, the sudden presence of regulatory oversight, the time commitment of maintaining a public face, and the added cost of complying with regulatory requirements among others. Before deciding whether or not to issue an IPO, companies need to spend some time evaluating the big picture.

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2 responses to “What is an IPO: Why Companies Go Public”

  1. […] shop and buy inventory. Oftentimes, companies will issue stock either privately (like Julie), or publicly (on the stock market) to raise the cash they need to invest in their […]