When companies use the term “going public”, it refers to making shares of the firm available for the general public to buy. “Going public” also refers to an initial public offering (IPO). An order to undertake an IPO, a business must go through an elaborate process requiring months and months of work and collaboration with other parties, including an investment bank and accounting firm. IPOs are a way for small businesses to obtain additional capital in order to sustain their growth and expand. However, IPOs have their difficulties as well, such as loss of management control and accountability. Just because a company has the means of becoming public does not mean that this is the best strategy in the long-term.
Nowadays, the types of businesses that have the most success becoming public are in the high-tech sector, or those with trendy and popular consumer products. Manufacturing companies, or other businesses that are less “exciting” will less likely have the same appeal to investors.
Company owners should be prepared to change the company direction from its initial goals when other shareholders are involved. Sometimes the market changes direction, opening up different opportunities that the owners had intended from the start. Owners should be prepared to accept input from investors and the board to change the firm products to serve an increasing demand elsewhere.
Here, you will learn about the advantages and the disadvantages of going public, as well as things to consider should you proceed with an IPO.
Advantages of Going Public
As mentioned earlier, one of the biggest benefits of going public is raising capital. Capital is needed for businesses that are looking to expand, whether by introducing new product lines, or entering into different markets. The funds can be used for research and development purposes or capital expenditures such as equipment and software. Capital funding can even be used to help sustain a business and pay off its debt, so that the company can focus on its future strategy.
Another advantage of going public is the prestige that comes with a public company. Publicly held firms hold a reputation as solid businesses that are accountable for their actions (whether or not it is true). There is publicity and increased awareness about the firm, which can help the business market its services or products to potential customers. A consequence of this effect is that investors become aware of the company and may follow the company to decide whether or not to invest. As for business operations and hiring talent, high-caliber employees may become attracted to working for the company and contribute to its overall successes. These actions can lead to increase market share for the company.
Sometimes, the company founders decide to go public as an exit strategy. These founders have usually started the business from the ground up. Upon seeing that the company is prospering, they decide to cash in to reap the rewards of their hard work.
Disadvantages of Going Public
Undertaking an IPO has its disadvantages as well. Public companies face a loss of control with the increased shareholders, and a need to disclose financial statements to the public. Public companies are regulated by the Securities Exchange in their financial reporting, and are closely monitored by the SEC. Especially with the increased requirements of the Sarbanes-Oxley Act, public firms must be very careful to disclose the nature of their expenses and accounting methods, or face the consequences. These can include fines, negative publicity and possibly imprisonment for fraud perpetrators.
Going public also involves the top management answering to a board of directors for their actions. The board oversees management actions and can replace them if business performance is not doing well. Consequently, management of public companies is often pressured to perform for short-term rather than long-term growth. Investors want to see that their shares are doing well, which may cause management to make decisions that boost earnings, but are in the best interests of the company in the long run.
There are high costs involved with IPOs. The process requires months of time-consuming work and money before a company can go public. Around a quarter of the business’s gross capitalization can be expected to go towards the costs of going public. These funds go towards paying the underwriters, internal company costs and underpricing.
After the business has gone public, the expenses don’t end there. A couple hundred thousand can be expected to go towards reporting fees, auditing, and SEC regulation requirements.
Things to Consider Before Going Public
If all the advantages and disadvantages above have made you even more eager to take your company public, there are key steps that should be taken before making the leap.
- Look at your management team. The management team should have extensive business experience, and be well-versed in both the industry they are working in and financial management. Management should have solid plans and goals for the future.
- Standardize company processes. The company should have a standard system in its operation, including pricing, hiring, and expenditures. A methodology for business operations should be in place.
- Hire permanent staff. Having company employees rather than contracted workers helps ensure stability in the company and greater control over employee actions. The employees are more accountable for their actions and more involved in the company processes.
- Keep company and personal finances separate. When a company becomes public, owners cannot take out company funds for personal use or mix personal and company resources together. The two must be kept separate.
- Predictable flow. The company should be keeping track of its revenues and expenditures for a time period long enough that it can reasonably predict future performance. Having predictability improves budgeting and increases investor confidence.
- Get contacts. Hiring board members and management that have extensive business experience will also have contacts in the financial industry. Introductions are important to selecting the right investment bank – one whom is interested in your company’s products and services, and has the right attitude to getting things done.