Going public – is it always a good idea?
For many ambitious entrepreneurs, an Initial Public Offering (IPO) on a stock exchange is a natural goal. The advantages are numerous, with the most obvious being the opportunity to raise money, and access future needed capital for business expansion more easily. Other advantages include raising the profile of the company, and improving the overall status and/or brand of the company.
This can make it easier to hire as the company may be perceived as more attractive. Shares of a listed company, particularly before the IPO, can be used as a powerful financial tool for incentivising and attracting talent. After the IPO, the shares can be used as currency for targeted mergers and acquisitions.
Of course for the venture capitalists (VC), it really goes without saying that an IPO is ideal. A sale of any stake in a company held by a VC can be sold off in a number of different ways, for example to another VC or financial institution. However, the IPO is generally regarded as the most lucrative method of exiting.
A successful IPO can also enhance the reputation of the VC itself. At the very least, an excellent IPO is excellent advertising for the VC.
And naturally the underwriter or broker for the IPO is another entity that stands to ‘win’ when a company goes public. The underwriter will collect a fee from a company that goes public. It will often collect a fee from the subscribers to the IPO. And then it will usually collect commission when the shares are sold by subscribers on the day of the offering, and/or collect commission from those who need to add to the holding because they did not get enough shares in the original IPO allotment.
With the deregulation of commissions and the resultant collapse in commission rates, most brokers make their money through underwriting. Hence no surprise that they are keen to encourage as many companies as possible to go public!
So what are the disadvantages of going public?
Clearly a listed company faces much more intense scrutiny from its shareholders, and there are specific listing requirements that need to be maintained and exchange regulations which need to be upheld. There are many more disclosure and reporting requirements, which add to higher expenses. Additionally, it is well known that it can be extremely difficult for the managers of any listed company to strike the right balance between rewarding shareholders, and setting and achieving long term goals.
There has been increasing focus on and criticism of the short termism of companies which are listed. But at the same time, shareholder activism and voices of shareholders demanding more say, for example on executive pay, are also on the rise.
Ultimately, the decision about whether or not to IPO should be made with careful consideration by any company or entrepreneur considering going this route. But with investment bankers and VCs focused quite logically on their own bottom line, an IPO will probably boil down to one question: Will it be successful on day one of listing? If the answer to this is probably yes, investment bankers and VCs will certainly do their absolute best to achieve an IPO!
Obviously if you are considering investing in an IPO, it is crucial to bear this in mind. Not all IPOs are created equal, and remember that highly-managed ‘window-dressing’, including short term ‘cleaning up’ of balance sheets and P&L statements prior to listing is only too common. As with any investment, you must always do plenty of detailed due diligence beforehand. Making sure you know the history of the company being initially offered is a good starting point.