Initial Public Offer
Initial Public Offer
The Pros and Cons of an Initial Public Offering
When a company is taken private by a buyout firm, the end-goal is to hold a successful initial public offering. Although the company may be sold to another private equity group, merge with another company or be acquired by another firm, most buyout firms favor the IPO exit. As the initial public offering may be returning as a popular exit for buyout firms, it seems that this will always be the favored exit strategy used by private equity firms. The following is a look at the pros and cons of an initial public offering.
Benefits of An Initial Public Offering
- More Capital. An initial public offering allows a firm to raise significant capital. Many firms choose to hold an IPO to fund future expansion of their business. It may also provide a firm with the necessary cash to survive until the product or service is launched successfully.
- Greater Stability. Being listed as a public company may bring a stronger reputation in the business world. Investors and potential business partners may be more likely to work with a public company because it requires stability and increased accountability.
- Obtaining loans. Some lenders may be more likely to give a loan to a public company than a firm held by a private equity firm. Similarly, debt rating agencies may improve the company’s score because it goes public.
- Greater liquidity. One of the biggest benefits of an IPO is the liquidity it brings. Management with a stake in the firm and private equity investors can now sell shares to new investors. However, they are often prevented from selling for a “lock-up” period, usually about 6 months.
- Management Talent. One typical way of compensating executives is through stock options and an IPO permits a firm to offer shares in the company in addition to salary. This is a great bargaining chip for getting talented management when the cash available for salaries isn’t high enough.
- Mergers and Acquisitions. A firm hoping to finance a merger or acquisition deal can use the funds raised by selling shares to the public.
Now, we can look at the downside to an initial public offering. The biggest drawback is simply the expense associated with an IPO.
Downside to an Initial Public Offering
- Cost. According to Private Equity: History, Governance and Operations the cost of an initial public offering “can be in excess of 10 percent of the overall IPO offering amount.” This is a significant expense that should be included when considering an IPO. The costs come from the management publicizing the company and putting together to prospectus; paying underwriters (could be as high as 7% of the offering); and paying legal and filing fees required for going public.
- The SEC. By selling shares to the public, a company is required to register with the Securities and Exchange Commission. Whereas the company had more leeway in its private days, it must now abide by laws and regulations demanded by the SEC. Ensuring the company is in compliance with the laws requires a lot of time and money. The company must draft documents it never had to before, like quarterly statements, and putting together a board of directors.
- Listening to Shareholders. Sometimes an idea or goal for the business may not benefit the shareholder in the short-term but it would be better for the company in the long-term. These types of ideas are often shot down by shareholders that won’t tolerate the risk and don’t want to see their stock value drop. Shareholders also have a say in compensation for executives and the influence of the public may also play a role in deciding who gets paid what.
- Answering to the Public. Private companies don’t have to deal with satisfying all its shareholders and their sometimes tiring inqueries. A public company needs to meet with Wall Street analysts and shareholders who rightfully want to know more about the company they are invested in, or considering investing in.
You may also be interested in reading about the possible return of initial public offering in 2009
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