IPO 101: Pros and Cons of Going Public

9/15/2018

An initial public offering, or IPO, is an important event in the life of a company. An IPO transforms a privately-held company into a “public company,” and the company’s shares are then bought and sold by the investing public on a stock exchange, such as the New York Stock Exchange (“NYSE”) or NASDAQ. An IPO has important implications for the company’s management, employees and investors, and is a way for the company to raise a significant amount of capital for business purposes.

This blog post discusses the pros and cons of going public (holding an initial public offering) from the company’s perspective.

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Pros:

Capital. An IPO is a great way for the company to raise capital. In an IPO, the company sells shares to IPO investors and receives cash, and usually a lot of cash. For example, event-ticketing company Eventbrite held its IPO and started trading on the NYSE on September 20. Eventbrite sold 10,000,000 shares of its Class A Common Stock for $23.00 per share, raising $230 million in its IPO. Not bad for a capital raise.
Liquidity. An IPO can provide liquidity (the ability to sell shares, in this case in the public market) to the company’s founders, employee or pre-IPO investors. If the company has venture capital or private equity investors, the IPO provides a path for the investor to sell its shares. Note that it is common for founders, employees and pre-IPO investors to be restricted from selling their shares in the open market for 6 months after the IPO as a way to help stabilize the stock’s price after the IPO. See my post on IPO lockups for more on this.
Acquisition currency. Once public, the company can acquire other companies and use its stock as the acquisition currency, instead of cash (or for cash and stock). This means the company can grow by acquisition (called inorganic growth) without using its cash.
Reputation. An IPO can enhance the company’s reputation and credibility. A customer might be more willing to try the product or a vendor may be more willing to extend credit terms if the company is public. Also, once public, the company will be covered by the financial press, so the company will be more in the public’s eye.
Recruiting benefits. Being able to offer employees equity (via stock options or restricted stock grants) is a valuable employee benefit. Some employees may prefer to work for a public company because the company is perceived as being stronger than a private company.

Cons:

Public reporting requirements. Once public, the company must publicly report on its operations and finances. These reporting requirements can be very burdensome (especially on the CFO but also the CEO), and the company lives under a microscope. If the company does well, the market will love the company. If the company doesn’t do so well, the market may react brutally to the company’s underperformance. Staying private means you can operate outside of the public’s glaring eye. This is a reason some public companies go private (such as in a buyout) – so they will be able to restructure the company’s strategies and/or operations in private, and then, when the company is doing well operationally, go public again.
Short-term focus. Because public companies are required to file quarterly and annual reports, there is concern that management of public companies focus on short-term results. This is because management typically receives a good portion of its compensation as equity. This provides management with an incentive to drive the stock price up, and the way to do that in the short run is by focusing on maximizing short-term results.
Public company costs. Being a public company is expensive. The cost of an IPO is high, and the cost of ongoing legal and financial reporting can be expensive. We’re talking over a million dollars a year for larger companies.
Competitor information. When the company files to go public, the company discloses a lot of information about the company – its market, its customers, its strategies, its competition, its operations, and also its finances. This information can be very valuable to its competitors.
Activist Investors. Activist investors buy shares of companies that they believe are underperforming so they can put pressure on management to sell the company, sell non-core or underperforming divisions or assets, or to replace the management team. When an activist investor attacks a publicly-traded company, management’s focus will be diverted from running the company to defending the activist attack. I doubt that senior management of any public company relishes the thought of defending an activist attack.
Short-Sellers. Short sellers are investors who believe the company’s stock is overpriced, and that the stock will fall. These investors enter into contracts to sell shares of a company’s stock when they don’t actually own the shares. When the stock price falls, these short sellers buy the stock to fill their orders and collect a profit roughly equal to the sale price less what they bought the stock. For example, say a stock is selling at $100 per share and a short seller thinks the price is worth less than $80 per share. The short seller will enter into a contract to sell a share at $95 in a month, and a month later, when the stock is selling at $80, the short seller buys the stock at $80 and fulfills the contract to sell at $95 and earns a $15 profit. Short sellers are often very vocal about what they perceive the problems to be at the company, and can influence markets. Management may have to divert attention to dealing with vocal short-sellers.
Poor IPO performance. Every company that goes public runs the risk that the company’s stock doesn’t perform well after the IPO. If the stock price falls below the IPO price, the IPO is known as a “broken” IPO, and the financial press will examine this rigorously. The bad press from a broken IPO could injure the company’s reputation in the marketplace for a short period of time.

IPO 101: Pros and Cons of Going Public

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