An initial public offering (IPO) is the first sale of stock by a company. Small companies looking to further the growth of their company often use an IPO as a way to generate the capital needed to expand.
Although further expansion is a benefit to the company, there are both advantages and disadvantages that arise when a company goes public.
Advantages vs. Disadvantages of Going Public
As said earlier, the financial benefit in the form of raising capital is the most distinct advantage. Capital can be used to fund research and development (R&D), fund capital expenditure, or even used to pay off existing debt.
Becoming an IPO is an expensive and time-consuming endeavor—the benefits to going public can be numerous but so can the drawbacks, especially for smaller businesses.
Another advantage is an increased public awareness of the company because IPOs often generate publicity by making their products known to a new group of potential customers. Subsequently, this may lead to an increase in market share for the company. An IPO also may be used by founding individuals as an exit strategy. Many venture capitalists have used IPOs to cash in on successful companies that they helped start-up.
Even with the benefits of an IPO, public companies often face several disadvantages that may make them think twice about going public. One of the most important changes is the need for added disclosure for investors. In addition, public companies are regulated by the Securities Exchange Act of 1934 in regard to periodic financial reporting, which may be difficult for newer public companies. They must also meet other rules and regulations that are monitored by the Securities and Exchange Commission (SEC).
More importantly, especially for smaller companies, is that the cost of complying with regulatory requirements can be very high. These costs have only increased with the advent of the Sarbanes-Oxley Act. Some of the additional costs include the generation of financial reporting documents, audit fees, investor relation departments, and accounting oversight committees.
- In order to become an IPO, a company must be able to pay for the generation of financial reporting documents, audit fees, investor relation departments, and accounting oversight committees.
- IPOs often generate publicity by making their products known to a wider potential swath of customers, but taking a company public is a huge risk.
- Smaller businesses may find it difficult to afford the time and money it takes to become an IPO.
- Privately held companies have more autonomy than public ones.
Public companies also are faced with the added pressure of the market which may cause them to focus more on short-term results rather than long-term growth. The actions of the company's management also become increasingly scrutinized as investors constantly look for rising profits. This may lead management to use somewhat questionable practices in order to boost earnings.
Before deciding whether or not to go public, companies must evaluate all of the potential advantages and disadvantages that will arise. This usually happens during the underwriting process as the company works with an investment bank to weigh the pros and cons of a public offering and determine if it is in the best interest of the company for that time period.
Example: SNAP Inc.
One of the highest profile IPOs of 2017 was Snap Inc (SNAP), best known for its flagship product Snapchat. Despite an initial surge, the stock was unable to gain much traction with investors during its first year as a public company. In November of 2018, Reuters reported that "Snap reported that it had received federal subpoenas related to a class action stemming from its IPO. The lawsuit claims investors were misled about Snapshot's user growth ahead of the company going public." In early 2019, Snap Inc.'s stock continued to go down.