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IPO Advantages and Disadvantages: Pros & Cons of Going Public

By Sami Yaghma, Jul 13, 2023

The iconic façade of the New York Stock Exchange with Corinthian columns and American flags fluttering in the foreground.

Welcome to the second installment of our educational blog series on initial public offerings. In our first blog, we examined the IPO process in great detail, discussing the alternative paths companies may take to list on a public stock exchange, the filings needed to launch an IPO, and much more. In our latest blog we’ll analyze the many advantages and disadvantages of going public, including how a company can balance the risks and rewards of a potential public listing, what a company should do if now is not the right time for an IPO, why seeking out guidance is key, and more.

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What Does it Mean to “Go Public”?

An initial public offering, or IPO, is defined by the process through which a privately held company offers its shares to the public for the first time, essentially allowing institutional and retail investors, or the general public, the opportunity to own a piece of said company. Deciding to go public is a huge decision for a company, and comes with a numerous step, including first and foremost, hiring an investment bank to underwrite an offering and acting as a chief “assistant” in the IPO process.

The main purpose of an IPO is for a company to raise capital by selling shares of its business to the general public. By doing so, a company can generate funds which can they be used for several purposes, including business expansion, debt repayment, research and development, or acquisitions. Further, an IPO can provide liquidity to a company’s existing shareholders—such as employees or early investors—that invested in the company when it was privately held. Lets discuss the pros and cons of going public.

When a company decides to begin the process of an initial public offering, it enters a time-consuming and lengthy period of time leading up to its IPO. We’ve broken down what goes into the full IPO process in our previous blog. Read The IPO Process: A Breakdown of What it Means to Go Public.

The Advantages of Going Public: High Risk, High Reward

While going public can provide numerous benefits to a company’s founders, employees, and investors, it also comes with certain drawbacks and considerations. Let’s first explore the pros of going public.

Access to Capital

An IPO provides the opportunity for a company to raise significant amounts of capital, by selling shares to the public. The funds raised from an IPO can be used for a number of purposes, including research and development, debt repayment, infrastructure investments, expansions into new markets, and much more. The infusion of capital raised from an IPO is also used to fund a company’s strategic objectives.

Liquidity and Exit Potential

An IPO offers liquidity to a company’s founders, shareholders, early investors and present employees. With the option to sell their shares on the newly accessed public market, these parties can monetize or cash-in their investments.

Stock as Currency  

As a publicly traded company, the entity has the advantage of using its stock as currency for future acquisitions. The opportunity to issue shares provides the company to facilitate mergers and acquisitions by offerings portions of its stock as consideration in a purchase. Stock as currency therefore opens the path to expansion, consolidation, and integration of business, often at a lower cash point.

Increased Visibility and Brand Recognition: 

Whether a company is small or already a juggernaut in its sector, an IPO will further boost its brand recognition, visibility, and investor following. The IPO process alone can provide major media attention and public listing, while a formal public market listing places a company on the watchlist of retail investors and institutional investing giants, therefor opening doors to expanding market reach and future business opportunities.

Employee Incentives

Many companies that successfully hold IPOs offer stock-based compensation to its employees, through stock options and employee stock purchase plans, which can attract and retain top employee talent. These incentives can also bring in more investors while motivating employees to contribute to the public company’s long-term success and mission statement.

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Enhanced Reputation and Credibility

An IPO has the potential to demonstrate a company’s reputation and credibility, potentially highlighting the company has reached a targeted level of maturity and stability, having met the specific requirements for listing on a public stock exchange. This level of credibility can in turn strengthen relationships with present and future investors, customers, business allies, and more.

Valuation and Market-Based Pricing

Going public allows the market to determine the value of the company’s shares based on supply and demand dynamics. This market-based pricing can provide a transparent valuation and potentially increase the company’s visibility and perceived value in the eyes of investors and stakeholders.

Currency for Further Capital Raises

Going public provides a platform for future capital raises. Once a company is publicly traded, it can issue additional shares through follow-on offerings, secondary offerings, or convertible debt offerings to raise more capital when needed. This ability to access the public market for future financing can support the company’s growth plans.

The Disadvantages of Going Public: All Eyes on the Company 

While the advantages of an IPO often command a company’s full attention, the potential cons of going public must be considered.

Regulatory Compliance and Reporting Obligations

Companies seeking an IPO must take on extensive regulatory requirements and reporting laws. Public companies must comply with regulations handed down by securities commissions, financial authorities, and stock exchanges. Within these obligations includes a disclosure of material events, governance standards, financial reporting, executive paygrades and bonuses, and other compliance requirements which can be costly. These requirements are often time consuming and costly to the company at hand. We discussed these requirements in greater detail in our previous blog, The IPO Process.

Market Volatility and Share Price Fluctuations

Publicly traded companies are subject to market volatility and fluctuations in their share prices. Share prices can be influenced by a wide range of factors, including market conditions, economic trends, industry news, and investor sentiment. These fluctuations can be unrelated to a company’s actual performance and may affect its perceived value and market capitalization.

Short-Term Focus and Market Pressures

Publicly traded companies face pressures to deliver consistent and favorable financial results on a quarterly basis. Meeting or exceeding market expectations becomes a priority, which can create short-termism and impede long-term strategic planning. Management may feel compelled to focus on short-term financial targets, potentially sacrificing long-term investments or strategies.

Increased Public Scrutiny

Once a company goes public, it becomes subject to increased public scrutiny. Shareholders, analysts, and the media closely monitor the company’s performance, financial results, and business operations. This level of scrutiny can put additional pressure on management and require transparency in decision-making and communication with stakeholders.

Loss of Control

Going public often involves dilution of ownership and control for existing shareholders, including founders and early investors. As new shareholders enter the picture, decisions need to consider the interests and expectations of a broader base of stakeholders. This can lead to a dilution of influence and decision-making power for the original owners and potentially affect the company’s strategic direction.

Loss of Privacy and Competitive Advantage

As a public company, detailed information about the company’s operations, financials, strategies, and other aspects becomes publicly available. Competitors can study this information, potentially eroding the company’s competitive advantage. It also exposes the company to the risk of intellectual property theft, imitation, or loss of trade secrets.

Increased Pressure for Short-Term Results

Public companies face pressure to deliver consistent and favorable financial results. This pressure can stem from the expectations of analysts, institutional investors, and the market in general. Meeting these expectations can lead to a focus on short-term profitability at the expense of long-term investments or strategies that may require time to generate returns.

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The Break-Even Point: Balancing the Risks and Rewards of an IPO

Balancing the risks and rewards of an IPO requires careful consideration and strategic planning. Ultimately, achieving a balance between the risks and rewards of an IPO requires a thoughtful and diligent approach. Here are some key steps a company can utilize to work towards balance; and should also consider when discussing whether an IPO is the right move.

Comprehensive Assessment

Conduct a thorough evaluation of the company’s financial health, growth potential, market position, and readiness for the public markets. Assess the potential risks, such as increased regulatory obligations, loss of control, and market volatility, as well as the potential rewards, such as access to capital, enhanced visibility, and liquidity.

IPO Readiness Plan

Develop an IPO readiness plan that addresses key areas such as corporate governance, compliance, financial reporting, and investor relations. This plan should outline the steps required to meet regulatory obligations, establish strong governance structures, and enhance transparency and communication with stakeholders.

Financial Preparedness

Ensure the company’s financials are robust and transparent. This involves having audited financial statements, solid internal controls, and clear visibility into revenue streams, profitability, and cash flows. Strong financials enhance investor confidence and minimize risks associated with financial reporting.

Professional Guidance

Seek advice from experienced professionals, including investment bankers, legal counsel, and accounting firms with expertise in IPOs. These professionals can provide guidance on the IPO process, regulatory compliance, valuation, underwriting, and investor relations. Their expertise can help navigate potential risks and optimize the IPO strategy.

Transparent Communication

Establish a culture of transparent communication with shareholders, employees, and stakeholders throughout the IPO process. Clear and timely communication helps manage expectations, build trust, and minimize risks associated with information asymmetry or misaligned perceptions.

How Should a Company Go Public: Multiple Paths to Consider

Over the past decade, a growing number of companies have chosen to forgo the IPO route, instead opting for alternative methods to listing on the public market.

Direct listing vs IPO

In a direct listing, or direct public offering, a privately held company goes public by selling shares of its business to investors on a stock exchange without holding an IPO. This process eliminates the need for an IPO underwriter, which can save the private company both time and money. This process has historically been utilized by small businesses that might be budget-conscious, which seek to avoid the large fees that come with holding a traditional IPO. As so, a direct listing might not reach the same large pool of investors that a traditional IPO does.

SPAC vs. IPO

A special purpose acquisition company, or SPAC, is a special type of company formed with the sole purpose of acquiring or merging with an existing private company to take it public. SPACs are commonly referred to as “blank check companies” because they exist without any specific business operations or assets. When a company gets acquired by a SPAC, it goes public without paying the high costs of an IPO, as the fees and underwriting costs are handled before the target company ever gets involved. SPAC mergers became especially popular during the COVID-19 pandemic, as a soaring public market had private companies rushing to go public. There are significant risks when going public via SPAC merger, including investors contributing capital to a SPAC without knowing which specific company it will acquire, less due diligence and transparency due to a SPAC merger’s quick turnaround, shareholder dilution—as SPACs tend to own a 20% stake in the company it acquires—compressed timeline for public company readiness, and more. Read more about alternative IPO paths in our IPO process blog.

What if Now is Not the Right Time For a Company to IPO?

If a company determines that going public is not the right decision at a particular time, there are alternative strategies and paths that are important to consider. It is first crucial to consult with relevant advisors, such as legal counsel, financial professionals, and industry experts, to explore the best alternative strategies based on the company’s specific circumstances, growth objectives, and market dynamics. Following consultation, here are some key options for a company to follow deciding it is not the right time to go public.

Private Funding

Explore private funding options such as venture capital, private equity, or strategic investments. These sources of capital can provide financial support for the company’s growth plans without the need to go through the complexities and obligations of becoming a publicly traded company.

Debt Financing

Consider debt financing as an alternative to equity-based funding. Debt financing involves borrowing money from banks, financial institutions, or private lenders. It allows the company to access capital while maintaining ownership and control. However, it’s important to carefully assess the company’s ability to service the debt and manage the associated interest payments.

Organic Growth

Focus on organic growth strategies to expand the business without external funding. This may involve refining the existing products or services, entering new markets, optimizing operations, improving customer acquisition and retention, and enhancing efficiency and productivity. Organic growth can be achieved through careful planning, execution, and investment in the company’s core capabilities.

Strategic Partnerships or Joint Ventures

Explore strategic partnerships or joint ventures with other companies in the industry. Collaborations can bring capital, expertise, market access, and other resources that support the company’s growth objectives. Such partnerships can be beneficial in terms of shared costs, access to new markets, technology sharing, and leveraging each other’s strengths.

Reassess and Plan for the Future

If an IPO is not the right decision at present, it does not mean it will never be an option in the future. Continuously monitor market conditions, revisit growth plans, and reassess the company’s readiness periodically. Develop a strategic roadmap that outlines the milestones and conditions that would make an IPO a more suitable choice in the future.

In Conclusion: The Importance of a Right Decision

The advantages and disadvantages of holding an initial public offering are in many ways endless, and while a company can become hypnotized by only the idea of striking gold through a public listing, it’s crucial that the proper guidance is sought out and necessarily regulated steps followed. A traditional IPO might not always be right for a company, and we’ve seen entities IPO via SPAC mergers and direct listing in years past. If there’s one theme to follow in all this, let it be this: Education is key. We hope this installment of our IPO blog series has been helpful to readers; be sure to visit our blog for the next installment in our series.

This material, provided by Linqto, is for informational purposes only and is not intended as investment advice or any form of professional guidance. Before making any investment decision, especially in the dynamic field of private markets, it is recommended that you seek advice from professional advisors. The information contained herein does not imply endorsement of any third parties or investment opportunities mentioned. Our market views and investment insights are subject to change and may not always reflect the most current developments. No assumption should be made regarding the profitability of any securities, sectors, or markets discussed. Past performance is not indicative of future results, and investing in private markets involves unique risks, including the potential for loss. Historical and hypothetical performance figures are provided to illustrate possible market behaviors and should not be relied upon as predictions of future performance.

FAQ’s

How does an IPO measure a company’s valuation?

When measuring valuation for an initial public offering (IPO), several methods and factors come into play. Valuation is the process of determining the worth or fair value of a company. Here are some key considerations in measuring valuation for an IPO:

1. Comparable Company Analysis: This method involves analyzing the valuations of similar publicly traded companies in the same industry or sector. By comparing key financial metrics such as price-to-earnings (P/E) ratio, price-to-sales (P/S) ratio, or enterprise value-to-revenue (EV/Rev), a valuation range can be established. This approach provides a benchmark by which to assess the company’s value relative to its peers.

2. Pre-IPO Funding Rounds: The valuation established during pre-IPO funding rounds can influence the IPO valuation. Pre-IPO investors, such as venture capitalists or private equity firms, often negotiate the company’s value before the IPO process begins. The IPO valuation may take into account the previous funding rounds and subsequent growth achieved by the company.

3. Investor Demand and Market Sentiment: Investor demand and market sentiment play a significant role in determining valuation. The IPO valuation ultimately reflects the price at which investors are willing to buy shares. Market conditions, investor appetite, and perceived growth prospects of the company can influence the demand for shares and impact the final valuation.

4. Discounted Cash Flow (DCF) Analysis: DCF analysis estimates the present value of the company’s future cash flows. It involves projecting future cash flows, applying a discount rate to account for the time value of money and the company’s risk profile, and arriving at the net present value (NPV) of these cash flows. DCF analysis focuses on the company’s expected future performance and cash-generating potential.

5. Earnings Multiples: Valuation can also be determined based on earnings multiples such as price-to-earnings (P/E) ratio or price-to-earnings growth (PEG) ratio. These multiples compare the company’s earnings or growth rate to its market value. For example, a higher P/E ratio suggests a higher valuation relative to earnings, indicating investor confidence in future earnings growth.

How does a pre-IPO company decide which public stock exchange to list on?

When a company decides to go public and list its stock on a public stock exchange, the choice of which exchange to list on depends on several factors.

1. Market Visibility and Investor Base: Consider the visibility and reach of the stock exchange in attracting potential investors. Major stock exchanges such as the New York Stock Exchange (NYSE) and NASDAQ are well-established and globally recognized, offering access to a wide investor base. The size, liquidity, and prestige of the exchange can impact the company’s profile and attractiveness to investors.

2. Listing Requirements and Regulations: Evaluate the listing requirements and regulations of different stock exchanges. Each exchange has its own set of criteria that companies must meet to qualify for listing. Consider factors such as market capitalization, financial performance, minimum number of shareholders, corporate governance standards, and reporting obligations. Choose an exchange where the company meets the listing requirements and can comply with the associated regulations.

3. Liquidity and Trading Volume: Assess the liquidity and trading volume of stocks on different exchanges. Higher liquidity and trading volume generally indicate a more active market and greater investor interest. A liquid market allows for easier buying and selling of shares, potentially attracting more investors and enhancing the market’s efficiency.

4. Geographical Considerations: Consider the geographical presence and focus of the stock exchange. If the company’s operations and target market are primarily concentrated in a specific region or country, listing on a local stock exchange may provide greater relevance and visibility to local investors. However, listing on a global exchange can offer exposure to international investors and potentially broaden the investor base.

Author

Sami Yaghma

Sami Yaghma

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