While some large and successful companies are still privately-owned, many firms aspire to become publicly-owned. They intend to gain access to another source of funds for operations. An initial public offering (IPO) represents a private company's first offering of its equity to public investors. This process is generally considered to be very intensive, and it includes many regulatory hurdles to jump over. The formal process to produce the IPO is well-documented and structured. However, the transformational process through which a company changes from a private to a public firm is more complicated.

KEY TAKEAWAYS

  • The first stage, the pre-IPO transformation, is a restructuring phase when a private company sets the groundwork for becoming publicly-traded.
  • The second stage, the IPO transaction, usually takes place right before the shares are sold.
  • The third stage, the post-IPO period, involves the execution of the promises and business strategies the company committed to in the preceding steps.

A company goes through a three-part IPO transformation process: a pre-IPO transformation phase, an IPO transaction phase, and a post-IPO transaction phase.

1. Pre-IPO Transformation Stage

The pre-IPO transformation stage is a restructuring phase when a private company sets the groundwork for becoming publicly-traded. Since the main focus of public companies is to maximize shareholder value, the company should acquire management that has experience doing that. Furthermore, companies should reexamine their organizational processes and policies. They must make the necessary changes to enhance the company's corporate governance and transparency. Most importantly, the company needs to develop and articulate an effective growth and business strategy. Such a strategy can persuade potential investors that the company is likely to become more profitable in the future. On average, this phase usually takes around two years to complete.

The pre-IPO transformation stage can be especially difficult for the founders of the company. In some cases, they have never been involved with a publicly-traded company before. As significant shareholders of a private company, the founders are used to running the business their own way. The founders may have dealt with venture capital funds on their way up. However, the ways that venture capital funds value startups are quite different from the stock market.

2. IPO Transaction Stage

The IPO transaction stage usually takes place right before the shares are sold. This phase involves achieving goals that should enhance the initial valuation of the firm. The critical part of this step is maximizing investor confidence and credibility to ensure the issue will be successful. For example, companies can choose to have reputable accounting and law firms handle the formal paperwork associated with the filing. These actions are designed to prove to potential investors the company is willing to spend a little extra. That can help to ensure the IPO goes according to plan.

The IPO transaction stage is where expectations often collide with reality, and the IPO can even fail. Before going public, successful firms and their management often receive glowing press reviews and rising valuations from analysts. As the IPO approaches, it becomes necessary to find investors who are willing to pay what the company is supposedly worth. While some IPOs, such as Uber, face difficulties, others fail entirely. For example, WeWork's IPO was canceled shortly before the firm was supposed to go public. It was becoming clear that the market would not pay anywhere near what analysts had claimed WeWork was worth.

The IPO transaction stage is where expectations often collide with reality, and the IPO can even fail.

3. Post-IPO Transaction Stage

The post-IPO transaction stage involves the execution of the promises and business strategies the company committed to in the preceding steps. The company should not strive to meet expectations, but rather, beat them. Companies that frequently beat earnings estimates or guidance are usually financially rewarded for their efforts. This stage is typically very long because this is the point in time when companies have to prove to the market that they are strong performers for the long-run.

Although less stressful than the IPO itself, the firm's management must learn to deal with stock price fluctuations in the post-IPO transaction stage. Private valuations arrived at by analysts often show steady progress. Every stock goes down as well as up at some point. When that happens, the company must learn to deal with a narrative that they do not control and relentless negative press.