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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.

What are some of the advantages for a company 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.
  • 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.

Public companies often face many new challenges as well

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. 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.
  • 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.

IPO or stay private?

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.

One of the highest profile IPOs of 2017 was Snap Inc (SNAP), best known for their flagship product Snapchat. Despite an initial surge, the stock has been unable to gain much traction with investors during its first year as a public company.

To learn more, see IPO Basics Tutorial, The Murky Waters Of The IPO Market, and Don't Forget To Read The Prospectus!

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