Private companies go public in order to generate capital to help further their growth, reduce debt, or fund other business operations. Going from a private company to a public one, known as an initial public offering (IPO), comes with both advantages and disadvantages and may not be the right move for every company.
- In order to become an IPO, a company must be able to pay for the generation of financial reporting documents, audit fees, investor relations 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.
The Pros And Cons Of A Company Going Public
Advantages and 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 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.
If a company wants to raise more capital sometime after an IPO, it can do a secondary public offering; offering new shares to investors.
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.
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.
One high-profile company that plunged following its IPO is Snap Inc (SNAP), best known for its flagship product Snapchat. The company raised $3.4 billion in March 2017.
Despite an initial surge above its $17 IPO price, the stock struggled to hold onto those gains. In its first quarterly report as a public company, Snap reported disappointing user growth figures. In May 2017, investors sued, alleging the company had made "materially false and misleading" statements regarding user growth. Snap settled for $187.5 million in January 2020.
Why Would a Company Not Want to Go Public?
A company may choose not to go public for many reasons. These reasons include the tedious and costly task of an IPO, the founders having to give up total control, and the need for more stringent reporting to comply with SEC rules.
When a Company Goes Public, Who Gets the Money?
When a company goes public, the company initially gets all of the money raised through the IPO. When the shares trade on a stock exchange after the IPO, the company does not get any of that money. That is money that is exchanged between investors through the buying and selling of shares on the exchange.
Is It Better for a Company to Be Public or Private?
Whether it is better for a company to be public or private will depend on the specific company and the goals of its founders. Remaining private allows the founders to run the company as they wish and not have to meet the many regulatory requirements of being a public company. Going public allows a company to raise significant capital and grow the business. At the end of the day, the best decision is that which is best for the founders and their vision of the company.
The Bottom Line
Taking a private company public raises capital so that a business can fund its growth or use the money for other business needs. It is a common step for many companies that grow out of the start-up phase.
Though taking a company does bring in more capital, there are also significant drawbacks. These include the time-consuming process of an IPO, ensuring the company meets strict regulatory rules, giving up complete ownership and total control, and being under the scrutiny of the public and investors.
It's important to weigh the pros and cons and have a vision for what the founders want the company to be before deciding to go public.