Initial public offerings, or IPOs, are a truly significant benchmark in the life of a company. IPOs are the means by which a company transitions from a private status to a public one, thus enabling it to sell stocks and shares. Doing so translates into the company acquiring increased funds and liquidity: in other words, more money to reinvest in itself or expand.
While the benefits are numerous, the IPO process itself can be laborious and complicated. Successfully taking a company public involves numerous participants, efforts and considerations.
To Go Public, or Not to Go Public?
Going public is not the right move for every company. Organizations must weigh various elements such as company finances, ability to commit to new practices and willingness to submit to new regulations.
Companies are required to meet certain financial requirements before they are even deemed ready for public trading. To be listed on the New York Stock Exchange, for example, companies usually need a total of $10 million in pre-tax earnings over the previous three years, and a minimum of at least $2 million in each of the two most recent years, according to Inc. The Nasdaq Stock Market has similar rules. Companies are required to earn more than $11 million in the prior three fiscal years and more than $2.2 million in each of the two most recent years.
Making the Decision
Finances are not the only consideration with an IPO. Several pros and cons of initiating IPOs are discussed by both PricewaterhouseCoopers (PwC) and CNBC.
Pros of taking a company public:
- Increasing cash and long-term capital. Gaining the ability to sell stocks means more financial liquidity is available to a company. This enables it to reinvest in projects such as infrastructure, business expansion, retiring debt and other endeavors.
- Increasing market value. Publicly traded companies tend to have higher values than private ones.
- Attracting and keeping high-value personnel. The ability to offer stock options can be an attractive perk for potential employees and managers.
- Building merger and acquisition collateral. If the company later decides to merge with or buy another company, stocks may be utilized as payment, thus conserving other monies and assets.
- Improving prestige and reputation. Publicly traded businesses are by and large considered successful. Good public opinion can easily translate into earnings.
Cons of going public:
- Increased and ongoing expenses. Going public is costly. During the IPO process, companies must pay a multitude of fees, including those for underwriting, legal, accounting, Securities and Exchange Commission (SEC) filing, exchange listings and more. Once a company makes the transition, it is also required to regularly report financial information. There are continual expenses associated with this responsibility, such as administrative costs, auditors, investor costs, premiums for liability insurance and more.
- Loss of privacy and control. As previously mentioned, when a company goes public, it is required to regularly report financial information. This can include sensitive information such as position in the marketplace, sales, cash flows, profits, major customers, compensation of higher-level personnel and security holdings of major shareholders. Furthermore, if outside stockholders purchase 50 percent or more of a company’s shares, it is possible for the company to effectively lose control of its operations.
- Performance pressure. Companies that are publicly traded become increasingly accountable to those who invest in them. Failure to create meaningful profit means that the company could ultimately decrease in value and lose investors.
- Practical inability for the company to return to private status. While technically possible, a public company going private is essentially never done, due to the extensive cost and effort.
While taking a company public is not the right choice for every business, those that decide to begin the IPO process follow a particular set of steps in their transition.
The IPO Process Timeline
Although going public can technically take as little as three months, PwC recommends that companies allow the process one to two years before the effective date, or the date a company officially makes its switch. IPOs require the synchronization of numerous participants and moving parts. Providing a substantial window of time sets up a company for a successful transition. The most crucial steps in the IPO process are listed below.
12 months or before effective date
Companies choose an underwriter
Underwriting is the process of raising and securing the funds that allow the company to go forward with its transition. Underwriters are among the most important players in the IPO process. Companies often choose just one underwriter, although several are sometimes used to better mitigate risk. Underwriting can be very competitive, so companies seeking to begin their IPO process do better when they consider a number of factors. Some of these factors include reputation, experience, long-term commitment to the company and success track record, according to the Merrill Corporation.
Underwriters and the company create a registration statement
After selecting an underwriter, a company must work with the underwriter to create a registration statement. This document discusses how much money each party will make in the IPO, identifies business and financial summaries, outlines securities and includes other negotiation details.
6-12 months before effective date
Once a registration statement is written, companies go into a “cooling-off” period. During this time, the company’s financial statements are reviewed by both accountants and independent auditors. Presentations are made to board members. The SEC and the Financial Industry Regulatory Authority (FINRA) also begin their initial involvements during this time. (These are the authorities to which publicly traded companies report). Essentially, the cooling-off period is a time to prepare, review and assess the offering before it is shown to a wider audience.
20 days before effective date
During this time, underwriters perform a “road show,” in which they present the company’s prospectus to potential investors in order to solicit interest. (This prospectus is often called a “red herring,” because while it contains information about the company’s functions and organization, it leaves out key elements, such as the number of shares offered or their price.)
These presentations can be performed either in person or remotely, from anywhere in the world. If investors show interest, underwriters are legally able to sell them shares before the company officially goes public. This is called IPO allocation. Road shows are done exclusively for institutional investors. Individual investors generally do not get access to these opportunities.
1-10 days before effective date
As offering day approaches, most major and minor parts of the IPO continue to move forward. Most notably, this is the time when investment bankers involved with the IPO may place a “tombstone ad.” This is a simple advertisement that tells the public about the new investment prospect.
Offering day is the effective date, or the day a company officially goes public. Many things happen on this day, including:
- The tombstone ad runs.
- The SEC declares the offering effective, and FINRA declares no objections.
- The company’s independent auditor delivers his or her final comfort letter, assuring that the company is financially sound.
- The company executes the underwriting agreement and issues a press release regarding the change.
After effective date
After the IPO is complete, companies and other involved parties still have duties to fulfill. Proceeds of the deal must be collected. Additional documents must be filed, updated and closed.
Companies must also follow a number of ongoing procedures. They must continue to disclose information about their financial status, have shareholder meetings and submit to surveillance by the SEC on their trading practices. They must face the continual challenge of maintaining investor enthusiasm, the loss of which could be seriously problematic for their reputation and revenue.
Business Education for the World of IPOs
Companies that undergo the IPO process require professionals with advanced knowledge of corporate business to steer them toward success. Point Park University’s online Master of Business Administration program provides the rigorous education students need to thrive in the high-impact world of startups and growing companies. PPU’s program covers critical business topics such as ethics, business law and international finance.