Introduction –

IPO (Initial Public Offering) is an essential event for those companies that are looking for a transition from private ownership to public ownership. This event indicates the first time that a company is offering its shares to the public. It can allow businesses to raise the required amount of capital money from investors to expand their business operations. Companies can also increase their financial growth rates by going public. This process involves a proper scrutinizing of the regulatory measures, costs, and market pressure. This article includes the proper definition of this process, its necessity, working procedure, advantages, and challenges.

Definition And Key Concepts –

IPO occurs when a company willingly sells its shares for the first time to the public. This will help in the process of transitioning the particular company from a private entity to a publicly traded entity in the market. This process will also help companies access capital investment markets and investors to raise funds for business expansion, paying off debts, or investing in business growth opportunities.
In this due process, these companies must fulfill the requirements laid out by the exchanges and the SEC (Securities and Exchange Commission) to hold an IPO. The companies can hire investment institutions to market, access demand set the price and date of the IPO, and many more. Also, an initial public offering can be noticed as an exit strategy for the founders and early investors of the company by releasing their full amount of profit from their private investment fund.
Normally, this particular transition phase from a private to a public entity is a crucial period for private investors to cash in and make a good level of profit returns that they were expecting. However, the private shareholders might hold on to their particular shares in the public market and may even sell a particular portion or all of them to achieve profits.
This event is performed by a team of professionals, including legal advisors, accountants, executives, and underwriters (from large investment banks). The underwriters have a crucial role in managing the entire process starting from defining the price and timing of the shares to marketing the share offerings to potential institutional investors. They will conduct due diligence to help with regulatory reports and manage the process of developing an interest in the stock. Once this offering is approved by related regulatory bodies, they will schedule the public sale of these shares on a stock exchange platform.

Why is Initial Public Offering Important?

A public offering is a strategic procedure for those companies that are looking forward to enhancing their growth and gaining long-term financial stability. Some of the major reasons why a company will opt for a public offering are explained in the below list:

Raising Capital Growth is a significant reason why companies go public. It will help them to access capital money. By selling the company’s shares to the public, they can collect a large amount of money. When compared to private funding procedures that mostly come with several restrictions, the capital fund collected through an IPO is more flexible and can be used for a wide variety of business purposes.

Companies will mostly use this money for – expanding operations, (such as opening new branches or entering new markets), funding the research and development section for developing new products or services, paying off existing debts to improve the company’s balance sheet, and investing in acquisition deals or other partnerships to improve the company’s market share.

Enhancing Visibility and Credibility of the Company – The company’s visibility and credibility are significantly increased when it is listed on several major stock exchanges such as the New York Stock Exchange (NYSE). This public offering will generate a public profile that can help attract more investors, business partners, and even more customers. For instance, most of the suppliers feel more confident in doing business with a publicly listed company because of the transparency and regulatory management.
Providing Liquidity for Founders and Early Investors – A public offering initiative will create a market for the shares of the company and allow early investors such as venture capitalists, founders, and employees to sell their holdings. This is one of the primary reasons why companies go public. It provides liquidity for the business stakeholders who have invested many years ago and might want to realize their profits at present.
Company Reputation and Leadership in the Market – When the company is publicly traded, it often indicates several qualities such as enhanced maturity, stability, and leadership in the market. It can also show the public, competitors, and potential clients that the company is well-established and trustworthy in the industry. In the case of industries where reputation plays a vital role, going public will also provide several competitive advantages.
Using Stock as Acquisition Currency Form for Merger and Acquisition – Once a firm goes public, the stock of that firm can then become currency for transactions related to its M and A. In other words, a firm can acquire other firms by issuing its shares as acquisition currency instead of using cash currency. This fluidity will also boost the expansion strategy of the company and allow it to gain a competitive advantage in the market.
Attracting and Maintaining Talent – Public companies can offer stock-based compensation rates such as stock options or restricted stock units (RSUs). This can be included in their employee benefits package. This is particularly attractive to those employees working in the tech and other growth-related industries since they can share in the success rate of the company. Certain levels of stock incentives may also be used as a good tool in attracting and maintaining many top-talent employees within a company in the presence of a competitive market.

Working Process of an IPO –

The entire process of an Initial Public Offering is highly complex and involves many steps to ensure that a company conducts its transitions very smoothly from private to public ownership. The below section has been provided to give an overview of the key stages involved in the entire process:

1. Decision to Go Public – The first step in the process is a strategic decision to go public made by the leadership personnel (board of directors, founders, and executives) of the company. This decision is generally based on the requirement for capital money, expansion goals of the business, or providing liquidity for early investors.

2. Selection of Underwriters – The company will then hire underwriters, normally investment banks, to guide through the IPO process. Underwriters will help the company manage the offering procedure, price the company’s shares, and ensure that the company meets all the essential regulatory requirements. The most common underwriters in the industry include top investment banks such as Morgan Stanley, Goldman Sachs, and JP Morgan.

3. Due Diligence and Regulatory Reporting – The company with its legal team and underwriters will now start preparing for the offering procedure by going through an exhaustive due diligence process. This involves preparing disclosure documents, auditing financial records, and drafting a prospectus.

A prospectus refers to a company document that detailed information about a company, along with its financial position, inherent risks, and business plans; it is submitted before the regulatory authorities. The latter review these papers to ensure proper transparency and accordance with regulations in place and allows potential investors the opportunity to decide accordingly.

4. Determining the Terms of the Initial Public Offering – The underwriters and the issuing company will decide several important factors, such as the number of shares to be offered and the offering price range. The number of shares offered depends on the amount of capital money the issuing company wants to raise. Underwriters propose a price range for the shares depending upon the financial performance of the company, valuation, and prevailing market conditions.

5. Marketing– The underwriters along with the company‘s leadership team will undergo a process of publicity, in order to present the business in an appealing manner to potential institutional investors like mutual funds and hedge funds. Marketing is crucial in developing interest in the offering and setting the final price for the shares. The underwriters receive the feedback from the investors to estimate the market’s level of interest.

6. Pricing Phase – In this phase, the company team and underwriters decide the final offer price and the exact number of shares that they intend to be issued. This price is usually influenced by the financial health of the company, demand in the market, and overall market conditions.

7. Going Public – After the final price is decided, the company will go public. The company will now officially become public. The shares are then open to the public, and the stock will be available for trade on the chosen stock exchange platform. Generally, on the first day of trading the market activity will determine if the stock opens at or above the price offered.

8. Post-IPO Stage – After accomplishing the successful completion of above stages, a company will then become publicly listed. This entails that the company would have to address regulatory requirements in order to act as a typical public company. These requirements incorporate quarterly and yearly reporting, disclosure about significant events; managing relationships of new public shareholders, and adherence to relevant market pressures to suit the expectations from the investors side.

Challenges Related to IPO –

IPO benefits a firm in many aspects, but there are several significant problems associated with it. Here, we have listed some of the major issues related to the whole process:

1. The major issue of the public offering is that the level of financial cost is pretty high. They are typically presented in terms of underwriting fees, legal and accounting fees, and compliance costs. The general rule in the investment banking is that it will charge large amounts of fees for handling the entire process. It normally falls within 5-7% of the overall amount of funds that the company raises.

2. Then, there are costs in preparation for an offering. It requires the company to hire financial, legal, and accounting experts to ensure that the company adheres to regulatory requirements. After publicization, companies will have to face continued expenses and costs to maintain this compliance and file regular reports and audits.

3. Regulatory requirements are abundant throughout the entire process of an initial public offering. The government bodies clearly regulate the company’s operations after going public. All this will require several detailed financial statements, disclosing the details about the major risks facing the company and other company operations, to be presented with rigorous reporting guidelines. If an organization is not following these laws, they face intense penalties and it may further bring some degree of damage to the company’s reputation also. The other most frequent issue at stake is the greater public scrutiny. Once an organization becomes public, they need to report its financial performance along with any kind of material changes in their entire business. This transparency in the procedure might make the company face severe scrutiny from the regulators, public, investors, and competitors. In addition, the reports about earnings are closely analyzed every quarter. Any failure in meeting these expectations will lead to the volatility of the stock price and negative media coverage about the company.

4. The loss of control is also another frequently seen challenge in the public offering. It generally results in a dilution process of ownership for the founders and early investors. Once the companies are public, decision-making authority is usually shared with the board of directors and large shareholders. Public shareholders will mostly have a significant opinion concerning the policies and strategic decisions of the company. This may even bring along the disagreement of the company management and investors.

5. Pressure caused by short-term performance- There is always pressure on publicly traded companies to deliver financial results at a significantly high level in the quarterly releases. Therefore, such pressure may result in an obsession by long-term strategies by favoring the short-term profit levels. Managers and top-level officials of the company might also be compelled to take decisions that can create great business revenues but do not fall under the right perspective concerning the growth of the company in the long run.

6. Market fluctuations and the volatile nature of the stock prices is the other frequent challenge. The stock market is said to be extremely unpredictable. Also, the stock price of the company may fluctuate with factors like political instability, macroeconomic condition, industry trends, and market sentiments. This will inevitably affect the company valuation process, making it difficult to have growth strategies in the long run. At times, the stock price may remain at a low in case the company is doing well.

7. Another potential issue is the distraction from company management. The offering process requires a large amount of time and effort from the side of the company’s management team. This can be a distraction running the day-to-day activities of the business. Even after the offering process is completed, a management team needs to dedicate its time to meeting its regulatory requirements, to manage the relations with investors, and to conduct its meetings with shareholders.

Conclusion –

Being a publicly traded company would strengthen the brand value, increase market influence, and open up new strategic business opportunities. Though it presents many critical challenges like regulatory scrutiny, pressure in the market, as well as other market demands of being a public company, companies must consider the costs and responsibilities that come along with going public. For those businesses that have prepared well and set up a solid plan, this public offering can be an effective and powerful means to speed up its growth and confirm its position in the market. In a nutshell, the initial public offering will be deemed as a critical change for a company that will provide it with considerable amounts of money, more visibility, and new opportunities for growing businesses.

FAQs –

1. What are the alternatives to IPO?

Several other alternatives for a company to go public and help them achieve similar goals are:

Special Purpose Acquisition Company (SPAC)
Direct Listings
Venture Capital (VC)
Debt Financing
Private Equity
Private Placement
Strategic Acquisition or Merger

2. What are the advantages of an IPO?

Increased liquidity is an advantage where the publicly traded shares become more liquid. It means that the companies can be easily bought or sold by investors.
Another accrual factor of Acquisition Currency; the company can use its publicly traded shares as its form of currency in several transaction deals such as acquisition of other companies.
Access to Capital is a major benefit. The public offerings can raise a significant amount of funds and sometimes even more than accessed by other methods like private equity or venture capital.
Employee Incentives are an added bonus to the initial public offering. The company can easily issue stock-based compensation. This might also help in attracting and retaining a talented workforce.
Increased prestige levels are a common advantage. Being listed on a major exchange platform will raise the stature of the company and enhance its reputation.

3. What is a lock-up period in an IPO?

Lock-up period is a special period of time (usually from 90 days to 180 days) after the process of initial offering wherein the inside people of the company such as its founders and early investors are restricted from selling shares that they own. This will prevent sudden inflow of the shares into the market since it could affect the stock price negatively.

4. Will the price of an IPO change after the Initial Offering Procedure?

Yes, the price can change after the initial offering. Once the company begins trading on the stock exchange, the stock price can swing based on investor sentiment, market demand, and overall market conditions. The initial offering price is set during the procedure, but various market factors will make the price go up or down post-offering.

5. How long does the Initial Public Offering process take?

The process as a whole can take time from 6 months to over a year. However, it depends on the company’s willingness, market conditions, and regulatory timelines. It will also include multiple stages of the offering procedure which are preparation, filing, marketing, and final approval before the company goes for public trading.

IPO: Definition, Significance, Process, And Challenges