Initial Public Offering Guide: Pros and Cons of an IPO

An initial public offering (IPO) is a limited sale of shares in a company that is transitioning from private ownership to public ownership. Institutional investors (such as pension funds and mutual funds) tend to buy the bulk of IPO shares, but public investors also buy shares during the IPO stage.

Some time after the IPO process concludes, the company begins its first day of trading on public exchanges such as the New York Stock Exchange and NASDAQ. From this point onward, the company's stock is on the open market, available to anyone from exchange-traded funds (ETFs) to Wall Street hedge funds to individual private investors who purchase shares through a brokerage.

When a company goes public, it must engage in a thorough IPO process before listing shares on the stock market.

1. 1. The pre-IPO: Before a company goes from private to public, it tends to be funded by a mixture of revenue and investment from venture capitalists and private equity funds. During this time, it may have stockholders, but the company's shares are not available to the general public.
2. 2. Due diligence: As a company prepares for the public market, it must disclose a great deal of financial information. Its financial statements and business records are presented to investment banks interested in underwriting the IPO.
3. 3. Underwriting: The company selects its underwriters—the financial institutions that will guarantee the value of the company to potential investors. Some investment banks have built an entire business model underwriting IPOs. Other underwriters may include a certified public accountant (CPA), lawyers, and financial professionals versed in the Securities and Exchange Commission (SEC), which oversees America's stock markets.
4. 4. Filing documents: Before issuing IPO stocks, the company files an S-1 Registration Statement with the SEC. Form S-1 contains a prospectus for the general public and additional private documents that will only be viewed by regulators.
5. 5. Marketing: The company begins marketing its forthcoming IPO in a process sometimes known as a roadshow. The goal is to drive up interest from large funds and individual investors in hopes of setting a high valuation and IPO price.
6. 6. Formation of a board: A publicly traded company must have a board of directors that oversees its management team. At this stage in the IPO process, board members are announced. A strong team can further increase the share price.
7. 7. Setting a date: With underwriters lined up, financial statements filed with the SEC, and a board of directors in place, the company sets an IPO date. Traditionally, IPO dates are somewhat fungible. The company will set an offering price, but if that price does not match outside parties' valuation, the IPO can be delayed. Companies want to succeed the first time they announce an IPO, but if they fear disappointing results, they can always pull back from the public market until a later date.

For a growing company, an IPO offers many advantages over staying private. These include:

1. 1. Access to capital: A company may never receive an injection of cash larger than what it yields in an IPO. An ambitious startup can enter a new era of financial solvency following its initial public offering.
2. 2. Future trading: Issuing new shares of a public company tends to be simpler than buying and selling equity in a private company.
3. 3. Increased prominence: Publicly traded companies tend to be better known than their private competitors. Staging a successful IPO also brings publicity in financial media.
4. 4. Greater flexibility: With an increase in cash, companies can spend more money hiring topflight talent and investing in fixed acquisitions.

Despite many benefits, initial public offerings are not a perfect solution for all companies. Their drawbacks include:

1. 1. Diminished autonomy: Public companies are not governed by their CEO or president; they are governed by a board of directors, which is directly accountable to shareholders. While the board empowers a management team to lead day-to-day operations of the company, they have ultimate authority and can undermine CEOs—even CEOs who founded the company. Some businesses get around this by going public in a way that guarantees veto power to their founder.
2. 2. Increased initial costs: The IPO process is expensive, as investment bankers and accountants charge top dollar for their services.
3. 3. Increased administrative work: Public companies must keep their financial records open to the SEC and the general public. This requires a massive investment in accounting personnel and software, which are ongoing expenses.
4. 4. Added pressure to show results: Publicly traded companies face intense pressure to keep their stock prices high in the face of market volatility. Executives may not be able to make bold moves if such moves negatively impact stock pricing. This sometimes shelves long-term planning in favor of short term gains.

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