Why Do Companies Go Public: Merits and Demerits
Created on 14 Jan 2021
Wraps up in 6 Min
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Updated on 07 Sep 2022
Suppose you have started a company with a few of your friends as the shareholders. The profit and loss of the company are shared among all these shareholders. As the company continues to grow and has bigger growth potential, any company’s founder would wish to expand its business even bigger, enter new markets, invest in a major R&D idea, product diversification, amalgamation and acquisition, etc. To achieve these greater goals, the company will require a huge capital investment.
A company cannot rely on bank loans every time it needs funds due to reasons mostly concerned with heavy interest rates. Hence, going public by issuing its IPO is a more suited alternative for the company to expand its market capitalization.
By going public, a company gains several advantages along with a few setbacks. Let’s have a detailed look at why private companies decide to become public companies.
Reasons why companies decide to go public
Going public helps the company to raise fresh capital quickly, by creating hype and publicity in the market. A private company going public can suddenly have investors from all around the world. Additionally, announcing the offer of shares to the public is always a good way to attract quality employees to the company as well.
Thus, going public can bring about a lot of merits for a company. Let’s have a detailed look at the advantages that a private company can get by going public:
A cost-efficient way to raise capital
A private company gets its funds from private parties like funds from its stockholders, venture capitalists, investors, etc. for projects and operations. While this can help it to get started, the company may reach a stage where it requires a huge infusion of capital to expand, scale-up operations to a wider range of services, and various other reasons based on the sector and the company’s performance.
Initially, to gather these funds, the company approaches its shareholders and investors first. However, in case the shareholders are unable to provide the required funds, the company starts looking at alternative options.
While banks are usually the primary choice, a company cannot rely on bank loans all the time as the interest rates can hurt its finances.
The other option a company has, without going into debt, is by going public to raise the required capital, which is known as the Initial Public Offering.
Going public means the company will have to reveal all its financial information to the SEBI (Stock Exchange Board of India). And SEBI will put that information on their official website to keep the transparency for investors. This option is a cost-efficient way to raise fresh capital.
Enhance the visibility and credibility of the company
SEBI regulates the share market and has laid down some conditions to allow companies to go public. Hence, if a company is going public for the first time, investors can be sure that the company has passed SEBI’s requirements and is hence a transparent and strong company. This helps improve the company’s overall credibility.
Improving liquidity and boosting profitability for existing shareholders
Suppose a private company has a limited number of shareholders to invest capital to keep the business running. As the company establishes and starts growing the business in the market over the years, the shareholders start earning profits.
However, in this situation, while a company’s goodwill can be earned in the market, it cannot be monetized until the company goes public. Once a company issues shares, the market price of the company’s shares will depend on the investor’s perception of the company’s performance.
Hence, if the company has a good presence and positive brand image in the market, existing shareholders can earn more profits for their existing shares in the company, thus boosting liquidity for existing shareholders.
Boost company’s market presence
IPOs are launched every month by several companies and gain attention from the public, but in many instances, investors are uninformed of the company launching the IPO and hear about it for the first time during the launch period.
As the company promotes and advertises its public offer, investors start researching the company, reading up on its business and financials, etc. This helps to give a boost in the market presence of the company and also helps to grow its business.
Advantages to the Investors Investing in IPOs
Let’s take a look at the benefits that the investors investing in IPOs can receive:
- IPOs have the potential to offer higher returns in the long-run as they are considered to be equity investments.
- When a company issues its shares to the public, investing in an IPO allows the investors to become a part of the company’s growth.
- IPOs usually have more transparency than any other investment instruments, as all potential investors can access all the necessary information about the company.
- As the shares are being introduced by the company in the market for the first time, the price of the share will be unaffected by the market demand. If an investor researched the company well, then it might be an opportunity for the investor to earn short-term gains as well as long term gains.
While there are various other benefits of IPO to investors, access to good quality unlisted stocks is the key reason behind IPOs being a popular investment instrument among investors.
Drawbacks of Going Public Faced by the Company
For a company, offering an IPO can bring enough funds to pay off its liabilities or fuel an expansion. An IPO also brings about lots of hype and publicity to the company.
Going public has many advantages, but it’s not all rainbows and unicorns for the company. Here are some drawbacks of going public, that the company offering the IPO might face:
Involves huge costs
IPOs do not come cheap. It includes the cost of legal fees, underwriting charges, accounting costs, advertisement costs, registration fees, etc. Companies also need to hire professionals who are specialized in the IPO process. Hence, the IPO process costs a lot to the company.
In 2012, the Wall Street Journal” reported that most small businesses prefer to use credit cards or bank loans to raise funds.
Reduces privacy and potential loss of control over the company
When a company is private, that means the majority of its shareholders hold control of the company’s business and projects. Once the company goes public, there is a possibility that this control might be lost.
To maintain their control over the company, shareholders ensure that they hold on to the majority of shares. But a small group of shareholders may influence the decision-making process.
Timely Financial Reporting
Once a company goes public, its information and data will also be made available to the public. Due to this, the company’s compliance requirements increases, and periodic audits and publishing of financial reports each quarter are also required.
Additionally, the company needs to ensure that the financial reports meet SEBIs requirements; otherwise, it can bring on inception from shareholders, which sometimes results in shareholder lawsuits.
Forces the company to focus on short-term growth
When investors invest in the company’s IPO, investors expect it to perform well. Every investor wishes to earn higher returns on their investment within a short period. If the company fails to do so, that might change the investor’s perception into negative, which will eventually affect the stock price and sales too.
Hence, to meet the investor’s expectations, a company sometimes pays more attention to short-term growth, which can further affect its long term goals.
When a company goes public and offers its IPO, it has a lot to gain. While a company with strong fundamentals can gain several benefits by going public, on the other hand, a company with weaker fundamentals might have to face several drawbacks.
Hence, it is the responsibility of every shareholder to evaluate every angle of this transition. For investors, IPOs come with a host of advantages and disadvantages. So if you are considering investing in an IPO, be careful to consider all of the advantages and disadvantages, be patient, and consider all of your alternatives before making a decision.
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