The ups and downs of IPOs

Enticed by the recent sharp rise in the share prices of listed companies, owners and partners of private companies see initial public offerings (IPOs) as a way to get rich. Many companies use initial public offerings as a means to increase the amount of financing available to the company and may create billions of dollars for owners in the process.

However, there are many bumps, roundabouts, and dead ends on the road to hope for large amounts of stock market cash. Too many companies think they are ready for the important moments of the New York Stock Exchange or Nasdaq IPO, but they may be far from ready.

Going public-the initial public offering of stocks-can be an effective means for companies to raise capital. However, before carrying out complex, expensive, and time-consuming preparations and taking the related risks, the pros and cons of this must be fully evaluated.

Key points

  • Owners and partners of private companies usually choose to “list” or conduct an initial public offering (IPO).
  • This choice can bring a lot of cash to the company, and it can also bring capital to the owner, but there are disadvantages to an IPO.
  • The IPO brings new funds that companies can use to develop their business without incurring excessive debt, better compensate investors and employees, and provide stock options or other types of compensation.
  • If needed, becoming a public company can also make it easier to raise funds in the future and can make the company more attractive to suppliers and customers.
  • On the downside, the financials of listed companies must be available for inspection by the government and the public; companies must also be accountable to the SEC, and preparing for an IPO is expensive and time-consuming.

Benefits of listing

By injecting cash from the sale of stocks, the company can develop its business without borrowing from traditional sources, thereby avoiding interest payments. This “free” cash for growth plans can ultimately lead to a better bottom line.

The new capital may be used for marketing and advertising, hiring more experienced personnel who need generous compensation, research and development of new products and/or services, renovation or new construction of physical factories, and many other projects to expand business and improve profitability.

As the cash in the company’s treasury increases, additional compensation can be provided to investors, stakeholders, founders and owners, partners, senior managers, and employees participating in equity plans.

Company stocks and stock options can be used as an effective incentive plan. When recruiting talented senior managers, stock options are an attractive incentive. For employees, performance-based stock or option bonus plans are an effective means to increase productivity and manage success. Stocks and options can also be used for other forms of compensation.

Once the company goes public, it can easily sell additional shares to raise funds. Public companies with well-performing stocks often find it easier to borrow money when they need additional funds, and with better interest rates.

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According to FactSet’s data, the number of company IPOs in 2019 was lower than the 274 IPOs in 2018.

Views on listed companies

A listed company may also have more influence when negotiating with suppliers, making it more attractive to customers. This is a key aspect of the business, and a company that keeps supplier costs at a low level may achieve higher profit margins. Clients usually have a better understanding of companies that do all business in major securities trading, which is another advantage compared to private companies. This is mainly due to the fact that listed companies must regularly undergo periodic audits and financial statement reviews.

A public company conveys a positive image (if the business goes well) and attracts high-quality talents at all levels, including senior managers. These companies are growth-oriented, respond to the continuous demands of the board of directors and shareholders to improve profitability, and quickly correct management problems and replace poorly performing senior managers.

Disadvantages of listing

After a company goes public, its finances and almost all related content, including its business operations, will be supervised by the government and the public. Perform regular audits and require quarterly and annual reports. Company financial and other business data are available to the public, which sometimes goes against the company’s interests. Reading these reports carefully can accurately determine the company’s cash flow and credibility, which may not be considered positive.

The company is supervised and regulated by the US Securities and Exchange Commission, including strict disclosure requirements. The information required to be disclosed includes senior management information, including salary, which is often criticized by stakeholders.

Regardless of whether there is a valid reason, the company will be subject to shareholder lawsuits. The lawsuit may be based on allegations of self-dealing or insider trading. They may question executive compensation or question major management decisions. A lawsuit filed by a dissatisfied shareholder can cause costly and time-consuming trouble for the listed company.

Challenges of listed companies

Preparations for an IPO are expensive, complicated and time-consuming. Attorneys, investment bankers, and accountants are required, and external consultants must usually be hired. It may take a year or more to prepare for an IPO. During this period of time, business and market conditions may undergo fundamental changes, and may no longer be a good time for an IPO, making preparations and expenses useless.

The profitability pressure of each quarter is a daunting challenge for the senior management team. Failure to reach the target number or forecast usually results in a drop in stock prices. In addition, falling stock prices will stimulate more dumping, which will further erode the value of stocks.

Before buyers and original holders of IPO shares may liquidate their positions, a lock-up period is usually enforced to prevent immediate selling. During this period, stock prices may fall, resulting in losses. Likewise, during this period, business and market conditions may change, which can damage the stock price.

The timing of the initial public offering is critical: preparations may take a year or more, by which time business and market conditions may change drastically.

Bottom line

From a distance, IPO seems to be a perfect way to make money. A closer look reveals many flaws at a glance. However, these should not prevent the company from going public. If all the pros and cons have been understood and evaluated, and all the inherent risks have been evaluated, if the situation is right, the IPO may bring new and profitable opportunities for companies that are preparing for public trading.

But an IPO is not a guaranteed money-making tool for the company and/or shareholders. Some companies are very disappointed with the price performance of the IPO. Finally, for companies that are currently publicly traded, the opposite move—privatizing a listed company—may ultimately prove more profitable than an IPO.

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