Going Public: Detailed Explanation, Process, and Implications

August 24, 2024 4 min read Economics Finance IPO Stock Market Investments Corporate Finance Public Companies

An in-depth look at the process of going public, how it works, and its implications for companies and investors.

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Going public is the process by which a privately held company offers its shares to the general public for the first time. This procedure typically involves the company selling its existing shares or issuing new shares to new investors in an initial public offering (IPO). The transition from a private to a public entity significantly impacts the company’s structure, governance, and financial strategy.

The Process of Going Public

Initial Preparation

Before a company can go public, it must undertake considerable preparation, which includes the following steps:

Internal Audit and Compliance: Ensuring all financial records are in order and align with regulatory standards.
Corporate Governance: Establishing a robust governance framework that includes appointing a board of directors and defining the roles and responsibilities of executives.
Valuation: Working with financial advisors and underwriters to assess the company’s value.

Working with Underwriters

The company selected bankers, commonly referred to as underwriters, play a crucial role in the IPO:

Due Diligence: Perform a thorough check on the company’s business model, financial health, and market potential.
Regulatory Filings: The preparation and submission of necessary documents to regulatory authorities, such as the SEC in the United States.
Pricing: Establishing the share price and the number of shares to be offered.

Marketing the IPO

The company and its underwriters engage in a “roadshow” to market the IPO to potential institutional investors. During this period, the company’s management presents its business strategy, growth potential, and financial performance.

Finalizing the IPO

On the day of the IPO, the company’s shares are listed on a stock exchange. Investors can now buy shares directly from the market, effectively providing the company with new capital to fuel growth and expansion.

Implications of Going Public

Advantages

Capital Access: Going public provides companies access to a massive pool of capital, which can be used for expansion, debt reduction, or new projects.
Increased Visibility: Public companies often receive more media coverage, increasing their brand recognition and market credibility.
Stock Liquidity: Shares become more liquid, offering shareholders the opportunity to sell their shares more easily.

Disadvantages

Regulatory Scrutiny: Public companies are subject to stricter regulatory requirements and must provide regular financial disclosures.
Market Pressure: The need to meet quarterly earnings expectations can result in short-term decision-making that might not align with the company’s long-term vision.
Cost: The IPO process is expensive and includes underwriting fees, legal charges, and increased administrative expenses.

Historical Context and Examples

Going public has a storied history, with some notable examples shaping the market:

Ford Motor Company (1956): Transitioned from a private firm to a publicly traded one to diversify its ownership.
Google (2004) and Facebook (2012): Their IPOs are among the most significant in technology history, significantly impacting the stock market.

Applicability

Public offerings are not limited to large corporations; small and medium-sized enterprises (SMEs) can also consider IPOs as a means to raise capital and formalize their growth strategies. However, SMEs must weigh the benefits against the costs and regulatory burdens.

Comparisons

Direct Listing vs. Traditional IPO: Unlike a traditional IPO, a direct listing allows companies to list their shares without issuing new ones or raising capital. This method has gained popularity among tech firms like Spotify and Slack.
Special Purpose Acquisition Companies (SPACs): These are shell companies that raise funds through an IPO to acquire or merge with existing firms, offering a less conventional route to going public.

Public Company: A company whose shares are publicly traded.
Prospectus: A legal document issued by companies going public, detailing their business strategy, finances, and risks.
Underwriter: Financial specialists who manage and guarantee the underwriting process during an IPO.

FAQs

Why do companies go public?

Companies go public to raise capital for growth, increase their market presence, and provide liquidity to their shareholders.

What are the risks involved in going public?

Companies face compliance costs, increased market scrutiny, and the pressure to meet quarterly financial expectations, which can sometimes lead to short-term decision-making.

How does an IPO affect existing shareholders?

Existing shareholders can benefit from the increased liquidity and potential appreciation of their shares but may also face dilution if new shares are issued.

References

Loughran, T., & Ritter, J. (2004). “Why Has IPO Underpricing Changed Over Time?” Financial Management, 33(3), 5-37.
Pagano, M., Panetta, F., & Zingales, L. (1998). “Why Do Companies Go Public? An Empirical Analysis?” The Journal of Finance, 53(1), 27-64.

Summary

Going public is a transformative process for a company, offering both substantial benefits and significant challenges. Understanding the intricate details of this process, from preparation to post-IPO implications, is essential for companies considering this path and for investors looking to participate in an IPO. With proper planning and strategic execution, going public can serve as a pivotal step in a company’s growth trajectory.