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This article aims to provide an understanding of Initial Public Offerings (IPOs), as it covers their definition, reasons for occurrence, process, costs, benefits, and potential technicalities. An IPO is a process through which a privately held company offers its shares to the public for the first time. By doing so, the company becomes publicly traded on a stock exchange, which allows investors to purchase shares and become partial owners of the company.
There are a number of strategic and financial reasons for which IPOs occur. One primary motive for going public is to raise capital to fund further business expansion, research and development, debt repayment, or any other corporate initiatives. IPOs also provide an exit strategy for early investors, founders, or employees who hold equity in the company, as they allow them to monetise their investments. Thirdly, going public enhances a company’s visibility, credibility, and reputation, which can attract customers, partners, and employees. Fourthly, a publicly traded stock can be used as a currency for mergers and acquisitions, as shares can be easily converted into cash (providing flexibility in deal structuring) and publicly traded companies have transparent market valuations (making it easier to negotiate acquisition terms). Lastly, companies that are publicly traded can offer stock options and equity compensation to attract and retain top talent, thus aligning employee interests with shareholder value.
The process of going public involves several steps. Firstly, the company hires investment banks (underwriters) to facilitate the IPO process. The bank will help determine the offering price and structure, and then proceed to market the shares to investors. The company will also conduct due diligence, as it discloses financial information, business operations, risks, and other material information to potential investors. It will then file a registration statement with the Securities and Exchange Commission (the UK equivalent is the FCA), which will contain detailed information about the IPO and the company's business. A roadshow will then be conducted by the company, along with underwriters, to pitch the IPO to institutional investors, analysts, and potential shareholders. Based on market demand and conditions, a price will be set, determining the company’s valuation and the proceeds that it will receive from the IPO. Shares are then allocated to a variety of investors (institutional and retail), with trading beginning on the designated stock exchanged shortly. The company’s ‘proceeds’ will be the total amount of money generated from the sale of its issued shares. For example, if a company offers 5 million shares at an offering price of $15 per share, the total proceeds would equal $75 million and subsequently, this can be used as funds for expansion projects, debt repayment, or other investments.
IPOs entail a number of risks for companies and investors. Going public includes exposure to market volatility, influenced by economic conditions and investor sentiment; this causes abrupt and unpredictable changes in stock value, which can erode investor confidence and cause uncertainty, leading to downward price trends. It also involves greater regulatory scrutiny, encompassing financial reporting and disclosure requirements, adding significant costs. Additionally, shareholder expectations for financial performance and growth can lead to ‘short-termism’ and pressure to prioritise quarterly earnings rather than long-term goals. There are also risks associated with the dilution of control for founders and management, due to public investors gaining influence over corporate decision-making.
IPOs represent a critical milestone in the evolution of a company, as they enable access to capital markets, enhance liquidity, and help to achieve many other strategic objectives. IPOs involve costs and complexities, meaning it is crucial to recognise and understand the risks associated with going public. There is often no way back after going public, as a number of factors make it difficult and impractical for a company to transition back out, such as the need for a majority shareholder approval (which can be challenging to obtain due to differing objectives). By proactively managing these risks, companies can maximise their chances of success when going public and create long-term value.
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