In our last post, What is an IPO?, we outlined the basics of a public listing, however the first question you may ask is why a company would want to go public. Many private companies succeed remarkably well as privately owned enterprises. Some of the most well-known businesses in the world, such as Dell Computers and Mars Confectionery, are privately held. Firms have to weigh up the benefits and drawbacks of a public listing before deciding to undertake an IPO.
What are the advantages?
The primary reason for going through the rigours of an IPO is to raise capital to fund the growth of a company, however, it is not the only reason. Often, existing stakeholders of a company may simply wish to cash out, either partially or entirely, by selling their ownership in the firm. Thus, as a means of exiting, they will sell shares in the IPO and get cash for their equity in the firm.
“When a company decides to go public, it takes a giant leap toward growing its enterprise. You stimulate innovation, entrepreneurship and job creation.” - Tom Farley, President NYSE Group
‘Going public’ gives firms the ability to easily raise further capital through the public markets. Once public, subsequent issues of shares can be done in a fast and cost effective manner. Furthermore, due to the higher requirements for disclosure and transparency, firms can often obtain far more favourable terms when accessing loans. A public listing increases the company’s ability to make acquisitions by providing a liquid ‘currency’ - the company’s shares. Going through the IPO process can also heighten a company’s prestige, brand image and credibility.
What are the pitfalls?
The IPO process is a costly, and time-consuming procedure due to the many parties involved including legal and financial advisors. In addition to the costs of the IPO, there are ongoing costs of maintaining a listing such as NZX annual fees, which can be over $60,000, as well as the increased costs of meeting the higher compliance and disclosure requirements. Another concern is when a public listing causes short-termism, whereby managers hold their share price and short-term financial results as their highest concern. Short-termism can have highly detrimental effects when it causes irrational and irresponsible conduct that disregards the long-term impact of decisions. The pursuit of short-term gains can come at the expense of long-term sustainability.
“Significant pressure exists to increase profits each period and to meet analysts’ expectations and this pressure may cause management to emphasise near-term strategies instead of longer-term goals” - Garner, Owen and Conway, 1994
The IPO procedure itself is highly distracting for the management of the company, and means they are not focusing on the ongoing running of the business. Being public can also limit their freedom to act, as they require board and shareholder approval on many major matters, and are heavily influenced my shareholder pressure and market sentiment.
Next up in our investor series, we’ll outline the basics of valuing a business, stepping you through the tools expert investors would use in deciding whether to part with their cash. Catch you next time.