Why Do Companies Go Public?
As per an Outlook India report, FY 2022-23 saw 37 companies going public and raising a mammoth ₹ 52,116 Cr from the market. This is despite the ongoing surge in global inflation rates and market slowdowns being observed across the major economies of the world. The previous year had set the IPO record in India with almost double the amount mobilised by new companies going public. With so many IPOs being launched, naturally, it warrants the question – why do companies go public? What are the key reasons for doing so, and how do they benefit from it? In this article, we answer this question and explain the associated factors that influence a company's decision.
What does ‘going public’ mean?
Before we dive into the reasons for a company going public, let's first understand what the term means. Going public is the ultimate culmination of the years of efforts and toil put in by the founders, employees, and promoters of a company. It is a significant milestone for any company, marking its transition from a private to a public entity. The process, though, can be rather complex and arduous involving several layers of legal and financial considerations. However, the benefits of going public often outweigh the costs and challenges, making it an attractive option for many companies and startups.
The most straightforward route for a company to go public is by launching an Initial Public Offering (IPO) through which it offers its shares to the public for the first time. The process begins with a company hiring an investment bank to underwrite the offering and sell the shares to the public. Thereafter, there are a variety of legal and financial requirements that need to be met, including preparing an offering prospectus known as a Draft Red Herring Prospectus (DRHP), filing with the Securities and Exchange Board of India (SEBI), and complying with ongoing regulatory requirements.
Upon successfully meeting all the criteria and after the shares are sold, the company becomes a public entity, and the shares can be traded on a public stock exchange, such as the NSE or the BSE.
Why do companies go public?
So, why do companies go for an IPO? What’s in it for them and how do they benefit? There are several reasons for this and advantages of a company going public. Here are a few of the prominent ones:-
Access to capitalThe opportunity to raise a sizable quantity of capital is one of the most important benefits of a company going public. By offering shares to the general public, a company can generate funds quickly and easily without turning to conventional bank loans or other types of debt financing.
If an IPO is oversubscribed, it means that there is more demand for shares than there are shares available. This heightened demand-to-supply ratio results in a higher price for the shares, which results in bringing in more money for the business.
Moreover, going public also gives businesses access to a bigger investor base, including institutional investors like mutual funds and pension funds, who are frequently prohibited from funding private companies. Having more access to money may help businesses develop and expand by enabling them to make investments in new products, services, or markets.
Liquidity for existing shareholdersGoing public provides liquidity for existing shareholders. Prior to going public, the shares of a private company are often illiquid, meaning that they cannot be easily bought or sold. This lack of liquidity can be a major barrier for investors looking to exit their investments or for employees seeking to monetize their stock options.
A company's shares can be traded on a public stock market once it becomes public, providing liquidity for existing shareholders. This may be especially useful for early investors who want to cash out their money and see a return on their investment, such as venture capitalists.
Ability to use stock as currency for acquisitionsAnother reason for ‘why would a company go public’ is that it gives them the ability to use their stock as currency for acquisitions. By issuing shares to acquire other companies, public companies can grow faster and more efficiently than private companies that rely on cash or debt financing.
Target firms, too, may find it appealing to use stock as payment for acquisitions as it enables them to share in the success and growth of the acquiring firm. Furthermore, because the shares issued as part of the acquisition are frequently exempt from immediate capital gains taxes, using stock as currency can be a tax-efficient way to structure M&A deals.
Enhanced public profile and prestigeGoing public can also increase a company's public awareness and prestige. The IPO process generates a lot of media attention, which can help raise the company's profile and attract new customers, employees, and partners.
Moreover, being a public company is often seen as a symbol of success and legitimacy, which can enhance the company's reputation and credibility in the eyes of stakeholders, such as investors, customers, and employees.
Ability to attract top talent with stock optionsHuman resources form the backbone of any enterprise and are often a key success factor. Stock options are a tool that public firms use to entice top talent as a form of equity compensation. Employees who have stock options have the right to purchase shares of the company's stock at a fixed price.
Offering stock options can be an attractive incentive for employees, as it aligns their interests with those of the company and gives them the potential to share in the company's success. Furthermore, stock options can be a valuable form of compensation for employees who are willing to accept lower salaries in exchange for the potential upside of owning stock in a growing company.
What are the pitfalls of a company going public?
Having discussed the various benefits of a company going public, let us take a look at a few of the potential drawbacks:-
Costs and ComplexityThe complicated and costly process of going public necessitates a major commitment of time, finances, and resources. Companies must work with attorneys, accountants, and investment bankers to create the prospectus for the offering, do due diligence, and promote the stock to investors.
Additionally, after going public, the company must adhere to a number of ongoing regulatory standards, including those relating to financial reporting, disclosure, and governance. These demands may take a lot of time and money, taking resources away from other corporate objectives.
Reduced controlA company going public often entails a reduction in direct control of the company's founders and existing shareholders. Once the company is public, it is subject to the scrutiny and demands of public shareholders, who may have different interests and priorities than the company's management team.
Moreover, aggressive investors can put pressure on public companies to make changes in management, strategy, or capital allocation. The board of directors, management, and shareholders may feel more strain and stress as a result.
Enforced short-term focusSince public companies are frequently subject to quarterly earnings expectations and stock price volatility, going public can put pressure on short-term results. This can cause people to choose short-term profits above long-term investment and growth.
This pressure to meet or exceed quarterly expectations can be a distraction for management, diverting their attention away from strategic priorities and long-term value creation.
Going public is a significant decision in the lifecycle of an enterprise and comes with its own set of pros and cons. While the ability to raise capital, provide liquidity for existing shareholders, and use stock as currency for acquisitions can be compelling reasons to go public, the costs, loss of control, and short-termism associated with being a public company must also be considered.
Ultimately, the decision to go public should be based on the company's strategic objectives, growth potential, and readiness to navigate the complexities and demands of the public markets. The decision for a company going public needs to be taken after weighing the benefits and challenges carefully, and ascertaining whether it is the right choice at the right time.