IPO 101 Series: Why Do Companies Go Public

SEC Form S-1 (IPO concept)When news of a widely anticipated IPO breaks, it triggers an avalanche of press coverage. Surprisingly, almost none of that coverage explains the rationale behind the company going public in the first place.

There are four major reasons to take a company public:

  1. Maximize shareholder value
  2. Raise money at more attractive rates
  3. Create an acquisition currency
  4. Increase company awareness.

Maximize shareholder value: If a company’s management believes it serves a large market and has a strong competitive position then it’s likely to generate more value for its shareholders by going public than through a sale to another company. That’s because future success can lead to a higher stock price if the company remains independent whereas the price associated with an acquisition is limited by the upside of the generally less attractive stock received in an acquisition.

Raise money at more attractive rates: Public financing allows management teams to raise larger sums of money than they can privately and at higher valuations. Valuations are typically higher in a public financing because the stock sold can be freely traded whereas stock sold in a private financing is not. Investors are usually willing to pay a much higher price for a security that has greater liquidity.

Create an acquisition currency: More mature companies often generate their growth through acquisitions and the most common consideration offered in a merger or acquisition is stock. Sellers in acquisitions are no different from investors in that they prefer to receive liquid securities. Private companies often find it difficult to issue illiquid stock in an acquisition because the seller can’t easily place a value on the stock and negotiating the proper discount for illiquidity is quite challenging at best. As a result acquisitions can’t typically be pursued as a growth engine until a company goes public.

Increase company awareness:  The hype associated with going public can bring awareness to the company that would not be possible through traditional public relations channels. A highly sought after IPO tends to attract the attention of most everyone in the financial and business press, well beyond what a company can achieve through its normal marketing efforts.

Do you have anything you’d add? Let us know in the comments. In our next post, we’re going to dive into the next common question, ‘how do companies go public?’ 

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