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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6 Responses to “IPO 101 Series: Why Do Companies Go Public”

  1. Anon September 24, 2013 at 10:47 am #

    I’d say a big reason is for founders to cash out

    • Andy Rachleff September 24, 2013 at 10:53 am #

      Actually going public is a terrible way for founders to cash out. It can take as long as 10 years to fully realize the value of their stock given all the extra restrictions they face. Unlike rank and file employees, officers must report all their stock sales. As you might imagine, officer sales are closely watched to try to get an insight into how management feels about their business. From a practical standpoint officers are forced into selling the same amount of stock every quarter independent of price to avoid sending any signals. This is accomplished through what is known as a 10b5-1 plan.

      If founders are primarily motivated to cash out then a sale of the company is a better route. You should only go public is you intend to build a very large company.

  2. Cody January 24, 2014 at 7:55 pm #

    My employer (a privately owned company) recently offered me stock options. I’m excited about investing in the company and have been trying to guess when we may go public. This well-written article addressed many of my IPO-related questions. Thanks!

  3. Anjie March 11, 2014 at 4:29 pm #

    Question: Why would investor who bought shares pre-public trading debut (IPO) sell shares on first trading day? Especially if shares go down past their IPO-listed price? Wouldn’t they be losing money and realize a loss?

    • Andy Rachleff March 11, 2014 at 9:23 pm #

      While unusual an investor may sell in your example because she needs the money or thinks the price of the company’s stock is likely to decline in the future. There are many companies whose stock trades significantly below the IPO price post lockup that never recover.

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