What Are the Advantages and Disadvantages for a Company Going Public

An initial public offering (IPO) is the first sale of stock by a company. Small companies looking to further the growth of their company often use an IPO as a way to generate the capital needed to expand. Although further expansion is a benefit to the company, there are both advantages and disadvantages that arise when a company goes public.

There are many advantages for a company going public. As said earlier, the financial benefit in the form of raising capital is the most distinct advantage. Capital can be used to fund research and development, fund capital expenditure or even used to pay off existing debt. Another advantage is an increased public awareness of the company because IPOs often generate publicity by making their products known to a new group of potential customers.

Subsequently this may lead to an increase in market share for the company. An IPO also may be used by founding individuals as an exit strategy. Many venture capitalists have used IPOs to cash in on successful companies that they helped start-up.

Even with the benefits of an IPO, public companies often face many new challenges as well. One of the most important changes is the need for added disclosure for investors. Public companies are regulated by the Securities Exchange Act of 1934 in regard to periodic financial reporting, which may be difficult for newer public companies. They must also meet other rules and regulations that are monitored by theSecurities and Exchange Commission (SEC). More importantly, especially for smaller companies, is the cost of complying with regulatory requirements can be very high. These costs have only increased with the advent of the Sarbanes-Oxley Act. Some of the additional costs include the generation of financial reporting documents, audit fees, investor relation departments and accounting oversight committees.

Public companies also are faced with the added pressure of the market which may cause them to focus more on short-term results rather than long-term growth. The actions of the company’s management also become increasingly scrutinized as investors constantly look for rising profits. This may lead management to perform somewhat questionable practices in order to boost earnings.

Before deciding whether or not to go public, companies must evaluate all of the potential advantages and disadvantages that will arise. This usually will happen during the underwriting process as the company works with an investment bank to weigh the pros and cons of a public offering and determine if it is in the best interest of the company.

The price of a financial asset traded on the market is set by the forces of supply and demand. Newly issued stocks are no exception to this rule – they sell for whatever price a person is willing to pay for them. The best analysts are experts at evaluating stocks. They figure out what a stock is worth, and if the stock is trading at a discount from what they believe it is worth, they will buy the stock and hold it until they can sell it for a price that is close to, or above, what they believe is a fair price for the stock. Conversely, if a good analyst finds a stock trading for more than he or she believes it is worth, he or she moves on to analyzing another company, or short sells the overpriced stock, anticipating a market correction in the share price. | |

Watch: Initial Public Offering (IPO)| |

Initial public offerings (IPOs) are unique stocks because they are newly issued. The companies that issue IPOs have not been traded previously on an exchange and are less thoroughly analyzed than those companies that have been traded for a long time. Some people believe that the lack of historical share price performance provides a buying opportunity, while others think that because IPOs have not yet been analyzed and scrutinized by the market, they are considerably riskier than stocks that have a history of being analyzed. A number of methods can be used to analyze IPOs, but because these stocks don’t have a demonstrated past performance, analyzing them using conventional means becomes a bit trickier. (For more information, check out ourIPO Tutorial and The Murky Waters Of The IPO Market.)

If you’re lucky enough to have a good relationship with your broker, you may be able to purchase oversubscribed new issues before other clients. These tend to appreciate considerably in price as soon as they become available on the market: because demand for these issues is higher than supply, the price of oversubscribed IPOs tends to increase until supply and demand come into equilibrium. If you’re an investor who doesn’t get the first right to buy new issues, there’s still an opportunity to make money, but it involves doing a substantial amount of work analyzing the issuing companies. Here are some points that should be evaluated when looking at a new issue:

1. Why has the company elected to go public?
2. What will the company be doing with the money raised in the IPO? 3. What is the competitive landscape in the market for the business’s products or services? What is the company’s position in this landscape? 4. What are the company’s growth prospects?

5. What level of profitability does the company expect to achieve? 6. What is the management like? Do the people involved have previous experience running a publicly-traded company? Do they have a history of success in business ventures? Do they have sufficient business experience and qualifications to run the company? Does management itself own any shares in the business? 7. What is the business’s operating history, if any?

This information and more should be found in the company’s S-1 statement, which is required reading for an IPO analyst. After reading the company’s S-1, you should have a pretty good understanding of the characteristics of the business and the operations at the company. Given these characteristics, find out what you believe to be a reasonable valuation for the company. Divide this number by the number of shares on offer to find out what’s a reasonable price for the stock. Other valuation strategies could include comparing the new issue to similar companies that are already listed on an exchange to determine whether or not the IPO price is justified.