Startup Words Wednesday: IPO

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For some CEOs and startup founders an IPO is the holy grail, while others dread the day they’re forced into one. Why do some companies want to “go public” at any cost, while others wish to avoid it? I dedicate this Startup Words Wednesday to exploring the almighty IPO.

Initial Public Offering

“It is the process where a privately held company becomes a publicly traded company with the initial sale of its stock.” -nasdaq.com

Benefits

The advantages of an IPO are nothing short of vast, and each industry has their own specific reasons for desiring one. However, we can articulate a few overarching drivers:

  • Resources: the first and most obvious benefit of an IPO is the prospect of raising massive amounts of capital. It can have a variety of uses from paying off debts, securing more loans for rapid expansion, expanding the labor force, diving deeper into research and development to surpass competitors, or even acquiring other smaller businesses. Here are a few of the largest global IPOs of all time as reported by Investopedia:
    1. Alibaba: $21.8 billion on September 18th, 2014
    2. Visa: $17.864 billion on March 18th, 2008
    3. Facebook: $16.007 billion on May 1st, 2012
  • Financing Acquisitions: in addition to using cash, many acquisitions are made using stock. Issuing shares is like printing money that can be used to finance or supplement corporate takeovers.
  • Shares as a Strategic Tool: Going public can also give companies a strategic edge. The company may buy back shares from investors which might inflate its market price by
    1. Showing that there is a consistent demand for the company.
    2. Providing some tax incentives at year end.
    3. Dividing its earnings over fewer shares since the company owns them. Earnings per share is a key metric for investors examining company profits.
  • Notoriety: the company’s marketability and brand equity skyrockets after an IPO. Their credibility and market exposure are instantly exponentially increased which helps their bottom line and also attracts top talent to their workforce.
  • Liquidity: Most importantly, this is often the reward portion of the risk-reward lifestyle that founders, early employees paid in stock, and investors had to live in during the company’s infancy. Everyone who at one point or another took equity instead of a paycheck is now rewarded. Initial investors can cash out their shares for a large pay day.

Disadvantages

The drawbacks of an IPO usually boil down to these:

  • Beholden to Shareholders: have you ever had a micromanager for a boss? Shareholders have very high, and frequent expectations for results. Work is heavily scrutinized with the constant expectation for profits at every turn. Stocks have a manic-depressive like personality to them especially in their first 6 months after an IPO and are heavily influenced by public perception and psychology alone. The unintended consequence is often that corporations focus on short-term gains rather than long-term growth and adopt questionable practices to boost earnings. Financial engineers are often appointed to the helm to fix earnings rather than produce organic growth and real products.
  • Pervasive Press: this is a double-edged sword. While notoriety helps a company succeed, it also adds an extra layer of performance anxiety often influencing C-level decisions that would otherwise be easy to make.
  • Reporting: public companies have to constantly comply with SEC regulations and abide by frequent and costly financial reporting
  • Loss of Control: in addition to shareholders scrutinizing your decisions, they can also determine your company’s future. If you’re a private company, you and your few investors can opt for more investors or turn down acquisitions. A public company does not have this luxury. Even if you do not think selling the company is in its best interest, the public can vote to move forward with an acquisition anyway. In hostile takeovers, an acquiring business can use a similar tactic to their advantage and employ the “bear hug” strategy of offering to buy shares of your company for much more than the fair market value. This forces you to sell because you’re legally obligated to keep the shareholder’s best interests in mind.

Elon Musk is a great case study for the benefits and disadvantages of an IPO. He publicly loathes them because he’s had control issues with his past companies and outside investors destroying his long-term visions. However, he strategically held an IPO for Tesla in 2010 to keep both Tesla afloat and pay back loans to SpaceX.

Regardless of your company’s vision, an IPO is an option that should never be entirely ruled out, but should not be taken lightly either.

Do you have any personal stories of your company facing an IPO? Please share in the comments section!

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