The process of offering shares in a private corporation to the public for the first time is referred to as initial public offering (IPO). Growing companies that need capital will often use IPOs to raise funds, while more established companies many use an IPO to let the owners exit some or all of their ownership by selling shares to the public.
In an initial public offering, the issuer, or the company that is trying to raise capital, brings in underwriting firms or investment banks to help determine the best type of security to issue, offering price, amount of shares, and time frame for the market offering.
Advantages of an IPO
The main goal of an IPO is typically to raise capital for a business. On the other hand, a public offering has other benefits as well.
- A public company can raise extra funds in the future through secondary offerings because it already has access to the public markets through the IPO.
- Many businesses will compensate executives or other employees through stock compensation. Stock in a public company is more attractive to potential employees since shares can be sold more easily. Being a public company may help the business with more talented people.
- Merger and acquisition activity may be easier for a public company that can use its shares to acquire another firm. In a similar manner, it is easier to establish the value of an acquisition target if it has publicly listed shares.
Disadvantages of an IPO
An IPO is quite expensive and the costs of maintaining a public company are ongoing and usually unrelated to the other costs of doing business.
- Fluctuations in a company’s share price can be a distraction for management, which may be compensated and evaluated based on stock performance instead of financial results.
- Strategies used to inflate the value of a public company’s shares, such as using excessive debt to buy some stocks back, can worsen the risk and instability in the firm.
- A public company must file reports with Securities and Exchange Commission that may reveal the secrets and business methods that could help the company’s competitors.
- Rigid leadership and governance by the board of directors can make it harder to retain good managers willing to take the risks.
Alternative Shares Offering Strategies
When an IPO is conducted, the investment bank or group of investment banks will buy shares from the issuer. The bank then plans to offer those shares on the secondary marketm where they will trade on an exchange. In addition to fees, the bank may profit from selling the shares on the secondary market at a price that is higher than what it paid the issuer for the shares.
In a Dutch auction, potential buyers are able to bid for the shares that they want and the price that they are willing to pay. The bidders who are willing to pay the highest price are then allocated the shares available. But they will all pay the same price.