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Private companies go public in order to generate capital to help further their growth, reduce debt, or fund other business operations. Going from a private company to a public one, known as an initial public offering (IPO), comes with both advantages and disadvantages and may not be the right move for every company. The price of raising capital can be high.
Key Takeaways
- Companies primarily go public to raise money to expand.
- Going public isn’t an option for all companies. The costs are steep and there are requirements that must be met to qualify.
- Higher costs aren’t the only potential barrier. Company founders must also relinquish more control and accept that their operations will be in the public eye.
- Public companies are more tightly regulated and have strict disclosure requirements.
- Going public can encourage companies to focus more on short-term results and, in some cases, even engage in deceptive creative accounting.
Advantages and Disadvantages of Going Public
Before deciding whether or not to go public, companies must evaluate all of the potential advantages and disadvantages that are involved. This usually happens 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 for that time period.
Here are some of the main pros and cons they have to consider.
The Advantages
Raising capital is the most distinct advantage of going public. When companies go public, they sell shares of ownership to the public in exchange for cash. The raised capital can be used to fund research and development (R&D) and/or capital expenditure, or pay off existing debt.
Another potential advantage is increased public awareness. IPOs often generate publicity, which can potentially make the company’s products known to a wider 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.
If a company wants to raise more capital sometime after an IPO, it can do a secondary public offering, selling new shares to investors.
The Disadvantages
Going public can also come with several disadvantages. One of the biggest factors that puts companies off going public is the need for added disclosure for investors. When companies go public, they are required to regularly keep the public updated about their activities and financial performance and do so in a certain way. These obligations are costly and can create public scrutiny.
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 the Securities and Exchange Commission (SEC).
The cost of complying with regulatory requirements can be very high, and as rules to protect investors continue to be added, these costs keep increasing. Some of the additional costs include the generation of financial reporting documents, audit fees, investor relation departments, and accounting oversight committees.
The Pros and Cons of Going Public
Special Considerations
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 use somewhat questionable practices in order to boost earnings.
Real-World Example
One of the most interesting IPOs of recent years was Snap Inc.’s. The company, best known for its flagship product Snapchat, raised $3.4 billion in March 2017.
Being in the public eye has presented challenges. In its first quarterly report as a public company, Snap reported disappointing user growth figures. In May 2017, investors sued, alleging the company had made “materially false and misleading” statements regarding user growth. Snap settled for $187.5 million in January 2020.
The share price has continued to be volatile ever since with financial performance disclosures and other external events triggering the occasional big swing in sentiment. However, the capital that Snap raised has helped the company expand and improve parts of the business. By Jan. 2024, its market cap was over $3 billion higher than its IPO valuation.
Why Would a Company Not Want to Go Public?
A company may choose not to go public for many reasons. These reasons include the tedious and costly task of an IPO, the founders having to give up total control, and the need for more stringent reporting to comply with SEC rules.
When a Company Goes Public, Who Gets the Money?
When a company goes public, the company initially gets all of the money raised through the IPO. When the shares trade on a stock exchange after the IPO, the company does not get any of that money. That is money that is exchanged between investors through the buying and selling of shares on the exchange.
Is It Better for a Company to Be Public or Private?
Whether it is better for a company to be public or private will depend on the specific company and the goals of its founders. Remaining private allows the founders to run the company as they wish and not have to meet the many regulatory requirements of being a public company. Going public allows a company to raise significant capital to grow the business. At the end of the day, the best decision is the one that is best for the founders and their vision of the company.
The Bottom Line
Taking a private company public raises capital so that a business can fund its growth or use the money for other business needs. It is a common step for many companies that grow out of the start-up phase.
Though taking a company public does bring in more capital, there are also significant drawbacks. These include the time-consuming process of an IPO, ensuring the company meets strict regulatory rules, giving up complete ownership and total control, and being under the scrutiny of the public and investors.
It’s important to weigh the pros and cons and have a vision of what the founders want the company to be before deciding whether or not to go public.