Why Do Companies Go Public and Its Importance

Having sufficient cash flow is crucial for any company as it allows smooth and efficient operations. However, as a company grows and expands, it requires more capital. In such situations, taking in more debt is not advisable as it can overburden the company.

That is why many privately-owned companies opt to go public through a process called an Initial Public Offering (IPO). Through this process, the company sells its equity ownership to the public in return for funds. Also, many people prefer to become early investors in newly-listed companies.

Now, let us learn how the IPO works, its importance, benefits, and disadvantages.

What Is Initial Public Offering (IPO)?

When a corporation puts up its share to the public for purchase for the first time, the listing process is known as Initial Public Offering (IPO). A company can issue fresh shares to raise capital or the existing shareholders can exit their investments via an IPO.

When a private company wants to go public, it needs to take the help of investment bankers to go through a lot of paperwork and disclosure requirements mandated by the Securities and Exchange Board of India (SEBI). Once the company decides on an initial price, IPO size, and other details, it will file draft papers with the SEBI for approval.

Investors who buy newly-issued shares from the IPO can sell them in the secondary market to make profits.

Why Are IPOs Important?

The fundamental motive behind an IPO by a company is to raise capital for various needs. This can include paying off existing debts or funding expansion, research, or for general corporate purposes.

Moreover, issuing shares to the public can uplift a company’s image and increase its brand awareness. As stock prices are directly proportional to the company’s growth, successful companies will have higher share prices and attract more investors. 

Another reason why IPOs are so important for the issuing company is that it offers an easy exit for early shareholders. When a company goes public, angel investors and the company founders get the opportunity to sell some or all of their investments. 

What Are the Advantages of Offering Shares to the Public?

You must be wondering why anyone would willingly let go of a percentage of a company to the public. So, let us understand its advantages:

• Raises Large Funds

When a company goes public, it attracts a large number of investors. These investors purchase the ownership of a company in the form of shares. The company, in return, receives funds that it can use to develop and grow its business.

As the company develops and establishes its presence in the stock market, it attracts even more investors. As a result, its stock price appreciates and it can gain more popularity and funding if required. 

• Boosts Liquidity

A company is run by its employees and its growth is facilitated by many others, including various stakeholders and venture capitalists. In return, the company pays them back for their hard work and trust with equity shares, pre-IPO.

When a company goes public, these early investors can reap what they invested by liquidating the shares.

• Diversification

As stated earlier, IPOs bring all sorts of investors from retail investors to large institutions to get ownership of the company. This diversifies the investors, and no single investor gets to hold the majority of a company’s share.

• Enhances Brand Image and Improves Credibility

Companies with creditworthy developments and financials can opt for public offerings, as they have to submit their financial data to the capital market regulator, SEBI. Doing so allows the company to showcase its growth and products for public scrutiny. This improves the company’s credibility and incorporates trust among investors.

• Increases Loan Credibility

Before going public, the company has to finance its expenses through debts from banks or other financial institutions. These loans are charged at higher interest rates or sometimes demand a certain percentage of company ownership. However, a publicly listed company can enjoy a negotiation advantage and avail of loans easily.

What are the Disadvantages of an IPO?

The section discusses the cons of going public:

• Immense Performance Pressure

After a company raises funds through an IPO, its investors and shareholders will put immense pressure on it to keep outperforming its peers and generate good returns. Otherwise, the company would lose market credibility. 

This level of pressure can hamper the company’s ability to make risky decisions, as even a small mistake may hinder all the progress they have built over the years.

• Hectic Administrative work

All publicly listed companies must submit their cash flow statement to SEBI annually, as per amended clause 32. Companies are also required to report their quarterly earnings. Therefore, administrators need to work rigorously to prepare an accurate financial report and audit them, which takes significant time and money. Losses and debt on the financial report can severely affect a company’s share price.

• Less Authority to Founders and CEO

A board of directors are responsible for policy decisions and workflow of a publicly listed company. Furthermore, they also have the power to remove a CEO or a founder to protect shareholders’ interests. Therefore, some CEOs and founders often choose not to give the public authority over their creative decisions.

Besides the above-listed reasons, IPO procedures are expensive, requiring investment in advertising, financial administration, and many more. This discourages smaller companies from going public.

Final Word

Listed companies often offer shares at a decent valuation. Newly listed companies with high growth potential also tend to offer significant returns over the long term. That is why IPOs attract numerous investors due to their high return potential. 

However, before you subscribe to an IPO, remember to thoroughly research the company’s fundamentals, its offerings, and market prospects. 

Frequently Asked Questions