Initial Public Offerings

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An initial public offering (IPO) is the process through which a privately held company issues shares of stock to the public for the first time. Also known as "going public," an IPO transforms a business from a privately owned and operated entity into one that is owned by public stockholders. An IPO is a significant stage in the growth of many businesses, as it provides them with access to the public capital market and also increases their credibility and exposure. Becoming a public entity, however, also involves significant changes for a business including a loss of flexibility and control for management. In some cases an IPO may be the only means left of financing rapid growth and expansion. The decision to

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go public is sometimes influenced by venture capitalists or founders who wish to cash in on their early investment.

Staging an IPO is a very time-consuming and expensive process. A business interested in going public must apply to the Securities and Exchange Commission (SEC) for permission to sell stock to the public. The SEC registration process is quite complex and requires the company to disclose a great deal of detailed information to potential investors. The IPO process can take as little as six months or as long as two years, during which time management's attention is distracted away from day-today operations. It can also cost a company between $50,000 and $250,000 in underwriting fees, legal and accounting expenses, and printing costs.

Overall, going public is an enormous undertaking and the decision to go public requires careful consideration and planning. Experts recommend that business owners consider all the alternatives first (such as securing venture capital, forming a limited partnership or joint venture, or selling shares through private placement), examine their current and future capital needs, and be aware of how an IPO will affect the availability of future financing.

According to Jennifer Lindsey in her book The Entrepreneur's Guide to Capital, the ideal candidate for an IPO is a small- to medium-sized company in an emerging industry, with annual revenues of at least $10 million and a profit margin of over 10 percent of revenues. It is also important that the company have a stable management group, growth of at least 10 percent annually, and capitalization featuring no more than 25 percent debt. Companies that meet these basic criteria still need to time their IPO carefully in order to gain the maximum benefits. Lindsey suggested going public when the stock markets are receptive to new offerings, the industry is growing rapidly, and the company needs access to more capital and public recognition to support its strategies for expansion and growth.

ADVANTAGES OF GOING PUBLIC

The primary advantage a business stands to gain through an initial public stock offering is access to capital. In addition, the capital does not have to be repaid and does not involve an interest charge. The only reward that IPO investors seek is an appreciation of their investment and possibly dividends. Besides the immediate infusion of capital provided by an IPO, a business that goes public may also find it easier to obtain capital for future needs through new stock offerings or public debt offerings. A related advantage of an IPO is that it provides the business's founders and venture capitalists with an opportunity to cash out on their early investment. Those shares of equity can be sold as part of the IPO, in a special offering, or on the open market some time after the IPO. However, it is important to avoid the perception that the owners are seeking to bail out of a sinking ship, or the IPO is unlikely to be a success.

Another advantage of an IPO is increased public awareness of the company. This sort of attention and publicity may lead to new opportunities and new customers. As part of the IPO process, information about the company is printed in newspapers across the country. The excitement surrounding an IPO may also generate increased attention in the business press. There are a number of laws covering the disclosure of information during the IPO process, however, so business owners must be careful not to get carried away with the publicity. A related advantage is that the public company may have enhanced credibility with its suppliers, customers, and lenders, which may lead to improved credit terms.

Yet another advantage of going public involves the ability to use stock in creative incentive packages for...