Companies have several options for raising capital, but a popular route is issuing stock to the public. For a private company to reach the widest range of investors, it must become a public company, and that's where IPOs come in.
How IPOs work
An initial public offering is the process by which a company first sells its stock to the public and becomes a publicly traded company. Once a company decides to move forward with an IPO, it must work with an underwriter (typically a bank or multiple banks) to create a prospectus. A prospectus is a detailed financial report designed to help potential investors make informed decisions. Once the prospectus is filed with the Securities and Exchange Commission, a date is set for the company's IPO. As the IPO date approaches, the underwriter and company must decide on a price at which to offer the stock. The price can depend on a number of factors, including the company's performance as well as perceived investor appetite for its stock.
Advantages of IPOs
The primary benefit of going public via an IPO is the ability to raise capital quickly by reaching a large number of investors. A company can then use that cash to further the business, be it in the form of research, infrastructure, or expansion. Additionally, by issuing shares, newer, lesser-known companies can generate publicity, thus increasing their business opportunities. There's also the prestige of being listed on a major stock exchange to consider, which is a motivator for some companies that go the IPO route. Finally, IPOs can help growing companies attract new talent by offering perks like stock options.
Disadvantages of IPOs
One major drawback of going public using an IPO is the time and expense of going through the process. It's common for an IPO to take anywhere from six to nine months or longer. During this time, the company's management team is likely to be focused on that IPO, which could cause other areas of the business to suffer. Plus, it costs money to go through with an IPO, from financial service and underwriting fees to filing fees. And once a company goes public, it becomes subject to a host of additional reporting and disclosure requirements, all of which also cost money.
Furthermore, once a company goes public, it must answer to its shareholders. When shareholders gain a significant ownership stake in a company, they can vote to override management decisions, or vote to get rid of managers and directors altogether. And because public companies often feel pressured to perform well for their shareholders, they sometimes make poor business decisions, sacrificing long-term growth for short-term profits.
To IPO or not?
The process of going public using an IPO can be complex and time-consuming. Any company contemplating whether to move forward with an IPO needs to evaluate the benefits and drawbacks involved.
Feel like you're ready to take the plunge into investing? Head over to The Motley Fool's Broker Center and get started today.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center, in general, or this page, in particular. Your input will help us help the world invest, better! Email us firstname.lastname@example.org . Thanks -- and Fool on!
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.