What Does It Mean When a Company ‘Goes Public’?
A company goes public when it meets the criteria of public reporting obligations laid down by the Securities and Exchange Commission (SEC). This includes sale of privately held shares on a public market through an offering such as an IPO, meeting the SEC’s investor base trigger for public reporting or voluntarily registering with the SEC to disclose certain business and financial information to the public. When a company goes public via a share offering, its privately owned stock trades on public markets for the first time and it ceases to be a privately owned company. This process allows companies to raise capital which may be reinvested in the business. In exchange for that capital, the founder or current owner forfeits a percentage of ownership in the company. Going public, whatever the mode may be, is a huge decision and requires a significant amount of preparation. Once a company is public, it’s subject to strict reporting requirements by regulators, as well as scrutiny from the shareholders who now own a part of the company. Public company reporting requirements include:
Quarterly and annual financial statements.Important events that shareholders should know about.Proxy statements that describe the matters shareholders can vote on.Disclosures about proposed mergers, acquisitions, and other transactions.
How Do Companies Go Public?
When a company decides it’s going public, there are a few different routes it might use:
IPO
An initial public offering (IPO) is the most common way that a company goes public. An IPO is a lengthy process, and afterward, firms are subject to many strict requirements. A typical IPO gets executed over a six- to 12-month time frame. The first phase of an IPO is when the company begins to prepare for the move and performs a readiness assessment to identify any issues. This is when the firm hires an investment banker, identifies its goals, lays out a timeline, and more. Next, the company begins executing the plan it developed in the first phase. During this time, companies are gathering the data necessary for registration and preparing all of their legal documents. Once the listing company files for registration with the SEC, it enters a quiet period until the SEC approves its IPO plans. In this period when IPO information release is limited, the SEC still allows companies to communicate about other matters, including disclosing factual business information. After the company gets a go-ahead from the SEC and meets the listing requirements of stock exchanges, its shares can begin trading. Now, the IPO is complete and the firm is officially a public company.
Direct Listing
A direct listing is a fairly new process that companies can use to go public and raise capital without doing an IPO. When a company goes public through a direct listing, it can bypass the traditional underwriting process. Unlike in an IPO where investment bankers undertake price discovery for the shares to be sold and, typically, larger investors get preferential treatment for allocation of shares, on the day of the direct listing, shares of the company become available to be bought and sold on the stock exchange by any investor and the price discovery takes place through the buy and sell orders on the exchange, without any bank underwriting. A benefit of this type of public sale of shares is that it increases the number of investors that can purchase shares of the company, which helps to level the playing field. In recent years, companies such as Spotify, Slack, and Coinbase have opted for direct listings to go public.
Reverse Merger
A reverse merger is a transaction in which a private company goes public by means of merging with or being acquired by a company that’s already public. In a reverse merger, the acquiring company is usually a shell company or a special purpose acquisition company (SPAC). While the mechanism has existed for many years, it has recently gained popularity as some market participants believe it offers more certainty for pricing and control over deal terms than a traditional IPO. A SPAC is a company that goes public without any real business operations or products to sell. The company issues an IPO and then uses the capital raised in the IPO to merge with or acquire an existing private company. After the merger, the private company’s leadership takes over, and the new firm continues to operate the business of the previously private company. For example, sports-betting company DraftKings merged with a public SPAC Diamond Eagle Acquisition Corp. and its shares began trading on the Nasdaq Stock Market in April 2020. A reverse merger often represents a quicker and cheaper means of going public because the private company can merge with an existing company rather than going through the entire IPO process from scratch.
Pros and Cons of Companies Going Public
Pros Explained
Increased capital: Going public gives companies increased capital and liquidity to reinvest in the company’s growth.Higher market value: Companies often see their market value increase after going public because of the increased transparency and liquidity. But that is not true for every company that goes public. Added brand recognition and reputation: Going public can increase visibility for a company, which can help it to grow even more.
Cons Explained
Loss of ownership and control: When a company goes public, it forfeits some of its ownership to the public. Even though the founder usually maintains at least 50% ownership, they still must answer to a board of directors and shareholders. Costs associated with going public: Going public can be a costly process. While it will eventually result in increased capital, companies first must spend money on administrative costs, underwriting, and more.More business and financial disclosure: Once the company goes public it is obligated to disclose a lot more business and financial information compared with a private company. If it doesn’t, the company can be subject to SEC action.Responsibility to shareholders: When a private company does poorly, the owner suffers all the financial losses. But when a public company performs poorly, it’s the shareholders who can lose out. As a result, publicly traded companies are subject to scrutiny from their shareholders and the public in general.
What It Means for Individual Investors
A company going public presents a great opportunity for individual investors because it’s often their only way to invest in companies. Most investors aren’t involved in venture capital or other types of private financing. Instead, they buy publicly traded shares on an exchange. There are generally two ways an individual investor can buy stock in a company after it goes public. First, you can participate in the IPO and purchase shares at the offering price directly from the company. For this to be feasible, you generally must be a client of an underwriter involved in the IPO. Retail investors rarely get to participate in IPOs, as high-net- worth clients and institutional investors such as mutual funds and pension funds get more preference in share distribution. The other way to buy shares of a newly public company is to buy them on a stock exchange once they are resold on the exchange after the IPO. In this case, you would simply purchase the shares through your brokerage firm, just like buying any other securities.
Alternatives to Going Public
Going public might be one of the most popular ways for companies to raise capital, but it’s not the only option. There are other ways that a company can get the financing necessary to grow without opening itself up to public ownership. Here are three of the most popular strategies:
Venture capital
Many companies don’t issue public shares until they’re well-established and have a proven business model. But in the early years, they may still need financing to help them get off the ground. And even in later stages, some companies simply don’t want to open themselves up to public ownership. Instead, many companies rely on venture capital, which is a type of private financing where investors and venture capital firms invest in private companies, often in exchange for a percentage of ownership. Venture capital is popular among startups and technology firms. If the company is in a more mature phase of its operations, it may also raise capital through a private equity deal, which may be a mix of both equity and debt.
Reinvestment
As companies grow, they can reinvest their profits back into the business to help them grow. Reinvestment is beneficial because founders don’t have to worry about forfeiting ownership in their company, nor do they have to go into debt to grow. However, reinvestment isn’t always an option. Companies just getting off the ground or those with thin profit margins will likely have to consider other options.
Borrowing
Another option that companies use to raise capital is borrowing. There are two primary ways firms can borrow money. First, just like an individual can take a loan from a bank, companies can also borrow from banks. But companies can also use a strategy popular with government agencies: bonds. A corporate bond is a debt security that allows companies to borrow from individual investors. The issuing company usually makes interest payments to the bondholders throughout the life of the bond. Then, when it reaches its maturity date, the company repays the full face value of the bond. Bonds may be attractive to companies because they don’t forfeit ownership, but they also must pay back the capital they borrowed, which isn’t the case for publicly issued shares.
