The Advantages & Disadvantages of IPOs

by Nancy Wagner, Demand Media
    An IPO allows investors to buy and sell shares of a company.

    An IPO allows investors to buy and sell shares of a company.

    The buzz in the finance world gets loud when a well-known private company decides to go public and sells and issues stock. All the commotion is because the company offering its first initial public offerings, known as an IPO. For some companies, the attention is part of the attraction of doing an IPO -- to get investors excited about what they offer so the stock gets bought up like candy. Before a company decides to pursue an IPO, however, it must carefully weigh the advantages and disadvantages of opening up the company to the public.

    Raising Capital

    Most companies do an IPO because they need to raise capital. Others do it because the new money helps them buy out other businesses that are part of their growth plans. Sometimes the funds go toward research and development. Some companies use the money to pay off existing debt. The stage is set after an IPO since the company usually finds it easier to raise cash in the future by using its equity. According to Ivo Welch, professor of finance at UCLA, about a third of all IPO issuers return to the market within five years to raise more capital.

    Liquidity

    Investors in a company find an IPO an advantageous situation since they can cash out their shares and get their investment back. The founder of a company may also sell all or some of his stock, a great benefit to him that’s not always perceived that way by the public. The public may see the owner’s willingness to sell some of his own shares as a sign that he’s jumping ship. This, in turn, may cause the public to panic and sell off tons of shares, causing the stock price to deeply drop and the public to lose faith in the company.

    Control

    Once shareholders enter the picture, the company founder may lose some of his independence in running the company. He may lose control of the company altogether, getting fired by a new board. Anti-takeover measures such as staggering the appointments of new members of the board help counteract these problems and are part of a wise IPO strategy. Otherwise, a swift change in leadership does not bode well for outside investors who see the struggle and begin to lose faith in the company, and therefore, its stock.

    Expense

    An IPO takes a tremendous amount of time and money to prepare. This can be a disadvantage to a company with limited funds. Before it sees a dime of the IPO money, the company must hire underwriters, audit companies and attorneys to advise it during the offering process. Many firms hire public relations firms to help them deal with the media. Much of this work is done to arrive at an asking price for the shares. The public views the cost of shares in different ways; lower priced stock may suggest the company is weak while higher priced stocks may cause some investors to shy away completely.

    About the Author

    Nancy Wagner is a marketing strategist and speaker who started writing in 1998. She writes business plans for startups and established companies and teaches marketing and promotional tactics at local workshops. Wagner's business and marketing articles have appeared in "Home Business Journal," "Nation’s Business," "Emerging Business" and "The Mortgage Press," among others. She holds a B.S. from Eastern Illinois University.

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