An initial public offering (IPO) is the first time a company offers its shares for sale to general investors. The process is called “going public.” The shares are listed subsequently on a national securities exchange, for example, the New York Stock Exchange (NYSE). This method is used by small, medium and large companies to raise funds. The company receives all of the proceeds of the offering. The timing of an IPO is crucial. It depends on a favorable market for a company’s products or services. High-profile IPOs of large, well-known companies that investors later judge to have been over-hyped -- like Facebook -- affect investor judgment about subsequent, smaller company IPOs.
A major reason for a company to go public is the creation of a market for shares owned by the company’s management. Company management rarely articulates this reason outright. They fear that aspiring investors, and capital market regulators, may view them as cashing in and quitting the business. Often, management hopes that their shares will rise in value after the IPO, even if they do not wish to dispose of them quickly. According to management consultants PricewaterhouseCoopers, the market value of publicly held companies is higher than that of comparable private ones.
Key employees in companies receive share options as part of their benefits package. These may come with restrictions that they may not be sold for between one and three years after the IPO. By creating a market in the company shares, the management hopes to retain key employees by providing a benefit that increases in value.
Equity Base Diversification
The creation of a market in a company’s shares provides liquidity for investors to enter and exit. This liquidity is important for short-term investors such as hedge funds that need to plan out their exit strategy. Longer-term investors such as pension funds hope to judge the company’s growth prospects over a longer term.
The IPO enables a company to raise funds in order to increase its asset base. It gives the company a competitive advantage against other similarly sized companies in the same market or industrial sector. With the creation of a market in the company’s shares, future share offerings may be used to fund acquisitions to grow the company further. The cost of issuing this equity is much lower than contracting debt to fund growth.
The public exposure provided by an IPO can be an excellent public relations exercise. The company becomes a visible entity on a local, national or international level. Its products and/or services become better known and give the company prestige to increase sales and earnings.
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