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For many private companies, going public can be an exciting possibility, one that can open the doors to greater capital, financing options, and growth potential - not to mention considerable monetary gains for management and investors.
When a privately owned company makes an initial public offering, or IPO, it offers ownership of the company to the public through the sale of securities. But, prior to the actual offering, companies embarking on an IPO must go through an extremely demanding, time-consuming, and expensive preparation process, requiring excellent support from IPO experts in many disciplines.
While the rewards for such effort are often tremendous, shifting from a private to a public entity may involve difficult adjustments that management needs to anticipate.
How to go public
Going public requires months of preparation, sometimes as long as a year. The cost can be considerable - companies should expect to pay fees for legal services, accounting, auditing, and printing, as well as underwriting commissions and expenses.
While a private company seeking to go public should have already assembled an outstanding management team, it now must put together an equally good team of outside professionals who specialize in IPOs. The attorneys and accountants a company selects are particularly crucial. These experts typically direct a great deal of the IPO process and could make or break its success. Together, these specialists will draft the necessary documents required for the public offering, including the registration statement that must be submitted to the Securities and Exchange Commission.
Various written materials will need to detail the company's products and services, potential markets, and audited financials. They will also name principal shareholders, officers, and directors. In addition, risk factors should be thoroughly explained in order to minimize the company's potential exposure to future misrepresentation or similar claims. A securities fraud lawsuit resulting from disappointing after-market performance can be disastrous.
The next, and most important, step in going public is choosing an investment bank to act as the underwriter. Underwriting is the actual process of raising capital through the public offering of securities for the company going public. Private companies should consider the investment bank's reputation, industry expertise, and distribution channels. The investment bank should also be able to put together a strong syndicate of large investors to back the offering.
No company wants speculators buying into its IPO for a quick sell and a short-term gain. The underwriter must create a strong market for the stock, in what is called the "after-market," by attempting to make sure that significant investors are holding it for the long-term. The underwriter itself typically should hold a considerable number of shares to help make a market for the stock.
After the company files its registration statement with the SEC, the company must enter what is commonly called a "quiet period." It is during this time that the company issues a preliminary prospectus, or red herring. The red herring introduces the company to the investing public and reiterates much of what is contained in the registration statement. This is the only information that can be provided during the quiet period.
About one month prior to SEC-approval of the issue, the management team generally goes on what is called a "road show" to acquaint brokers, portfolio managers, and institutional traders in many different cities with the company. During these meetings, managers familiarize the audience with the company and the information contained in the red herring.
Once the SEC approves the issue, the offering price is determined based on current financials, financial projections, comparisons to similar companies, and other investment trends. The price per share and the amount of capital the company wants to raise determines how many shares will be offered for sale to the public.
On the date the issue becomes effective, a final prospectus is issued and the company's securities are offered to the public.
What to expect after the IPO
Public ownership can have a dramatic change on a company, and the transition is not always easy. The company's managers suddenly must face new responsibilities that they didn't encounter when the company was private - namely, shareholder accountability.
The company's founders still must answer to the board of directors, which has the power to remove executives from their positions. But they aren't the only "bosses" of the company any longer. Managers now also have a responsibility to public investors, analysts, and money managers, all of whom can share in the company's gains and losses. For that reason, public companies must comply with disclosure requirements about their finances and operations.
Both during and after the IPO process, careful preparation and realistic expectations are key to success. With the help of top financial professionals, months of hard work, culminating in the emotionally charged day when the company finally goes public, will likely pay off if management has been properly discriminating about all aspects of the IPO.
The growing pains that come with a public offering are to be expected and must be overcome to face the new challenges of developing as a publicly held company and increasing shareholder value.
Updated: January 1, 2013
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
© 2013 Wilmington Trust Corporation.