Question

Research suggests that at a certain growing stage, most businesses find it desirable to go public. Still, companies in countries like Germany & Italy mostly remain private, however in other countries like USA, companies opt for going public. What factors impact the decision of firms going public? Discuss the advantages and disadvantages of IPO.

Answer 1

What factors impact the decision of firms going public?

There are several factors that impact the decision of firms to go public. They are as shown below:

1. The primary reason is the need for capital. A company may need the capital for growth, expansion, acquisition or for debt reduction. This may lead a firm to decide to tap the capital markets and go public.
2. Diversify shareholders' base: When the firm want's reduce it's dependence on select shareholders of the company and want to enhance its shareholding base and thus spread risk over a larger shareholder's base.
3. Part or full exit to existing shareholder: Existing promoters or venture capital funds or private equity players may want a part or full exit and hence force the company to go for an IPO.
4. Buoyant market conditions: Sometimes markets are so good that a company may get an attractive valuation and hence go for an IPO.
5. A company might have glorious past and has managed to move into a stable and mature zone. It may want to capitalize on its glorious past. IPO helps a company capitalized on its sound and robust historical financials.
6. Size and scale: When a company achieves a size and scale so as to get the attraction of institutional investors, the company should start planning for an IPO.
7. Need to lower its cost of capital: A listed company has relatively cheaper cost of capital than an unlisted company. Hence, need to raise capital coupled with need to raise it at cheaper cost, may also make a company consider an IPO
8. Need to strengthen the brand image: IPO helps improve the visibility of the company among the investors' community. It helps in strengthening its brand. This need may also make a company think for an IPO.

Advantages of going public

1. Access to capital: Capital can raise an unprecedented level of capital through capital markets, if it has right fundamentals. In fact, for a company with sound fundamentals, can raise capital continuously, once listed.
2. Access to relatively cheaper capital: Once the stock becomes listed, the illiquidity discount goes out and hence the capital becomes relatively cheaper.
3. Ability to leverage: With more equity on balance sheet, the firm's ability to leverage improves.
4. Enhanced negotiation powers: The companies can now negotiate better interest rates and coupon rates with lenders, banks and non banking financial institution on long term as well as working capital debt.
5. Transparency: IPO brings several regulatory and reporting requirements. Compliance with those automatically insures transparency in reporting and corporate governance.
6. Ability to raise further capital: A company, once listed, can raise more capital through Qualified Institutional Placements ("QIPs") and Rights Issue. These options are not available to an unlisted company.
7. Improved visibility and brand
8. Provides ability to a firm to reward employees through employee stock option plans
9. A firm can improve its activity in mergers and acquisition space as its shares are now listed. Shares can also be used as a mode of financing the acquisitions.
10. An investor investing in the company through equity need not worry about liquidity and exit, once the company is listed.

Disadvantages of going public:

1. Initial time and resource: Usually a company spends around a year preparing for an IPO. The time and effort required is enormous.
2. Initial cost of going public: A company has to work with numerous intermediaries such as merchant banks, underwriters, due diligence service providers, legal advisors, law firms while preparing for an IPO. At times, the cost of going public can add up to as high as 3 to 5% of the IPO issue size.
3. Sustained cost of compliance: On a sustained basis, the firm has to spend towards monitoring and compliance. An IPO necessitates several regulatory filings and monitoring. A full fledged team for Investors relations work continuously to meet these requirements. The firm has to bear this cost on a sustained basis.
4. IPOs require the firm to maintain transparency. So there is indeed loss of confidentiality. Information and data have to be made public. All the financial figures, operational data are in public domain and hence are freely available to your customers, competitors, suppliers etc.
5. The management is under continuous pressure maintain a pattern of growth over a period of time and report strong results quarter on quarter. At times, market can punish you heavily if performance is not up to the expectations.