Different ways companies go public

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How companies go public

Publicly-traded companies are known for holding a greater value than similar private entities. With public ownership, a company and its shareholders can enjoy a wide range of significant benefits, including the prospect of accessing capital to finance future expansion and growth. Therefore, the decision to transform from a private to a public company is a crucial milestone for any entity.

Typically, companies go public by making a first-time issuance of securities to the public through a process known as Initial Public Offering. However, in the recent past, private companies have adopted more alternative methods to raise capital and attain the publicly-listed-company status. In this post, you will find the various ways companies can take on to go public.

Going Public Explained

Going public refers to the first-time sale of privately-held shares to new public investors. This means that investors from the general public can now access securities from a previously privately-listed company. The complexity of going public presents a set of unique challenges and setbacks, which is why companies take in high specialised experts to spearhead the process.

Benefits of Going Public

Transitioning from a private to a public entity comes with plenty of financial and organisational benefits. Some of the advantages of going public include the following;

Access to Capital

The most obvious benefit of going public is the ability to access capital for expansion. Unlike privately-held companies, public entities have a broader scope of raising capital. This includes diversifying investments into larger markets, financing acquisitions, shareholder buyouts, debt retirement, or investing in research and development.

Increased Visibility

Distributing securities to a wider range of diverse investors enhances the visibility of a company’s products and services to the general public. This prospect provides public companies with a competitive advantage over similar privately-held entities, making it easier for them to expand internationally.

Enhanced Financial Status

Ideally, a publicly-listed company has a larger equity base, financial growth leverage, and improved debt-to-equity ratio. As a result, a public company is in a better capacity to renegotiate existing debt and borrow more funds on favourable conditions.

Enhanced Liquidity for the Owners

Going public increases the liquidity of shares and securities for the owners. This explains why most owners of private companies consider going public as an ideal exit strategy. It is easy for company founders to cash on their entities once the entities they founded go public.

5 Ways for Companies to Go Public

Here are the various ways that companies are taking to go public.

[1] Initial Public Offering (IPO)

IPO is the traditional way of going public. It is virtually how every unicorn gets listed on major stock exchanges like the London Stock Exchange, the National Association of Securities Dealers, and the New York Securities Exchange.

IPO traces its way back to the 1600s when the world was birthing its first stock markets. Since the first IPO in 1602, the concept of going public through an IPO has undergone a series of regulatory changes. Today, companies are required to file a registration statement with the relevant exchange commission, such as the Securities Exchange Commission (SEC). This step is mandatory prior to selling securities to the public for the first time.

Going public through an IPO can be quite a lengthy and complicated process. A series of hoops are involved, which sometimes may take several months or even years. Not to mention that an IPO may have a significant financial impact on your company. For this reason, a company considering going public will hire a corporate finance team or an investment expert to steer the process. The institution hired by the company must be authorised or licensed by the Financial Conduct Authority in the UK or SEC in the United States. The investment bank offers the services of guiding in the IPO process in exchange for a commission, typically 4% to 7% of the funds raised.

The role of the investment bank, also known as the underwriter, includes preparing the prospectus documents, such as the Form S-1. The underwriter is also involved in determining the share price of the company’s securities and deciding on the exchange to use for public listing. Once the initial public offering process is complete and the company’s securities sold out, it is listed on a stock exchange.

The Pros and Cons of Initial Public Offering

Pros
  • An IPO gives you access to a diverse investing public for capital funding. An example of a successful IPO is Warpaint London, a colour cosmetics company, that received investment funding from cornerstone investors like Gresham House, JP Morgan, Blackrock, and Unicorn.
  • Facilitates easier acquisition of finances as issued out by the investment bank.
  • The additional exposure to stock and investment analysts increases the demand for the issuing company’s shares.
  • An IPO increases the company’s visibility to the general public, enhancing its sales and profits.
Cons
  • An IPO can be extremely expensive and time-consuming. This includes the cost of restructuring and maintaining a public company that occurs during the IPO process.
  • Increased risk of raising low funds due to underpricing. This happens when the company’s shares are priced lowly by the underwriter.
  • Disclosure of such information as business methods, tax, accounting, and financial details may expose the company’s business secrets to the advantage of competitors.

[2] Reverse Mergers

Today, more companies are performing reverse mergers as a way of going public and raising capital. A reverse merger, popularly known as a reverse takeover, refers to the process where a privately-held entity transitions to a publicly-listed company by buying the control of a publicly-held entity. Typically, the shareholders of a private entity will acquire control of the board of directors of a public company and a controlling amount of its shareholding. As a result, the public and private companies come together to form one large publicly-held entity.

In most cases, public companies involved in reverse merging are the dormant shell corporations that lack assets and operations but still hold the status of a publicly-listed company. About a decade ago, the Securities Exchange Commission enforced action against reverse mergers by suspending trading in companies formed through reverse merging. However, reverse mergers are still legal, with various companies using the method to go public. For example, in 2018, Dell re-entered the public stock market through a reverse merger with VMware.

Pros and Cons of Reverse Mergers

Pros
  • The process of going through reverse mergers is fast and cost-effective. Unlike IPOs, reverse mergers can take about one month at a lower cost.
  • Reverse mergers come with greater liquidity benefits to the original investors.
  • In case of adverse market conditions, reverse mergers are unlikely to be put on hold or cancelled.
  • The private company taking over can enjoy a tax shelter from the merging public company. The public company in question has most likely incurred a series of losses, which the private company can carry over to its future income after the merger. As a result, the merger can help shield a proportion of the newly-formed public company’s profits from taxes in the future.
Cons
  • Some public companies may come with unseen liabilities like litigation, which may adversely impact your finances.
  • Running publicly-held companies requires unique expertise and experience, which the executive teams of private companies may lack.
  • A reverse merger may result in a reverse stock split, reducing the number of outstanding shares significantly.

[3] Direct Listings

Direct listing, also known as Direct Public Offering (DPO), is the direct opposite of an initial public offering. In an initial public offering, private companies go public by issuing new securities to the general public. For a direct listing, however, privately-held companies go public by selling a proportion of their existing securities to the public.

With a DPO, there are a few exceptions compared to IPOs. Firstly, DPOs do not require underwriters or investment banks, as the private companies involved may not have the necessary resources to pay them. Secondly, private companies may want to avoid the lock-up agreement applied in initial public offerings, where shareholders are limited from selling their shares to the public.

Notably, shareholders of private companies applying direct listings can sell their securities once the entities are listed publicly. This means that transactions only happen once the shares have been sold, as there no new shares under issuance.

An example of companies that went public through direct listings is Spotify. Spotify is one of the largest tech entities to use DPO for public listing. However, the listing of Spotify as a public company is quite unique. This is because the company applied DPO to go public while offering new shares to public investors.

Pros and Cons of Direct Listings

Pros
  • Existing shareholders can freely sell their securities in the public markets, providing them with great liquidity.
  • The cost of going public through a direct listing is lower than the use of an IPO. This is because private companies can avoid the costs that come with hiring underwriters and investment banks.
  • Since there are no lock-up agreements, investors can place their shares on sale once the company is listed publicly.
Cons
  • Without investment banks and underwriters, it might be extremely difficult to earn the interest of investors. This is unless your company is popular with the public.
  • The stock prices set in a direct listing are dependent on supply and demand in the market. For example, if the shareholders are unwilling to sell their shares on the listing day, then there would be zero transactions. The opposite is also true.

[4] Dutch Auctions

A Dutch auction is a strategy where investors bid for the value they are willing to buy. Typically, the value of the item under sale is reduced from the highest to the lowest value acceptable to investors. However, in going public through a Dutch auction, private companies specify the number of shares available for sale and the price per share. In return, investors indicate the number of shares they are willing to pay and at which price. Consequently, the winning bidders receive the number of shares they are willing to buy at the last successful bid price.

The concept of Dutch auctions means that the investors decide how much they are willing to pay in relation to going public. The direct implication is that the value of the company in question is determined by the investors. This is unlike the initial public offering, where investment banks determine the worth of a company.

Google is among the many companies that used Dutch auction to go public. According to Google, Dutch auction was the ideal way to eradicate the unreasonable speculation, stock price volatility, and low initial share float that companies suffer when going public.

Pros and Cons of Dutch Auctions

Pros
  • Dutch auctions are the only way companies can democratise public offerings. Small investors are involved in determining the value of company shares, unlike IPOs, where every decision is made by the underwriters.
  • Through a Dutch auction, private companies receive the going market rates for their shares. A company will not have to worry about the underpricing of shares as commonly imposed by investment banks.
Cons
  • Risk of less rigorous analysis by the involved investors. The stock price established by the investors may not always reflect the prospects of the company.
  • A lot of uncertainty on the stock prices and the number of investors willing to buy the shares.

[5] Special Purpose Acquisition Companies (SPACs)

SPACs, also known as blank check companies, are entities established to raised capital through IPO to acquire an existing public company. Although SPACs have been in existence for over two decades, the method has only gained popularity recently. Usually, SPACs are created without specific business operations, purpose, or plan. Like shell companies, SPACs do not have assets, and the owners do not have to disclose the acquisition target upon formation.

Typically, SPACs are formed and managed by professionals within a specific business sector or industry to rally business ideas within that sector. Upon identifying a potential acquisition target, managers of a SPAC use proxy documents to present business to investors. The share price is determined by the investors prior to an initial public offering, after which the voting process for the acquisition is initiated. Additionally, SPACs identify investment banks and underwriters long before the issuance of shares to the public.

Pros and Cons of SPACs

Pros
  • Companies acquired by a SPAC have the advantage of a faster IPO process.
  • SPACs are an excellent alternative for smaller companies, struggling older companies, and fast-growing early-stage start-ups aiming at going public.
Cons
  • Susceptibility to execution risk, as the success of a SPAC is dependent on the investors’ decision.
  • Sponsors and founders of SPACs get to receive a proportion of the acquired company’s equity. This poses a risk of share dilution, affecting the value of the company significantly.

Wrap up

Private companies and unicorns are always on the lookout for ways through which they can acquire capital funding and transition to public markets. Fortunately, there are many more options for going public today other than the traditional initial public offering method. Strategies like reverse mergers, direct listings, Dutch auctions, and special-purpose acquisition companies have been applied by giant companies in going public.

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