Why Do Companies Go Public and Importance
India has recently witnessed a new boom for IPOs where every next company is working up to get listed on the stock market. But why do companies go public? Well, there is more than one reason behind that. This carries huge benefits for companies and investors looking for new investments. With IPOs being one of the more prominent sources of capital for companies, we will try and understand why private companies try to go public.
Alongside this, we will also explore the pros, cons, and importance of such a phenomenon. This information is highly beneficial for investors trying to get into the scene of IPOs and venturing into the stock market.
Why Does A Company Go Public?
Think from a company's perspective— it starts with a few members (founder, co-founders, executives, and so on). Whatever profits and losses are made are distributed among these members. That is the scene for a private company. But, in the long run, as the company grows and matures, there comes a time when the founder may decide that there is a need for expansion and further growth. For such a situation, the company would need more extensive resources, including capital.
When the company is private, its resources are limited only to the members and what they can bring in. These restrictions on resources can become a huge hurdle in the way of expansion and growth of the company. This is when a private company decides to go public.
Going public for a company means inviting the public to come and invest in the company by allotting several shares to the public. Investors (outside of the company) will then buy the shares and hold a percentage of ownership of the same company and receive returns respectively. The invested amount is termed directly under 'Share Capital', which the company then uses for further development, expansion, and growth.
To sum it up, here are the reasons why a company may decide to go public:
Formation of Capital
As mentioned earlier, once a company goes public, it receives an enormous amount of capital in the form of share capital. The company can use this share capital to develop new products, increase product line-up, expand into other line-ups, and grow further.
Assessment of Company Value
When a company gets listed on the stock exchange, there is a clear understanding of its value, which directly depends on the amount investors are willing to pay for its shares. This offers many benefits for the company that wishes to expand and grow further.
Improve Public Image
Once a company goes public, it leads to a significant amount of public exposure. Due to its transparency and valuation, the public’s trust in the company and its products increase, thus boosting the public image.
The Process Of Going Public
Before we move on to why this process is important or the pros and cons of it, we will briefly understand how to go public with a company. This is where IPO becomes relevant. It will also benefit investors to know about the process. So, with that in mind, let us quickly look into the process and also understand what an IPO is.
When a company decides to go public, it first appoints an underwriter on its behalf. An underwriter is a pool of investment banks that drafts the application for IPO to the SEBI. The draft includes details by the investment banks, including the number of shares the company will issue, the price bandwidth of the shares, and an overall assessment of the company's financial standing.
Once the application is drafted, it is then submitted to the SEBI. The SEBI takes time to scrutinise the draft, ensuring the company meets all the criteria. Once the SEBI approves the application, the company is allowed to issue the Red Herring Prospectus. This document outlines the details, including the number of shares issued, the price range of the shares, the company’s past performances, and what the company intends to do with the investments.
Soon after, the IPO is opened, and the public can bid for the number of shares. If you are allotted shares, you will be notified of it. That is how a company transitions from being a private company to a public one with the help of an IPO.
Requirements For A Company To Go Public
A common question here is what the requirements are for a company to go public. There are quite a few requirements that companies should meet to do so. Here is a brief outline of a few of those requirements:
- The net worth of the company should have been at least Rs. 1 crore in the past three years.
- The company must possess tangible assets of Rs. 3 crores for the past three years. Of this amount, a maximum of 50% should be cash or cash equivalent.
- Of the past five years, three years should see the company have a profit of Rs. 15 crores pre-tax.
- The company should have a low debt-equity ratio.
Advantages Of Going Public
There are a lot of advantages that a company can look forward to once it goes public. Listing a few will help you understand the reason why a company may want to go public.
Raise capital for expansion and growth
It is apparent at this point that a company going public has the immense benefit of easy formation of capital. The capital received from an IPO can:
Write off existing debts
Going public can be a costly move to pull off. Therefore, it is quite normal for companies to incur debts in that process. Another benefit a company gets from an IPO is that it can use the capital to write off existing debts or at least bring them down. This move also benefits investors because the financing and debt charges increase due to the credit crunch.
Going public increases the liquidity factors for the companies because then, it becomes easy for the company owners/founders to convert their ownership into other forms of investments and currencies.
Help work on public image
If a company can pull off a successful IPO, it means guaranteed media coverage and terrific publicity. The company can utilize public attention to enhance its public image and earn the trust and confidence of the public.
Aid in acquisitions and mergers
It also helps in easing out acquisitions and merger plans for the company. When a company grows, there is a high chance of merging or acquiring smaller companies or competitors. Being a publicly owned company helps ease out this process as the deals usually include transactions of shares.
Disadvantages Of Going Public
Trading will always have a good potential for pros and cons, opportunities, and risks. The same is true in this case. So, let us quickly take a look at the possible disadvantages a company might face when it decides to go public.
Keeping up with reporting costs
The process of applying for an IPO can be long and costly. The first expensive step in this process is appointing an underwriter. As these are investment banks, the price for appointing them could be pretty high. Other steps, like all the applications, submissions, and legal steps, can be heavy on the company funds too.
The expenditures do not end with receiving the IPO investments. Companies need to periodically submit reports and proxies to legal and regulatory bodies and keep the shareholders in the loop. These costs are expenditures to look out for.
Dragged decision-making processes
Once the public invests in the company, they also hold a percentage of ownership in the company. As such, they come together to choose the board of directors for the company, who will be responsible for taking major decisions for the company. Therefore, any changes or decisions to make will first have to be approved by them to initiate execution. This process can sometimes hinder swift decision-making.
Lack of privacy and control
When a company is private, the founders may run it as they please. They have complete control of operations and which course to steer the company in. However, when the company becomes public, the ownership shifts, with the public holding a certain percentage of rights over the company. Under that condition, the public holds the right to confidential information about the company, which the company will have to share with them. We are talking about key projects, visions, goals, strategies, financial standing, and KPIs (Key Point Indicators), all need to be shared with the public at large.
What does going public mean? It would simply mean that the company is now listed on the stock exchange. Now, we all know that the stock market is susceptible to volatility, depending on how the market reacts to various factors. As such, events in other industries may also affect the companies.
To wrap it up, a company may decide to go public because it would like to procure capital to expand further. It can do so by issuing an IPO, as approved by the SEBI. Once an IPO is issued, the public can invest in the company by buying its shares and later trade them on the stock market.
Going public can have several benefits for both the companies and the investors. But along with that, it can also bring in a boatload of disadvantages that a company must confront. All in all, the visions the owner of a company holds and the kind of path the founder has determined for the company would decide whether they would want it to go public or not.
Frequently Asked Question
Why does a company go public?
A company may decide to go public to procure more capital for further expansion, development, and growth of the company.
What is an IPO?
An IPO is the first offering of shares that a company issues for the public to invest in. It is the process through which a privately owned company transitions to a publicly owned company.
What is the full form of IPO?
The full form of IPO is Initial Public Offering.
Is it better for a company to stay private or go public?
It depends on the company's long-term goals and where its founders vision it in the future. While staying private allows the founders to run it as they want without having to keep up with various legal requirements, going public will enable the company to quickly and steadily generate a considerable amount of capital.
Who gets the money when a company decides to go public?
The initial money raised through the IPO goes straight to the company. But once the shares are up for trading in the stock exchange, the money is exchanged between investors through buying and selling. The company does not receive this money.
What are some of the major disadvantages for a company to going public?
Some significant disadvantages include the expensive IPO process, losing control over how to run the company, and complying with strict and uncompromising rules and reporting regimes set by SEBI.
Do I need something specific to invest in an IPO?
Yes, you would require a Demat account and a PAN card to invest in an IPO.
How long does an IPO stay open?
An IPO may stay open from 3 to 21 working days, though on average, it mostly stays open for up to 5 days.