Going Public vs Staying Private: Advantages and Disadvantages

An initial public offering, or IPO, is where the stock of a private company is offered to the public. Several companies had turned public, and all of them have one goal: To expand their capital.

In an IPO process, every investor must be prepared for both favorable and unfavorable risks.  In this lesson, we will give you some of the advantages and disadvantages of companies going public.

READ ALSO: Business Risk and How It Occurs

IPO FAQs

Q: Are all companies turned successful after going public?
A: No. There were notable IPO flops in the market history, but it's on the investor’s point of view of when to say that an IPO turned out completely unwell. Known or not—every company turning public can’t really tell its outcome. Going IPO means opening your company into greater public scrutiny and fickle market forces.

Q: When should a company go public?
A: It will always depend on a company’s need for cash or liquidity to pursue its strategic plans. A market consensus said that there is a ‘window’ where companies can affect IPOs. Open or closed window, conditions will still depend on the economic conditions and investor’s readiness for risks.

Q: In the company, who are involved in IPO?
A: Going public needs proper and professional advisors. An IPO team will be composed of a lead underwriter and potentially o-managing underwriters. In addition, an independent auditing firm with significant public company experience, outside legal counsel, a transfer agent, and a financial printer are also necessary.

The Pros and Cons of Going Public

It will be tough for an investor to predict a stock’s performance on its initial day of going public and in the near future, as there is often little historical data to use to analyze the company. It makes this process very risky. Also, most IPOs are for companies that are going through a transitory growth period, meaning that they are subject to additional uncertainty regarding their future values.

PROS:

IPOs are appealing to every investor as its good results, if successful, can drastically increase a company’s potential for growth, technology, and overall development. If a company needs massive money for further expansions, then IPO is an option.

For owners, successful IPO can cash in all their hard work. They usually award themselves a specific percentage of the stock shares. IPO puts investors on the ‘ground floor’ process. IPO shares often skyrocket in the value when they are first made available on the stock market.

Also, by going public, a company can improve its financial condition by having money that does not have to be repaid.

Eric Chen, an associate professor of business administration at the University of Saint Joseph in Connecticut stated, “Going public gets you cash—and usually lots of it; where you might have been cash-constrained before, you’re now flush with capital that you’re supposed to invest in the company in order to make it grow exponentially.”

Chen said he participated or led more than 25 companies going public.

Going public provides certain legitimacy, Chen added. “People will know about you. Being public will make it easier for you to do business with others. Securing financing will also be easier.”

Since the money companies raise from going public usually shores up the balance sheet, potential investors, and business partners may feel more comfortable working with the company going public because the Securities and Exchange Commissions will file your company’s information and it will be available for everyone to see.

Going public also means a company’s stock, by means of stock options, can be offered to employees and contractors as a form of incentive compensation. Company’s stakeholders also benefit from holding shares that are freely marketable and may be used as collateral for loans. However, holding shares are subject to given restrictions.

Furthermore, publicity traded shares command higher prices than shares that are not publicly traded.

CONS:

Several requirements needed for IPO are expensive and time-consuming, and being publicly traded have significant drawbacks.

Going public makes a company’s management loses some of its freedom to act without the approval of the board and majority of the stakeholders in certain matters.

Going public means spending more money than a private one. Chen said that going public itself is an expensive process. “You have to pay for road shows, and your senior management is going to spend lots of time preparing for the offering instead of focusing on the business.”

From above statement, IPO can essentially distract company leaders—putting their focus on going public rather than their scope of work. This can hurt profits.

A company should submit detailed sensitive information on an ongoing basis. This includes business strategies, salaries, compensation arrangements, and financial records. It is also required to have its financial statements audited on a regular basis.

In addition, offering an IPO means a company will surrender some control to stockholders. They may judge the management in terms of profits, dividend, and stock prices—making the management strategize short-term rather than long-term goals.

Keep in mind that public companies are responsible on their shareholders. A negative public sentiment or a lack of trust from shareholders may cause a company’s fall, as shares sell for lower prices and investors become more difficult to find.

Business owners may not also able to take many shares for themselves. In some cases, original investors might require them to put all the money back into the company. Even if they take their shares, they may not able to sell them for years.

The Pros and Cons of Staying Private

One advantage of a company staying private is the management can have and maintain the full control over the company. Although it is possible to maintain control even throughout equity offerings, it invariably will erode the founder’s hold on the business to some degree, and the dilution of ownership is undesirably understandable.

Private limited companies enjoy tax advantages; they are exempt from higher income tax rates compared to those companies that are public.

Another advantage is keeping and preserving a company’s culture. Some individuals prefer and got used to working in a less stellar environment. Bringing outsiders, public or private, means bringing their cultures on the inside.

On the other hand, entrepreneur and trader Mike Ser said that staying private may lose a company’s chance to attract top talent through benefits like stock incentives. Private companies cannot use stock as currency to acquire competitors or other companies. “If you're a private company, it's more of a challenge as you either have to have cash or borrow debt to acquire companies,” he said.

Furthermore, staying private limits liquidity for current investors, as selling their stake in the company through public exchange would be quite difficult for them. In the case of a lesser-known company, the only potential buyers are only the other existing owners. 

Why some companies prefer to stay private longer?

One probable reason for this is the fact that public market investors don’t buy small companies; they have a preference for larger companies—which are given higher multiple at the time of IPO and in the aftermarket.

Startups today aren’t valuable for future exit potential, but for the proprietary data produced while a company still is private.

From Public to Private

A public company can also go private. A “take-private” transaction means that a large private-equity group, or a consortium of private equity firms, purchases or acquires the stock of a publicly traded corporation.

In the United States alone, the value of “take private” deals surged from $14 billion for the entire 2012 to roughly $80 billion by Early August in the following year.

A survey by consultants McKinsey on the difference between public boards and private equity-led boards concluded that public company boards “Focused more on budgetary control, the delivery of short-term accounting profits, and avoiding surprises for investors.”

“Public boards operate in a more complex environment, managing a broader range of stakeholders and dealing with a disparate group of investors, including large institutions and small shareholders, value and growth investors, and long-term stockholders and short-term hedge funds.”

Struggling companies may go private, fix the firm on the inside by resolving internal conflicts, and also strategize the plan straightforwardly. If successful, it can go public again.

Summing It All Up

Both advantages and disadvantages of going and staying private were mentioned above. Always keep in mind that Issuing an IPO isn’t always the best choice for one’s business. It isn't the only way for a company to raise capital. Access to the public comes at a high price in the form of scrutiny for both SEC and shareholders. As a result, several private companies tend to stay private and find other sources of capital.

If one wants to maintain control and avoid the filing process, he can turn to loans as a way to get the money the company needs to expand. Venture capital, which comes from firms that invest in companies with a high potential for growth, doesn't give investors a controlling interest in the company but does tie them to its financial future. Business can also sell off assets, including property and patents, as a means of raising capital to invest elsewhere in the company.

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