The Ins and Outs of IPOs
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What it is: "Going public" is the traditional endgame for most emerging companies. It is about lining up an investment bank as an underwriter and joining the likes of Apple and Google as a public company with stocks traded under a ticker symbol in a market. The Nasdaq Capital Market remains a popular choice for smaller, less-capitalized companies, called small caps.
How it works: The months-long process starts with retaining a law firm to engage in the tedious process of assembling the detailed public disclosures needed in the Initial Public Offering prospectus that is included in the Securities Exchange Commission Form S-1.
Then there's the interviewing and selecting of an investment bank or group of investment banks that will handle the underwriting, which involves setting the price and lining up the large institutional investors needed for a successful Wall Street rollout. The bank assumes the risk of selling the company’s shares in return for a percent of the proceeds called a spread.
In the weeks leading up the IPO, company executives and the underwriter engage in a "road show" to meet with analysts, stock portfolio managers and mutual fund managers in several large cities to drum up interest in the stock and gauge public interest.
Then it’s show time.
Related: The Basics of IPOs
Upside: There can be immense advantages to going public, as long as the business fits the profile of a successful public company. That means an annual growth rate of 20 percent and the potential to bring in hundreds of millions of dollars in revenue a year.
Public companies can use secondary stock offerings to raise money without having to borrow. It is easier to secure funding and loans from private sources. Stock awards can be used to attract and retain key employees. And there is the prestige and high profile that comes from being a publicly traded company.
Going public can also provide a major payday for entrepreneurs, venture capitalists and other business partners after years of effort to build a successful venture.
Downside: An IPO involves a huge time commitment that can potentially distract business owners from other strategic priorities. Going public is also pricey.
The Small Business Administration (SBA) says the fees and expenses of going public can reach into the six or seven figures. U.S. investment banks managed to charge a 7 percent spread on IPOs in the past decade, about 3 percentage points higher than their European counterparts, according to researchers at Oxford University.
Expenses and time commitment will also be ongoing once the company hits the markets, thanks to the plethora of SEC regulations governing public companies. IPOs took a major hit after the late 1990s tech bubble and the 2002 Sarbanes-Oxley Act accounting reforms, which made it more cost prohibitive for small companies to operate as public entities.
It is little wonder that fewer than 1,000 businesses a year are successful at IPOs, according to the SBA. Emerging companies have instead turned to other strategies to cash out investors, such as trying to get acquired.