When business angels or venture capitalists put money into a business, there has to be a way they can realize their investments at a future date. There are majorly 3 ways for raising capital or to attract the investors as follows:
- an Initial Public Offering (IPO);
- an acquisition;
- or a buyback of the investor’s stock by the company itself.
Most investors prefer an IPO for raising capital as it produces the highest valuation in most cases. A firm doing a buyback is more likely to be with IPO as the acquisition is not feasible.But somehow the company arranges a re-financing in which it buys back the stock owned by the original investors.
Certainly, IPOs are glamorous and generally yield the highest returns for their IPO investors; however, in the long run, they aren’t always satisfactory for the entrepreneurs and the management team, for a variety of reasons.
Advantages of Raising capital from IPO
The principal reason for a public offering is to raise a substantial amount of money that does not have to be repaid. Hence the company need not part with precious existing capital to secure ownership.
A public company can raise more capital by issuing additional stock in a secondary offering, and hence there will now be a backup source to raise funds for the benefit of the company.
Realizing Prior Investments
Once a company is public, shareholders prior to the IPO know the value of their investment. What’s more, their stock is liquid and can be sold on the stock market after the lock-up period is over. Hence, prior investments may now be realized.
Prestige and Visibility
A public company is more visible and has more prestige. This sometimes helps the company in marketing and selling its products, outsourcing, hiring employees, and banking.
Compensation for Employees
Stock options presently held by employees or granted in the future have a known value, and therefore present a beneficial option for the employees to be compensated.
Acquiring Other Companies
A public company can use its shares to acquire other companies, and hence acquiring smaller or similar firms in order to expand consumer base or capture fresh consumer base becomes a valid option.
Disadvantages of Raising capital from IPO
Expenses associated with going public are substantial. These include legal and accounting fees, printing costs, and registration fees. These expenses are not recoverable if the company does not actually go public, which happens to about half the companies that embark on the IPO process and fail to complete it. If the company does go public, the underwriter’s commission takes approximately 7% of the money raised.
When a company goes public, SEBI regulations require that it disclose a great deal of information about itself, which until then has been private and known only to insiders. That information includes compensation of officers and directors, employee stock option plans, significant contracts such as lease and consulting agreements, details about operations including business strategies, sales, the cost of sales, gross profits, net income, debt, and future plans. The IPO prospectus and other documents that have to be filed with the SEBI are in the public domain.
Short-Term Time Horizon
After an IPO, shareholders and financial researchers expect ever- increasing performance quarter by quarter. This expectation forces management to focus on maximizing short-term performance rather than on achieving long-term goals. In the long-run, this may hurt the sustainability of company profits.
After an IPO, the CEO and the CFO have to spend time on public relations with the research analysts, financial journalists, institutional investors, other stockholders, and market makers—so named because they make a market for the company’s stock. This is a distraction from their main job, which is running the company for optimal performance. Some public companies have executives whose main job is dealing with investor relations.
A public company sometimes becomes the target of an unwelcome takeover by another company. This is known as a hostile takeover and can create all manner of difficulties for the company.
A rising stock price boosts the morale of employees with stock or stock options, but when it is sinking, it can be demoralizing—especially when an employee’s options go ‘‘underwater’’ (the stock price falls below the options price). Underwater options can make it difficult to motivate and retain key employees.
When an entrepreneur accepts money from a financial investor such as a business angel or a venture capitalist, there has to be a future harvest when the investment can be realized. Initially, the harvest is for the investors rather than the entrepreneurs. For any help about the funding, feel free to contact us at LegalRaasta.