Becoming a public company is usually the dream of many start-up founders. The biggest question among new entrepreneurs is on how to become a publicly traded company. In this article, we will explain how to be a public company.
- 1 What is a Public Company?
- 2 Differences Between Private and Public Companies
- 3 Why Companies Go Public
- 4 How Companies Become Public
- 5 How an Initial Public Offering (IPO) Works
- 6 What Are the Cons of an IPO?
- 7 Main Participants in an IPO
- 8 Final Thoughts on How to Become a Public Company
What is a Public Company?
A public company is one that is traded in the stock exchange. There are so many companies that are traded in exchanges around the world. In the United States, there are more than 4k companies that are traded. These companies are of all sizes. The biggest publicly traded companies in the US are Microsoft, Apple, Amazon, and Alphabet, Google parent company. These are valued at more than $1 trillion.
Differences Between Private and Public Companies
There are several differences between a public and a private company. First, a public company is mandated by law to release several important information to the public. For example, it must release its quarterly earnings. Private companies are not mandated to do this.
Second, a public company’s shares are very liquid. This means that investors can easily sell their shares. This is not the case with a private company. In some cases, it is usually very difficult for shareholders to sell their holdings. A good example of this is Elizabeth Holmes, who founded Theranos. At the height of her career, Holmes was worth more than $4 billion. However, when the company started to collapse, she could not sell her stake to anyone.
Third, public companies have an easier way of raising capital than private companies. This is because a public company can sell its stock if it needs to raise capital. It can also issue bonds. This is not the case for most private companies.
Fourth, private companies can do whatever they want with their income. This is not the case with public companies. In publicly traded companies, a company must justify what it does to its income.
Lastly, public companies can be target of activist investors. An activist investor is a person who invests a small amount of money in a company and then advocates changes. Bill Ackman and Carl Icahn are two prominent activist shareholders. This cannot happen in a private company because the company’s owners has a bigger say.
Why Companies Go Public
Being a public company is a good thing. However, it also has several challenges. For example, companies are always at the mercy of shareholders and analysts. It is not uncommon to see a stock fall because of an analyst who released a negative report. A good example of this is General Electric, whose stock fell by more than 10% after an investigator released a negative report. Therefore, the question is on why companies chose to go public:
- Liquidity. Public companies are more liquid than private organizations. This means that investors can buy and sell shares at any time.
- To raise money. Companies go public to raise money in a cheap way. For example, Casper, which became public on February 6, 2020 did so because it was impossible to raise money from original investors.
- Exit strategy. Many companies are funded by venture capital (VCs). These VCs pressure a company to go public so that they can make a profit from their investment.
- Credibility. Many companies go public to boost their credibility. This is because many people seem to trust companies that are public.
How Companies Become Public
Companies become public by merely selling their shareholding to other investors. There are three main methods that companies become public:
Initial Public Offering (IPO)
This is a process where a company sells its shares to the public. The company works with banks and other advisors to list the stock in an exchange.
This is a process that is becoming relatively common these days. Slack was one of the companies that skipped doing an IPO and opted for direct listing. In this process, a company sells shares directly to investors.
This is a process where a public company buys a private company and makes it public. A good example is what happened to Virgin Galactic. Social Capital Hedosophia, a company that became public a few years ago, bought Virgin Galactic. Virgin is backed by Richard Branson.
How an Initial Public Offering (IPO) Works
The Initial Public Offering is a long process where a private company becomes a publicly traded company. The process has a number of steps. These are:
- Selection of advisors, lawyers, and investment bankers.
- Documents submission.
- Initial public offering.
Selection of Advisors, Lawyers, and Bankers
The process of an IPO starts where a private company decides to go public. The company then talks to advisors, lawyers, and investment bankers. These advisors helps it start the process of being a publicly traded company. Examples of these advisors are companies like Goldman Sachs, JP Morgan, and Lazard. These advisors cost millions of dollars.
The next main step is when a company submits its prospectus to the Security and Exchange Commission (SEC). The prospectus is known as form S1. The form, which is usually more than 100 pages long describes in detail the company. It describes what the company does, the risks it faces, the amount it is raising, the valuation it is seeking, and the finances of the past few years.
These documents help shed light on the company. WeWork is a good example of this. As a private company, WeWork was valued at almost $50 billion. However, investors started to question the company when it submitted its S1. They saw the losses the company was making.
An IPO roadshow is a process where the company goes to big investors and explains to them about their operations. The goal of this process is to create demand for the company. The goal is also to see whether investors are interested in the company. It is in this stage that you start seeing a company’s valuation start to rise or fall.
The final step is when the company starts trading. In this stage, the underwriters work with the exchange to introduce the company to the market. After the company goes public, retail investors can start buying and selling the shares.
What Are the Cons of an IPO?
There are some cons or challenges that are associated with an initial public offering. Some of the main cons are:
- Long process. An IPO is a long process. On average, it can take more than 6 months before a company becomes public.
- Disclosures. Disclosures like the S1 can dampen the mood of the company. This happened with WeWork, which saw its value drop from $45 billion to less than $10 billion.
- Expensive. The IPO process is not cheap. Lawyers, advisors, and underwriters tend to charge millions of dollars for these services.
Main Participants in an IPO
There are several stakeholders who must participate in an initial public offering. Some of these participants are:
- Lawyers. Lawyers are used to ensure that that a company does everything legally. Some of the biggest IPO law firms in the US are Cooley, Pavlaw, Goodwin Procter, and Letham & Watkins among others.
- Investment banks. The top investment banks in the United States are Evercore, JP Morgan, and Goldman Sachs.
- Advisors. These are companies that advise on IPOs. Examples are Lazard and Morgan Stanley.
- Exchanges. These companies provide a venue where a company’s stock is traded. Examples are New York Stock Exchange (NYSE) and Nasdaq. (Check out the Nasdaq minimum listing requirements)
- Government. The government is involved to ensure that everything follows regulations. The SEC must be updated during an IPO.
Final Thoughts on How to Become a Public Company
There are thousands of publicly traded companies in the United States. The number is declining, as mergers and acquisitions increase. In this article, we have looked at what is an IPO, the pros and cons of being a public company. We have also looked at the benefits and challenges of being a public company. Also, we have looked at the key players in the process.