We examine the benefits and pitfalls of two ways a company can go public, with recent examples
A company is a private entity until it chooses to issue stock shares and go public, primarily to raise capital and offer an exit plan to initial investors in the firm; but not every company can go public. Requirements for listing a company include having audited financials, a predictable and consistent revenue, the cash to finance the listing, and growth potential in its sector.
Advantages for listing (aside from a stronger capital base) include easier acquisitions, diversified ownership, and the prestige of belonging to the growing group of companies in the public sector. The cons are increased costs, pressure on short-term growth, public transparency, and loss of control and decision-making on the part of the business owners. Here are two paths a company can take to list publicly.
With a traditional Initial Public Offering (IPO), the company hires an investment bank to underwrite shares, agrees on the number and price per share, and tries to sell those shares with the goal of securing a profit. Just like different mortgage lenders have their own set of requirements, underwriters do as well and they can include varying minimum revenues and annual profits and five-year growth projections. The entire process can take up to a year and cost as much as a billion dollars.
2020 saw 480 IPOs debuting on the U.S. stock market, the highest number ever and over 20% higher than the last record year of 2000. The first company to go public in the U.S. was Bank of North America, circa 1783. One of the largest more recent IPOs was Facebook in 2012, valued at roughly $16 billion. Companies like Airbnb and Snowflake have taken the route of the traditional IPO when listing last year.
Other companies, like QuantumScape and Nikola, chose the route of the Special Purpose Acquisition Company (SPAC), also known as a ‘reverse takeover’ or ‘reverse IPO.’ In this transaction, investors from a private entity take over the majority shares of a public company, which is then merged with the purchasing company. Why would a company choose a SPAC over a traditional IPO? It’s cheaper and faster.
The underwriting fee for a SPAC tops off at 5.5%, whereas with a traditional IPO, it can be as high as 7%; additionally, the timeline for the entirety of the SPAC offering is 3-4 months versus up to a year with an IPO. With a SPAC, a private company can offer forward-looking guidance for profitability and revenue whereas a traditional IPO company can only share past financials and discuss the total addressable market. SPACs also have a time limit to close their deals which gives investors a shorter horizon to see a possible upside.
There were 248 SPACs in 2020, the highest number ever and a four-fold increase over 2019 because companies are trying to get to market faster and at a discount.
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