Why Do Companies Go Public?
Hello, traders. Welcome to the stock trading course and the first module, Introduction to Stocks.
In this lesson, we’re going to discuss why companies decide to go public and why do they decide to be listed as a publicly traded company. And there’s a lot of reasons why companies decide to go public but the main reason is financing, and that’s what we’re going to discuss on this lesson.
But first of all, let’s talk about the public appealing of an IPO. Going public and offering stock in an Initial Public Offering, or IPO, represents a big milestone for most privately owned companies. First of all, it shows that the company has grown to a size that even the public is interested in investing in. But this is not the main reason companies go public. I mean, why would the founders of this company want to share the profit with thousands of other people? I mean it sounds illogical but I’m going to show you, or I’m going to tell you, right now why it isn’t. The reason is that at some point, every company needs to raise money outside the private banking circle. And when I’m talking about banking circle, I’m talking about investment banking circle, okay? Now, these first rounds of privately raised funding for a startup come to an end when the company rose to a size that they need to raise money in order to keep them financially backed.
When companies achieve this size, it’s cheaper to sell a part of the company than to borrow the money because it doesn’t require for the company to pay back the money. Now this is very straightforward. If you borrow money for financing, you are going to have to pay this money back, plus interest. But if you sell a part of the company, you are going to get the same amount of money that you want but you are not going to have to pay it back, and that’s the difference. Financing the company by borrowing money is called debt financing and financing it by issuing stock is called equity financing. And that is why privately owned companies go public, to finance the company, increase the company value by issuing millions and millions of shares.
In addition to the prestige of being listed, another key reason why companies go public is to spread the risk of ownership among a large group of shareholders. Spreading the risk is important when a company grows and the original shareholders want to cash some of their profit while still wanting to remain shareholders for the company.
As publicly traded, companies get more leverage when obtaining loans from financial institutions and that is another big reason why companies go public because in the eye of the financial system, they are much healthier and easy to loan to. There is also the exposure part of being listed. It attracts big players to invest when before being listed, they pass or these companies pass under the radar. Stock can be offered to potential employees, making the company more attractive to top talent. And when trying to acquire other companies, listed companies can offer a package of cash and stock in order to acquire them.
So, there’s a lot of reasons why companies should go public. There’s not only the financing part, which is a big part of an IPO, but also the exposure these companies get with being listed.