Pros and Cons of IPO for Early-stage Companies

Founders of most early-stage companies need capital. Most initially seek capital from private investors and venture capital firms, which ultimately dilutes the founder’s ownership interest. To grow the business and get investors the return on investment that they desire, additional capital is often needed.

A lot of founders would like to exit by way of an Initial Public Offering (IPO). An IPO exit strategy makes a sense given the enormous success of companies like Facebook and Amazon. However, does an IPO make sense for your company? Let’s take a look at some of the advantages and disadvantages of an IPO strategy. First, let's explore some advantages: 

Advantages of an IPO 

• The first and probably most obvious advantage is access to capital. An IPO provides a founder with access to a potentially enormous amount of capital from sources that wouldn’t otherwise be available. This capital can be used for research and development/product development, which could lead to organic revenue growth. It can also be used to fund inorganic growth via acquisitions. In addition, this additional capital can be used to build out a top-tier team.

• An IPO will certainly help build the management team, as well as lead to a stronger corporate governance structure, which is something that a lot of early-stage / boot-strapped companies lack.

• An IPO leads to access to traditional financing. Most early-stage companies with a private investor base lack the ability to obtain traditional bank financing due to a limited history of revenue growth and recurring losses. After an IPO, organizations can grow revenue, reduce losses and become more creditworthy, which makes them more attractive to traditional financing sources.

• By successfully completing an IPO, a company can create more brand awareness almost overnight. In addition, due to additional capital and increased liquidity, the company has more financial resources to devote to advertising and creating additional brand awareness.

• Lastly, an IPO can give a founder a long-term role with the company that they created. In many cases, the founder will remain with the company in a key leadership position. In contrast, when a company exits to a strategic buyer, the founder might have a much shorter tenure with the acquiring company.

Now, let's take a look at some disadvantages of an IPO:

Disadvantages of an IPO 

• First off, going through an IPO is extremely expensive and time-consuming. The professional fees spent on an IPO can be cost-prohibitive. In addition, the time commitment can be several months, or even years, as the company gets ready to become publicly traded.

• A company that is considering an IPO will be subjected to additional scrutiny from regulators including the SEC. Many reporting requirements will be in place for the remainder of the time the company is public. Complying with such requirements is costly, and the results are available to the public.

• An amplified compliance requirement increases the risk that the company could fail to meet those requirements, which could directly impact the value of the company. In addition, many companies face increased volatility in stock price for several years after an IPO.

• Many founders of a company that goes through an IPO will experience a loss of control of the company, due to a dilution in their ownership, even if they retain a long-term executive leadership role.

• Lastly, there is a higher risk of failure for companies that go through an IPO. According to a recent study by Jay R. Ritter, the Cordell Eminent Scholar, Eugene F. Brigham Department of Finance, Insurance, and Real Estate at Warrington College of Business, University of Florida, the majority of new companies coming to market are unprofitable when they undergo an IPO. Ritter’s study found that since the 1980s, unprofitable IPOs have risen from around 20% to 80% of the total IPOs each year. However, Ritter qualified that observation by noting that just because a company is unprofitable when it raises public capital for the first time doesn’t mean that it will be unprofitable over the longer term.

As you can see, there are many advantages and disadvantages to going through an IPO. All of these points and others need to be considered before making the decision to go through an IPO. There are many other growth and exit strategies to consider. It can be confusing and overwhelming for a founder; however, it is important to fully understand all options before making a capital raise or exit decision.

If you are considering an IPO or seeking advice on options for building capital for your early-stage company, contact Trevor Warren, Assurance Shareholder.

Related Articles

This article is part of a series exploring the complex business challenges startup and early-stage companies may encounter as they grow. Additional articles include:

• Top Accounting Advisory Needs for Emerging Technology Companies
• Best Practices After an Equity Raise for Start-Up Companies
• Five Tax Considerations for Start-up Companies
• Understanding Leases In Technology Arrangements
• Emerging Technology Companies and the R&D Tax Credit
• Compilation, Review or Audit? What Early-Stage Companies Should Know 

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