Whilst reading IPO and Equity Offerings by Ross Gedes, I came across the following advantages of going public. These will be compared with the disadvantages of a company going public in a later post.
The advantages of going public that will be discussed in this article include:
- Liquidity and increased share price,
- Management and employee motivation,
- Enhanced image/prestige,
- Access to alternative sources of capital,
- Ancillary benefits.
Valuation and liquidity impact
Companies listed on a stock exchange are typically worth more than similar companies that are privately held. The information contained in an IPO prospectus and subsequent annual reports reduces the uncertainty around performance and hence increases the value of a business.
In addition, investors are willing to pay a premium for liquidity: the ability to easily buy or sell shares. Private companies have limited or no liquidity in most cases. The liquidity premium varies over time and economic conditions, but a reasonable estimate would be in the 30 per cent range. This means that if two identical companies exist, one listed and the other not, the listed company will typicallly be valued approximately 30 per cent more than the private company in the marketplace by investors.
Daily liquidity means that insiders know the value of their holdings more accurately, as well as facilitating further sales of shares. This leads a good proportion of private companies to at least consider going public.
Motivate management and employees
The use of incentives such as stock options and stock bonuses to attract and retain both employees and management became very popular; particularly in the USA and UK during the 1990s.
Equity-based awards and ownership tend to be spread more broadly among management and employees in public companies compared to private companies. In addition, management and employees of public companies can see the results of their efforts in the share price more immediately.
A significant, but intangible, benefit of a flotation is the increased visibility of the company through its ongoing disclosures to the stock exchange or securities commission. Many analysts believe there is considerable prestige attached to managing and working for a publicly listed company.
A flotation may bring marketing benefits, by making the company seem stronger and more substantial. Press coverage of public companies is typically greater than that of privately owned firms.
These factors can lead to the recruitment and retention of higher quality employees and increased sales due to greater corporate exposure.
‘While both good and bad news must be disseminated to enable investors to make well-informed decisions, a public company that is well run and compiles a record of success can gain a first class reputation that can prove an immeasurable benefit in many ways. As a company’s name and products or services become better known, not only do investors take notice, but so do customers and suppliers, who often prefer to do business with well-known companies.’ (Garner et al., 1994: 17)
Access to alternative sources of capital
Another benefit as a result of a company going public is the ability to gain access to alternative sources of capital in the future. Public companies are often able to raise money for expansion more easily and at better rates than private companies of similar size. The public debt markets are more accessible to public companies than to companies without a listing.
Moreover, going public generally improves a company’s debt to equity ratio and may enable it to borrow on better terms in the future.
One study by Pagano et al. (1998) found that Italian companies that went public were able to borrow more cheaply after their IPO. They also found that the number of banks willing to lend to a company increases after its flotation. However, they report that a similar study conducted in Spain (Planell) uncovered no significant decrease in interest rates paid after the IPO.
Ancillary benefits of flotation
The flotation process often forces a company’s management to formulate and document a clear business strategy for the first time.
This is typically beneficial to the future success of the business and in many cases is just what a private company required to truly grow from small to medium or from medium to large in size.
Along similar lines, the anticipation of public ownership leads many companies into improving their management and financial structure. Fast growing medium-sized companies often neglect the formal structures which will help them in their attempts to become larger and more profitable companies.
If you enjoyed this article, please also have a look at my blog on the disadvantages of a company going public.