Stay level-headed as you consider more than just the achievement and yield.
Publicizing a private company is a notable accomplishment that can bring several critical advantages. However, if you’re deciding whether the time is right for your company to pursue an IPO, you have several factors to consider beyond the success of reaching the milestone.
The IPO Market Today
When a business expands, private owners may better understand market pressures from competition that they were never exposed to before.
The IPO market is increasingly competitive, and comparisons are limited to critical players, with investors expecting products to innovate with the best possible customer service continually. On top of that, financial markets are pressuring privately-owned companies to take significant undertakings to prepare for becoming a public company, giving other market players an edge as they can contribute to the company’s consistent growth and benefit from it.
On the other hand, the market wisdom tells us that any company that outpaces the industry will have a better chance of attracting key investors than only a few with higher risk-taking approaches.
Investment bankers want the subsequent IPO that they support and underwrite to be successful. Therefore, they search for companies that can meet several benchmark criteria to boost the chances for a successful offering and solid performance in the aftermarket. Most bankers evaluate a company based on several measures before getting into the conversation about its success criteria. However, they create a picture where the public market can analyze or verify its potential success.
With all this in mind, here are several factors to consider when deciding whether your company is ready for an IPO.
Role in the Market
The first criteria are the size of the addressable market. A company’s role in the market is one critical test for the analyst addressing the opportunity to expand their revenue. The company must present a unique and differentiated business model from the traditional players. A disruptive business model with an attractive product or service is always favored.
The company’s essential product or service can be competitive, preferably with the first-move status (or right behind with product differentiator). Many companies develop great vision, strategies, or follow simple principles, but that's not enough. What you deliver must be well-thought-out, with a focused business plan based on a proven track record.
When you test a strategy with real customers and prove you can retain them, it gives investors and analysts confidence that your company not only knows "what" to sell but “how” to sell it. Showing discipline with thinking is critical. Therefore, bankers turn their eyes toward management, expecting to see a good execution plan (beyond any doubt) to help them evaluate public company readiness. Management must be experienced operating in the post-IPO environment to sustain the growth and execution process.
Having strong financial, operational, and compliance controls can be a big challenge for a scaling company because it might be perceived as a growth inhibitor or unnecessary red tape. Still, it's a required adjustment.
Unfortunately, future investors or markets won’t tolerate the company's flexible approach to commitments or industry-related expectations. As a result, a few financial aspects of the evaluation must be met before the company-ready status is confirmed. Revenue growth and visible future earnings, and cash flow are the most typical assessment areas. You might think profitability would be a key indicator, but it's not always necessary for a company to be a strong IPO candidate. However, profitability significantly increases the company’s credibility before going public (especially if it's a 20%+ operating margin). The most significant factor is the pace of subscription or contract acquisition with followed customer retention rate.
Many examples of IPO-ready companies were meeting only a few of these criteria. Each IPO is slightly different and provides different types of opportunities (which is its beauty, actually). Companies that don't meet those criteria may still have excellent potential to expand their specifics. Their product or service might be highly unique or simply of the public interest. Great examples are coming from industries that require more prolonged incubation before the product is built. These are riskier IPOs, but they help these organizations collect the necessary capital to accelerate their product delivery (e.g., automotive or biotech industries).
Capital Strength
Sufficient capital is among several other factors to consider while exploring moving to a publicly traded company.
Building an ability to execute in changing market conditions requires capital. That's even more critical when entering traditional industries or markets with incumbent players. Increased cash and long-term money should provide the necessary funds to support growth, increase working capital, invest in cutting-edge infrastructure (e.g., plant and equipment), continue higher spending in research and development, or retire debt.
Once public, the company will likely have a higher market value (capitalization) than its privately-held competitors. The main reason is increased liquidity and the transparency and availability of information on publicly traded security.
A public company can use its stock as asset acquisition currency in the mergers and acquisitions market. It helps the company conserve cash for other expensive projects or provide good stock value to their investors.
Transparent Communication
After an IPO, there is no private company anymore, so the company must communicate in different forms than before.
Getting more transparent with the public company status might impact the ongoing business during negotiations. In addition, a public company can enhance its reputation and brand beyond its shareholders and company.
The financial or non-financial statements are public information and can impact stock performance. Among the biggest are the registration statement and subsequent filings for public company reporting. These sometimes require painful disclosures of many facets of a company’s business, operations, and finances that may never have been known outside the company. In addition, all market players will have access to sensitive areas that the company didn’t share.
These disclosures become available to competitors, customers, and employees. They include extensive financial information (e.g., P&L, Balance Sheet and your Cash Flow statements, business segment data, related-party transactions, borrowings, significant customers, and assessment of internal controls). That's an entirely new experience for the entire organization, and many individuals may have never been exposed to that operational and financial challenge.
Another significant change with an IPO comes with compensation disclosures for officers and directors, including cash compensation, stock option plans, and deferred compensation plans. Additional reporting is required for officers, directors, and significant shareholders (depending on their shares, ownership, or question scale). In a few instances, the companies must report various corporate practices required due to their industry (e.g., Dodd-Frank Act regarding conflict mineral disclosures that must include the source of their minerals, name of the mineral, country of origin, etc.).
Very often, companies are getting exposed to their personnel after becoming public. Once a publicly owned company, part of the employee incentive plans are usually stock purchase plans that act as a retention mechanism. Continuing growth in stock value could help attract key talent with more generous salary arrangements. Stock options become a bit more attractive for critical managers due to the higher upside potential.
Additional Costs
Going public will cost add extra cost. A few key factors play a role in determining the cost of an IPO, but these costs are unavoidable. Various prices usually include multiple fees to legal and accounting advisors and printing costs. These fees continue beyond the advisory fees with driven regulatory purposes, including the SEC filing fee, the exchange listing fee, and any Blue Sky filing fees. Usually, the IPO costs will not be expensed in the income statement. However, if the IPO is not completed or is not likely to be completed, the costs will be expensed.
Unfortunately, that's not the end of the list of additional costs. In addition to that, many companies need to keep moving as public companies. Pre- or post-IPO company needs include demand for new employee roles to meet the responsibilities of being a public company, like collecting and reporting information for the SEC requirements.
The most significant impact on additional staff needs will be finance and reporting, legal, human resources, IT, and investor relations. There will be ongoing expenses related to these changes, such as the expense of independent auditors. On top of the new headcount hire, we have additional administrative and investor relations costs. These expenses are generated by the necessity of creating quarterly reports (10-Q), annual reports (10-K), proxy materials (shareholder voting materials), transfer agents, and public relations.
Possible Loss of Control
The last point to consider is losing control over the company. The company’s significant change, from the operational perspective, is driven by slightly different, non-negotiable dates that fit the public market.
Many companies go through the IPO process so that management and the board of directors may maintain adequate control, even though they own less than 50 percent of the shares. Other examples of IPO companies decided to go public with different offering structures.
After an IPO, the founder (or founders) still maintains control. In those situations, advisors suggest using dual-class stock, corporate governance, and voting structures. It might work exceptionally well if a company doesn't have large-scale sales yet.
The Bottom Line: IPOs are Still a Sign of Success
Although many exit strategies exist, an IPO remains the golden standard of a company's success. However, the successful process will create additional costs that will likely be more than you may expect if you have not gone through the IPO process before.
However, the most significant part of the investment focuses on making the company operationally and financially ready. That comes obviously with necessary incremental investment, but it can be less acute if you establish a disciplined approach to operational excellence. That could be introduced early enough without exposing the organization at scale to lengthy and hindering the IPO readiness process.
A company's founders should consider relying more on finance and revenue operations to facilitate this disciplined approach. Reducing that risk should be an equally important objective as growing your product or scaling customer acquisition; instead of focusing on the "what,” we should focus on the "how" that makes it a reality.
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