While many IPOs turn into hits — such as Google (NASDAQ:GOOG), Salesforce.com (NYSE:CRM) and LinkedIn (NYSE:LNKD) — success is far from guaranteed. Some companies, like Pets.com, have filed for bankruptcy within a year of an offering. In other cases, companies end up going back to private ownership. This actually was a huge trend from 2002 to 2007, which benefited private equity firms like the Blackstone Group (NYSE:BX) and KKR (NYSE:KKR).
And through the years, the IPO process has become much tougher. For example, there is an extensive set of regulations that require lots of disclosure, as well as strong information systems. The result: It can cost millions of dollars a year just to keep up with compliance requirements!
A public company also must find ways to develop interest in its stock. Again, not an easy task. Because of consolidation on Wall Street, fewer analysts provide coverage. In fact, it’s not at all uncommon for a public company to have no analyst coverage.
Then why go public? Despite the drawbacks, there certainly are some major benefits. Here’s four reasons why companies go public:
Cash: The obvious one. A typical IPO will raise between $100 million to $150 million. Of course, in some cases, the amount has topped $1 billion, as seen with Zynga (NASDAQ:ZNGA), and Facebook is expected to raise $5 billion. This money can be critical for hiring more people, building facilities and creating breakout products, and it also can be extremely helpful for making important business-growing acquisitions. However, part or even all the cash might instead go to the existing shareholders, such as the founders, senior executives and investors. One such case is Dunkin’ Brands (NASDAQ:DNKN). During its IPO last year, the company’s private equity investors — Bain Capital, Carlyle Partners and Thomas H. Lee Partners — cashed out shares at a tune of $21 million each.
Credibility: Being a publicly trading company is considered a major achievement. And it also is a statement — it means a company has the wherewithal to meet rigorous federal regulations. This is especially important for companies that eventually want to land larger customers. Going public provides a sense of corporate stability.
Currency: The value of private stock is difficult to determine. After all, it’s usually difficult to covert it into cash. But such is not the case with public stock. And because of this, a company can use its stock as currency to buy other companies.
Liquidity: As Facebook’s Mark Zuckerberg stated in the company’s prospectus:
“We’re going public for our employees and our investors. We made a commitment to them when we gave them equity that we’d work hard to make it worth a lot and make it liquid, and this IPO is fulfilling our commitment. As we become a public company, we’re making a similar commitment to our new investors and we will work just as hard to fulfill it.”
The fact is that by being public, a company’s key supporters can get rewarded for their efforts and risk-taking. This means being able to sell shares in the company over time. Often times, these stock options can be worth much more than an employee’s salary. In Facebook’s case, more than a thousand employees are millionaires because of their stock options.
Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “The Complete M&A Handbook”, “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli or reach him via email. As of this writing, he did not own a position in any of the aforementioned securities.