8 August 2022
Most companies shy away from going public. They are usually reluctant to subject themselves to the increased public scrutiny of being a public company. However, there are circumstances under which an unwilling private company can trigger a forced Initial Public Offering (IPO).
Here is everything you should know about a forced IPO.
A forced Initial Public Offering is an IPO that happens when a company reluctantly offers its shares for public trading because it meets the requirements to be a reporting company. In essence, the company opts to become a publicly traded company only because, given the existing regulations, it makes more financial sense.
While most entrepreneurs, stockholders, and board members dream of the day that they offer their shares to the public for the first time through an IPO, some try to avoid the process.
Here are reasons why it isn’t always a great idea.
Public companies don’t have the luxury of privacy. From the time they declare their intention to go public, the law requires them to disclose every material fact that relates to their internal operations. It is an intrusion that some private shareholders would instead do without. As a result, they may be reluctant to list their company on the stock exchange.
Therefore, it is understandable why a board of directors may squirm at the idea of listing their shares either on the New York Stock Exchange (NYSE) or Nasdaq, especially if they have the option of raising capital from private investors. They may not want to expose themselves to the extensive liability concerns of being a director or an officer of a public company.
Another way going public interferes with a private company’s autonomy is the power that minority shareholders gain once the company goes public. While the majority shareholders have a significant degree of management control, going public usually strips some of this autonomy. In a public company, minority shareholders have significantly more power in the management of the company than they would have had had the company remained private.
Some directors and company officers prefer full autonomy in running their companies. Since losing this autonomy is part of the price of going public, they would rather keep their company private.
To conduct an IPO, existing shareholders must put up a given number of shares on sale. If the company is already successful, this may be unpalatable for the owners, especially when you consider they don’t have control over who ends up owning the shares that they list. The thought of going public may not be as attractive for some owners.
Given the reasons above, it is easy to understand why private company owners prefer to keep their companies private, especially if they are startups. But why do they go public even when they don’t want to?
Unfortunately, a company may be forced to go public.
It happens in cases where:
Once the company has met these thresholds, the law requires them to become a reporting company. It means that they have to file their financial reports. They also have to make public disclosures that range from their internal operations, director compensation, board resolutions, and all other disclosures that a publicly listed company would have to make.
Therefore, the owners have to make a choice. They can bear all the burdens of being a public company without the easy access to capital that often comes with going public. Another option, and what almost every company opts for, is to go public. The thinking is that they are already suffering the restrictions and intrusions that securities laws impose on public companies; they might as well become one and enjoy access to the stock market.
In short, you call it a forced IPO because the private company has no real choice. The regulations make it unpalatable to remain private. Therefore, the rules essentially shepherd them toward a forced Initial Public Offering.
Just because a company has a forced IPO does not mean it is not beneficial. Most forced IPOs have proven to be lucrative to shareholders. Here are the main benefits of such an IPO.
Companies are forced to IPO to increase transparency. Once the company’s assets exceed $10 million and its shareholder count exceeds 500, it is in the public’s interest for the company to disclose its financial health.
The increased scrutiny and oversight that comes with the company becoming a reporting company under the Exchange Act is thus meant to protect existing and potential investors from incidences of fraud or mismanagement.
The first step in a forced Initial Public Offering is a private company meeting the criteria set out in the Exchange Act of 1934. According to the regulations, a private company should start meeting the auditing and reporting requirements of a public company once:
After meeting the threshold, the company will have to register under the Exchange Act. This entails having to file annual and quarterly reports. But since most companies choose to also file for an IPO under the Securities Act, they often follow the following steps in the IPO process.
Real-world examples of forced IPOs include:
Even though it was a forced IPO, it proved lucrative for Facebook shareholders. They raised over $100 billion from the stock market, and after the successful IPO, most of the early investors in the company became rich.
Unfortunately, they couldn’t keep their shareholder count below the mandated 500 shareholder limit. Therefore, they unenthusiastically went public. However, the company going public ended up yielding over $1.2 billion from the stock market.
If you are interested in learning more about the financial market, check out our other guides. You can also contact us for further inquiries.