18 July 2022
Going public with an initial public offering (IPO) and private equity are the two main options available to business owners who want to raise capital. What is the difference between these two options and what would one consider when choosing either of them?
An IPO- initial public offering- refers to when a private company does a public issuance of its shares to raise capital. Initial public offerings are usually initiated by entrepreneurs or business owners when they need liquidity for operations, to expand, or other reasons. Initial public offerings are managed by investment bankers who do the valuation and underwriting.
IPO shares give public investors part ownership of the issuing company and are sold on the public capital market. Once listed in the IPO market, the issuing entity becomes a public company and must publish its books.
IPO shares are usually bought by two types of public investors: retail investors and institutional investors. Retail investors are people who participate in the buying and selling of shares in the capital markets. Institutional investors are organizations or investment firms like mutual funds that also participate in the trading of shares in the markets.
The starting price for an IPO is known as the listing price and is usually determined by the underwriting company or investment bank. Once listed in the public market, the pricing of IPO shares is determined by free market forces. The price can go up or down depending on investor appetite for the IPO share.
On the other hand, private equity funding refers to when a private business or entrepreneur raises capital by selling a percentage of the company to accredited private investors or a private equity firm. To raise capital through private equity, a company does a private placement. The private investors become part owners of the corporation.
Corporations that take the private equity funding route remain private entities and are not listed in the capital markets. Their shares are not available to anyone outside the private investor pool or private equity firm. The voting rights given to the private investor(s) are subject to the agreement between the parties involved. Private equity is a great option for a startup that is not yet ready to go public.
The choice between an IPO and private placement comes down to issuing company’s capital-raising preferences and a few external factors. In most cases, entrepreneurs will assess their business model, what they are trying to achieve from investors, and the options available to them.
IPO and private placement are both viable options for corporations wanting to raise capital. Here are some of the things that determine whether a company will go the IPO way or the private equity route:
Often, the issuing company’s present and future valuation determine whether it can meet its funding goals through private equity or an IPO. Sometimes a company might be too small to go public or too big to find accredited investors who have the financial muscle to meet their capital needs.
Corporations may want to evaluate their existing ownership structure before choosing a capital-raising method. Sometimes a corporation may be forced to choose private equity if it had already taken on funding from private sources who are not ready to cede their equity.
More often than not, corporations that are going public bank on their reputation to attract investors to their IPO. Reputation is determined by the company’s performance and the relationships it has built with all stakeholders such as customers, employees, and society
In some cases, a company may attract enough interest from accredited investors or private equity firms that it does not need to go public. For example, some startups attract funding from venture capitalists who end up becoming their majority shareholders for the long term. Unless the company grows big enough to go public or the private investor wants to cash in, it may never need to go public.
The securities and exchange commission has specific requirements for private Corporations raising capital through public equity. Entrepreneurs usually evaluate the regulatory environment and assess if they meet the requirements needed for the entire IPO process.
On the contrary, private equity firms usually operate under a different set of rules and use internal mechanisms to evaluate the corporations they invest in.
Private equity firms are mainly involved in the buying and selling of equity in private Corporations as well as the management of investment portfolios for their members. Private equity firms do not participate in IPOs although a number also raise equity through IPOs and are listed. For instance, over 20 private firms went public in the 2020-2021 period with a combined valuation of $5.27 billion.
Public equity refers to the publicly listed shares of a corporation. Public equity is available to any investor and can be bought or sold at any time. On the other hand, private equity refers to the share of a corporation held by privately accredited investors.
Both IPOs and private equities have their advantages and disadvantages as sources of capital. Here are some of them:
For a corporation needing fast capital injection, private equity is usually the best option. There are fewer regulatory hoops to jump and even fewer parties involved in the entire process. Sometimes private equity deals can be completed in a matter of hours or days depending on the parties involved.
Corporations owned by private investors don’t have to worry about their fluctuating wildly and affecting their net worth or liquidity.
Decentralized management- in most cases, a smaller pool of investors means control is ceded by the founders to the board. Also, some private equity investors may want to restructure the corporation.
Less Visibility- Publicly traded corporations are generally more visible than privately owned ones because more people are interested in them and they are listed in public exchanges.
The representative democracy model in publicly traded corporations allows founders to retain a higher level of control through share classes and voting rights.
Corporations usually go public because they want to gain access to the large pool of investors in the open market. A successful IPO issue guarantees that the issuer will raise the capital it needs.
It’s easy to buy and sell shares of a public corporation. When necessary, the corporation can buy back a portion of its shares to gain more control.
Going public gives a corporation continuity meaning only when it is formally dissolved does it cease to exist. Board members and shareholders can change over time but the corporation will remain intact.
The IPO process is usually long and complex because of the number of stakeholders involved and the requirements to go public.
Going the IPO route means a corporation has to publish its books for regulatory and public scrutiny. It has to comply with the requirements of the Sarbanes-Oxley Act, Securities Exchange Act of 1934, and other regulations or reporting standards.
A publicly listed company’s valuation or share price is at the mercy of investors. Depending on market conditions, the price can fall or rise and affect the net worth of the underlying company negatively or positively. Often, Corporations have to do everything to keep investors happy.
Overall, IPOs and private equity are viable capital raising. Generally, a business would want to explore private equity or venture capital until its valuation is big enough to go public.