2020 was anticipated to be a big year for tech IPOs,
with speculation that companies like Airbnb, Palantir, Topgolf, and more
were preparing to make their public market debut.
However, due to the coronavirus pandemic,
the IPO market slowed down significantly in the first half of the year.
Fortunately, things are starting to pick up again, and there are several tech companies expected
to make their public market debut between now and the end of the year.
In this blog, we will be walking through what it
means for a company to go public,
different means of taking a company public, and how that can impact pre-IPO investors.
Going public refers to when a privately-owned company
becomes a publicly owned and traded entity.
Traditionally, going public occurs through an initial public offering (IPO),
in which a company registers and offers shares of its stock on the public market.
However, there are other routes companies can take to go public.
What’s the purpose of going public?
Oftentimes, companies will go public to raise capital through the sale of shares.
Going public can also serve as an exit strategy for founders.
In addition to raising capital and potentially opening up opportunities for expansion,
becoming a publicly-traded company is also considered a significant milestone
that can generate larger brand awareness.
Downsides of going public
One of the most significant downsides of taking a
company from private to public is the loss of autonomy.
Publicly traded companies must navigate additional regulatory and reporting requirements as well as
added disclosures for investors to help them understand a company’s business, financial condition, and prospects.
Generally, public companies are afforded far less privacy than private ones.
Different ways to go public
1. Initial Public Offering (IPO)
An initial public offering, or IPO,
is the process through which a company raises capital by selling ownership in the company (stock)
to the public for the first time.
An IPO is underwritten by an investment bank that manages the registration and
eventual listing of the company’s stock on a stock exchange.
While hiring an underwriter is expensive, their role is one of the advantages of pursuing a traditional IPO.
Underwriters are hired for their financial expertise as well as their network of potential buyers
(other investment banks, hedge funds, broker-dealers, mutual funds, and insurance companies).
As the underwriter solicits interest, they are able to better gauge investor appetite and set a reasonable IPO price per share.
2. Direct Listing (DPO)
A direct public offering, or DPO, removes the
underwriter from the equation. Unlike
where new outside capital is raised, a DPO enables owners of privately held shares (employees or early investors)
to convert their ownership into stock that can be listed on a public exchange.
Once the shares are listed, they can be purchased by the general public.
Unlike an IPO, there isn’t a predetermined number of available shares or price per share for a direct listing.
On the day of the DPO, the number of shares available is dependent on the owners of privately held stock
who decide to list their shares. Share pricing is unpredictable, reliant on supply,
market demand, and market conditions. DPOs are considered riskier, although faster and cheaper than a traditional IPO.
3. Reverse Merger (RTO)
A reverse merger, (or reverse takeover, (RTO), is a
means by which a private company can go public
by merging with an already public company.
After the reverse merger, all that remains of the
original public company is its organizational structure.
To complete the transaction, the two companies must exchange information, negotiate terms of the merger,
and sign a share exchange agreement.
At the close of the deal, the shell company issues a majority
of its shares (and board control) to the shareholders of the private company.
The private company’s shareholders then contribute their shares in the private company to pay for the shell company
they now control. This exchange of shares and control completes the reverse merger, taking the private company public.
Going public via a SPAC is very
similar to the reverse merger process;
in fact, it is technically a type of reverse merger.
The SPAC raises funds by conducting an IPO
with the goal of acquiring a private target at a later date.
After the IPO, the SPAC has a set time period in which it must identify an acquisition target
and complete the transaction.
After the selection, negotiation, and closing processes have been completed,
the SPAC and target company combine to form a publicly-traded company.
The key difference between the regular reverse
merger process and a SPAC is that a SPAC is a shell company
created with the explicit purpose of acquiring another company to take public,
whereas, in a reverse merger, the public company may be an operational business.
What does going public mean for investors?
Regardless of how a company goes public, the major
potential benefit to shareholders of non-public equity
is increased liquidity for their shares, should they desire to sell them.
In an ideal situation, these shareholders would see
a large gain in the value of their shares
when the company goes public, though, of course, that isn’t always the case.
A potential downside for investors when a company
should it issue new shares, is the possibility of dilution.
Dilution can shift shareholder positions, including value and earnings of shares, voting power,
and percentage of ownership.
However, dilution isn’t necessarily a bad thing.
For a company to grow and raise its valuation in the long-term,
it will most likely need to spend some capital and take on some additional investments.