Initial Public Offerings

You may have read about how some small company became an overnight success story by deciding to go public through an initial public offering (IPO) of its stock. Going public simply means that a company that was previously owned by a limited number of private investors has elected, for the first time, to sell ownership shares of the business to the general public.

Reasons to Go Public. The public sale of ownership interests can generate funds for working capital, repayment of debt, diversification, acquisitions, marketing, and other uses. In addition, a successful public offering increases the visibility and appeal of your company, thereby escalating the demand and value for shares of your company. Investors can benefit from an IPO not only because of the potential increase in market value for their stock, but also because publicly-held stock is more liquid and can be readily sold if the business appears to falter or if the investor needs quick cash. The availability of a public market for shares will also help determine the taxable values of the shares and assist in estate transfers.

Work Smart Publicly traded stock can also make a business more attractive to prospective and existing employees if stock option and other stock compensation plans are offered. Employee stock-based programs are worth more if transfer restrictions, such as those normally accompanying private company stock, are not placed on the stock.

The use of IPOs had increased in popularity before the market meltdown of 2008, but despite the IPO hype, most small companies are not going to "go public;" IPOs largely remain a financing option limited to rapidly growing, successful businesses that generate over a million dollars in net annual income.

The use of IPOs is limited primarily because: (1) there is a very high cost and much complexity in complying with federal and state laws governing the sale of business securities (the cost for a small business can run from $50,000 — $500,000); (2) offering your business's ownership for public sale does little good unless your company has sufficient investor awareness and appeal to make the IPO worthwhile; and (3) management must be ready to handle the administrative and legal demands of widespread public ownership. Of course, an IPO also means a dilution of the existing shareholders" interests and the possibility of takeovers or adjustments in management control are present.

Securities laws are complicated. The sale of "securities" to the public is regulated by federal and state laws that have two primary objectives: (1) to require businesses to disclose material information about the company to investors, and (2) to prohibit misrepresentation and fraud in the sale of securities. Under federal law, a "security" is broadly defined and would include stocks, notes, bonds, evidence of indebtedness, and most ownership interests. The law defines a "public offering" of a security not by the number of investors to whom the stock is offered, but by the classification of whether the investors are considered "sophisticated" or not. However, state law definitions of a "security" and of a "public offering" can vary from the federal law.

Possible exemptions from securities laws. Many small businesses can sell stock to insiders or to a small group of investors without being subject to securities laws; in effect, they can take advantage of alternatives to going public. However, it's not always clear where the exemptions end, so you should always consult a knowledgeable attorney before selling any stock in your company. The process of soliciting money from the public through the issuance and sale of securities requires a working knowledge of the state and federal registration statements concerning the securities to be sold, complex disclosure documents about the company with detailed information for potential investors, and financial statements. Employing professionals (attorney, accountant, and sometimes a stock underwriter) to assist in the process is a practical necessity.