Why Companies Want an Initial Public Offering

Often, we hear entrepreneurs talk about starting a company with the ambition of listing it on a stock exchange one day. We might even get excited about the potential opportunity to invest in a company which we will not have thought of creating or managing ourselves.

However, from an investing stand point, it’s also important to consider  the motivation behind a company’s wish to be taken public. By asking ourselves, “Why would a company’s management and founders want to do so,” we can help shield ourselves from getting the shorter end of the straw.

Increase public image and prestige

Sometimes, it can be as simple as just plain old prestige. Ego plays a big part in being a successful entrepreneur, as it provides the confidence and optimism needed to bring a company to a level no one else can imagine. Being part of top management teams of a listed entity would very likely give entrepreneurs something to be proud of.

Access to public funds and other financing

A more logical and business-oriented reason for a company wanting to float its shares on the public market could be due to its need for funds to grow or to clean up a debt-bloated balance sheet.

While the founders of Q&M Dental Group (SGX: QC7), Sheng Siong Group (SGX: OV8), and Neo Group (SGX: 5UJ) were all successful self-made businessmen, they might have lacked access to adequate capital to scale to where they are today were it not for the founders’ decision to take their companies public.

Cashing out by management

We’ve seen some positive reasons for a company wanting an IPO. But, there are also potentially negative reasons behind companies wanting to be taken public.

For instance, the main shareholders of a company might be looking for an exit plan and an IPO can allow them to exit the business in an easier manner instead of finding a buyer for the whole business.

This could be a negative for investors if the main shareholders are also the ones managing the company. That’s because the initial entrepreneurial drive to solve problems and grow the company might not be present anymore once these owner/operators cash out of their businesses. Investors who aren’t careful might end up holding shares in companies with either the original but no-longer-motivated management team or, wind up with an entirely new management team whose abilities might not be up to par.

In other cases, the main shareholders who are cashing out might be private equity investors who had taken up a stake in the company prior to its IPO. Private equity funds often have an IPO in mind as their end game for cashing out on their investments. And in such instances, it’s not hard to imagine how the seller (the private equity funds) would be motivated to get the best possible deal for themselves, leaving the buyer (investors at the IPO) with a poorer deal. So, that’s something for investors in the stock market to take note of as well.

Buyers beware

With so many motivations behind an initial public offering, that might explain why many investors tend to disregard this space as a whole. The lack of information and a track record about the business and its management team as a listed company might present unnecessary risks to an uninformed investor.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.