IPO: An Exit Route for Start-Ups

The typical successful start-up obtains funding from various private investors at the earlier stages of the business. Now, these investors do not want to stay with the company forever. They just provide capital to help the company become a full-fledged business.

Once the operations of the company are in order, the private investors generally want to exit. At this stage, the start-up company generally does not have enough money to buy out the shares of the private investors. Hence, the company tends to go for a public issue. This means that the shares which are being held by private investors are offered to the general public for sale. The initial public offer is therefore a viable exit strategy that is used by many start-ups. In this article, we will understand the pros and cons of using IPO as an exit route.

Pros of Using IPO as an Exit Route

IPOs are widely used as an exit route by entrepreneurs. This is because of the fact that there are many benefits to using this approach. Some of the benefits have been listed below:

  • Higher Valuation: The first and most obvious benefit of using an initial public offer as an exit route is that the company tends to get a higher valuation. Many start-up companies have been able to sell their stock at very high valuations in the market. This is because of the buzz surrounding the success of the company in the private market. However, a high stock price is beneficial for all investors. The investors actually selling the shares are able to exchange their shares for a higher amount of cash. The other investors see a notional gain in the value of their assets.

  • Ease of Raising Capital: Once the company gets listed in the stock market, it has permanent access to the market if it wants to raise more capital. This makes it easy for the company to concentrate on finding useful projects where the money can be deployed effectively. Listed companies can raise money very easily since they do not need to find investors and pitch them the company once again. Listed companies can launch a follow-on public offer. If the company is doing well financially, odds are that the offer will be oversubscribed several times.

  • Liquidity for All Investors: Another benefit of using an IPO as an exit route is that it creates liquidity for all investors. Even though some investors may not want to sell their shares immediately after the IPO. However, these investors will always have the option to exchange their shares for cash at very short notice. Most investors find this option valuable since it makes them independent. They do not have to wait for the entire company to be sold. Instead, they can simply sell their own shares whenever they need to liquidate their holdings.

  • Brand Awareness: Another important thing about an initial public offer is that it tends to be a grand affair. Companies that go public spend money to create a brand image. They tend to get a lot of publicity. This helps in creating brand awareness. A lot of the time, this positive brand image spills over to the sales of the company. Many start-up companies have seen their sales go through the roof after their IPO took place.

Cons Of Using IPO as an Exit Route

There are several cons associated with using the initial public offer as an exit route. Some of the cons have been listed below:

  • Pressure to Maintain Growth: A lot of the time start-up companies tend to have unconventional strategies. This means that they often prioritize growth over profitability. As a result, it is common for companies to have negative cash flow.

    As long as these companies are privately held, negative cash flow is not an issue since investors tend to be on board with the overall strategy of the company.

    However, when the company is in the public domain, there is tremendous pressure to generate positive cash flow. This is because once companies are in the public domain, they are expected to work keeping traditional metrics such as cash flow and profitability in mind. Many start-ups may not be comfortable with this since it interfered with their business strategy.

  • Compliance and Admin Costs: As soon as a company goes public, the compliance and admin costs of the company rise rapidly. This is because public companies take money from the general public. Hence, they are under a lot more scrutiny. Also, the law assumes that the officeholders of the company have complete knowledge about the information which needs to be shared with shareholders as well as the regulations which need to be complied with.

    It is not uncommon for companies to appoint several new lawyers, consultants, and even a chief compliance officer to ensure that they are compliant with the law. This can lead to an astronomical increase in overheads which ends up eating into the profitability of the company.

  • Loss of Control: Lastly, start-up companies need to be able to make quick decisions if they want to survive and thrive in the market. However, public companies cannot make decisions very quickly. They are bound by law to disclose information periodically to the public. Similarly, they are bound by law to take decisions only after following a certain procedure. This can create a feeling of loss of control amongst the founders of the start-up and can cause harm to the company if it works in a competitive landscape.

The fact of the matter is that initial public offers are the most popular way for investors to exit a start-up company. However, the pros and cons need to be understood before making a final decision.

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