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Reading: Why Go Public?The IPO DecisionWhy does it make sense for the owner(s) of a private company to sell stock to the public? Think about what an initial public offering (IPO) means. The owner(s) are accepting some number of strangers as partners in their business. Furthermore, there are no restrictions on these new owners’ ability to sell their stock, so these unknown partners can sell to other unknown partners.The usual reason to go public is the need to expand the business. The company wants to take advantage of some business opportunity but does not have the cash to do so.Risks of Going PublicGoing public can have its negatives for the company and its owner(s):Other people will own part of the company and share its profits.The money from the sale of stock does not go to the original owner(s).The company’s current owner(s) must give up a lot of control over the way the business is run, because management must consider the needs of public investors.The company must be managed in a more formal, more deliberate way, which means decisions will take longer.The federal Securities and Exchange Commission (SEC) will oversee the way management reports financial results, and the company will face significant legal penalties for violations.Pressure from stockholders to produce a profit every quarter may limit management’s ability to take a long-term view of the business.Benefits to the Original OwnersThe other side of going public is that it can offer benefits to the company and its original owners. If all goes as expected, the company’s sales will grow with the influx of new capital, and the company will make much more money. With the money it makes, it can pay a healthy dividend on its stock, causing the price of the stock to increase. Even though their ownership in the company has been greatly reduced, the original owners can benefit from stock dividends and the higher value of the stock they do own—and may make considerably more money in the long run.The IPO ProcessWhen a company decides to issue securities (a certificate of ownership in an investment), it generally hires an investment bank to underwrite the stock offering. Underwriting means the investment bank (or a group of investment banks known collectively as a syndicate) agrees to one of the following:Firm underwriting: The investment bank or syndicate will buy all the available shares of stock and then resell them to investors at a profit.Best efforts underwriting: The investment bank or syndicate will sell the stock as the company’s agent, earning a commission on however many shares are sold.The first sale of securities by a private company to the general public is called an initial public offering (IPO). The underwriter (or lead underwriter in the case of a syndicate) plays a pivotal role in the IPO. The underwriter/lead underwriter handles all the legal and financial details of the sale. It also helps the company:Prepare a prospectus, a legal document that gives pertinent information about the company offering the shares.Prepare an advertisement—called a tombstone because of its heavy black border and use of capital letters—for the IPO.Line up investors or offer the shares to the public.IPOs are distributed through investment bankers in the primary market. If the underwriters have agreed to buy the stock directly from the company, they sell it to the public for the first time. If their involvement is on a best-efforts basis, they sell the stock as the company’s agent, earning a commission on the shares sold.Who Buys the Stock?Selling large amounts of stock a little at a time to thousands of investors is costly and time consuming. Underwriters want to conduct the sale as quickly and cheaply as possible, so they prefer to sell to very large investors. Underwriters usually offer IPO stock to pension plans, mutual funds, and very large private investors first, with the hope that it will sell quickly. Later on, these investors will sell smaller blocks to smaller investors.Who Benefits?When everything goes according to plan, the company raises the needed capital for expansion, debt relief, operating expenses, or whatever reason it specified in the prospectus. The underwriter makes a profit by buying all the new securities at one price and selling them to the public at a higher price (or by collecting a commission on the shares sold). If the company puts the new capital to good use, it becomes much more profitable, and its investors make money. ................
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