Startup founders are constantly thinking about exit options for startups as they grow their company. From a merger to an initial public offering (IPO), a suitable exit strategy can be a very difficult decision to make, both for financial and emotional reasons. In this article, we examine the option of exiting a startup through an IPO.
What is an IPO?
An IPO, or Initial Public Offering, is where a startup will offer a specified amount of shares for public sale. After a valuation process, the shares will open on the stock market at a price determined by the startup company. Once shares enter the market at the listed price, the shares will freely be able to float on the stock market. The decision to list means that the market will determine the price of the shares and co-founders (and any employee/investor with shares) will lose direct control over the value of your company. If successful, the company will be left with a large amount of equity and cash.
Are IPOs Good for Startups?
A significant benefit of choosing an IPO as an exit option is that IPOs will, if successful, create large amounts of capital in a short period as buyers will increase the share value. This move is particularly useful for startups as they are often looking for ways to receive cash to grow further and expand their company.
Another big bonus of choosing an IPO for a startup is that you create an easy way for your existing investors to receive financial returns on their investment. Your investors will also be able to sell their share of the startup to the public much more easily now that the shares are free floating on the market.
Additionally, once a company becomes listed on the stock exchange, there is more buzz and hype surrounding the company’s initial offering. Increased publicity will help the company improve their customer base, as well as increase their brand awareness.
What’s the Catch?
While the prospect of a large amount of cash in a short time may appear very lucrative, there are a number disadvantages for choosing an IPO.
Firstly, an IPO would mean that you would lose a degree of control in your startup. This decision could be a very confronting situation for the founders of the startup company. Decisions that were once quick to enforce and act upon will now be a much slower and formal process, reporting to shareholders. For example, you may need to consult shareholders for particular decisions and require their vote to allow you to act on your decision.
Secondly, now that you have a significant number of shareholders, you would now need to prioritise their concerns. Shareholders want to see profits, revenue and growth from their investments. Any dividends from their stocks are an extra bonus. If shareholders see a constant decline in profits or growth, they may sell their shares and move on to more promising investments. This may ultimately harm your company by decreasing your share price and market capitalisation.
One of the most significant disadvantages for IPOs is that they are very expensive. They can cost over $100,000 without any guarantee of success. Startups must pay for underwriters, valuations of the company and also adhere to the listing requirements, such as being audited periodically and honour ongoing transparency with the market and their shareholders.
Lastly, a factor to consider would be the financial market, especially your industry’s market. We advise that before you decide whether or not to exit via an IPO, research into other recent IPOs in your industry and see their level of success.
Questions? Ask our startup lawyers on 1300 544 755.