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Initial Public Offerings

UPDATED: August 9, 2013

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Making an initial public offering or "going public" can provide benefits to a company and also increase the company owner’s obligations. An initial public offering, or IPO, can raise capital quickly; these incoming funds can be allocated to the research and development of new products, and they can pay for capital expenditures or help pay off debt.

An IPO can also serve as a marketing tool or a means of increasing market share. Some venture capitalists generate revenue by creating new businesses and then converting them to public companies. This type of entrepreneur will use a public offering as an exit strategy.

Creating an Initial Public Offering

Creating an initial public offering, by definition, means selling once-privately owned shares to the public. After the offer is made, these shares are traded on a recognized stock exchange. To create an IPO, start-up companies and small businesses must demonstrate the potential to develop into lucrative enterprises. Larger companies must show an ability to generate profits and increase marketability over time. When considering the pros and cons of making an initial public offering, company owners should begin by making an honest assessment of an organization’s earning capacity.

Making a public offering comes with new legal obligations, which include registering with the Securities and Exchange Commission (SEC) and complying with the Securities Exchange Act. The Securities Act requires companies to disclose all material facts that could impact an investor’s decision to purchase a company’s stock or bond. The SEC routinely reviews registration documents to ensure disclosure rules are being followed.

The Exchange Act requires companies to make information about their management, financial condition and business operations public on a regular basis. This information must be delivered to investors, usually in the form of a quarterly or annual report. The company must also send this information to the SEC. All of this comes with additional costs to the company.

Pros vs. Cons of Making an Initial Public Offering

Making an initial public offering entails considerable costs and obligations, in addition to the cost of compliance with securities laws. Going public will require capital, since up to 25% of the company’s equity can be lost to public purchases and the fees associated with them. After the offering, the company’s management structure will have reduced flexibility, and the company will need to comply with rigid practices regarding reporting to shareholders, particularly if they have voting rights. If an investment bank underwrites the public offering, restrictions will come with that assurance.

There are also significant benefits to becoming a public company. Capital will increase and the company will become more widely known through contact with new investors. If the company grows and becomes a stable force in its market, it will attract additional investors, and financing will become cheaper and easier to obtain.

IPO Alternatives

After weighing the costs and benefits, you may decide that an initial public offering is not right for your company, especially if the company is in its early stages. But there are other ways to raise capital, including loans from financial institutions or the Small Business Administration. As a company owner, you can also sell securities without having to register with the SEC. Private offerings can be made to potential investors, like family and friends. You can also do an intrastate offering, which entails offering shares to a limited number of investors in the state where the company is incorporated. These offerings are exempt from SEC registration, which makes this process an appealing alternative to a traditional IPO.

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