What are the Advantages and Disadvantages of IPOs for Startups?

An IPO is one of several ways that business founders and owners can raise cash or exit the company altogether.

It is a complex process where shares in the business are made available – often through a stock exchange – for outside investors to buy. In return, these new stakeholders will become part owners of the business and have a say in the way it is run.

IPOs can create a world of opportunity for companies to move to the next level. However, they also have huge drawbacks that can make them unsuitable for certain firms. Some of the main pros and cons of public offerings are as follows:

Advantages

Creating an accurate valuation

Obtaining a valuation for your business depends on a variety of different factors and can be a difficult process. An IPO can make this process simpler as, before a company’s shares begin trading, an investment bank is employed to determine their value.

After listing, the market then decides the value of a businesses based on investor demand for its shares.

Access to vast amounts of capital

Going public often provides a firm with levels of capital that can be impossible to source elsewhere. This can help take company growth to the next level: it can be used to expand operations, develop and launch new products, and even make acquisitions.

Compared to other exit strategies, IPOs usually provide much better liquidity for companies because they have a greater number of potential investors to draw money from.

Great advertising

Selling shares on the London Stock Exchange or any other major exchange can work wonders for raising a company’s profile. IPOs attract vast amounts of media attention which can make customers aware of a company’s existence along with the products and services it provides.

Public offerings can also significantly boost the brand power of a firm and its products which, in turn, can help it attract customers alongside partners and staff.

Boosting best practice

To preserve their reputation as a safe space for investors, stock exchanges place strict regulatory rules on newly listed companies when it comes to things like financial reporting and corporate governance.

Not only can this make a company much more attractive to investors. It also means firms implement better governance and management practices that improve the profits they can make.

Disadvantages

A long and expensive journey

Getting your company’s shares trading on a stock exchange is a drawn-out and expensive affair. Teams of lawyers, financiers, accountants, and consultants must be hired. And by the time a business is ready to list its shares the IPO landscape may be far less advantageous than it first appeared.

What’s more, keeping a listing going on a stock exchange is also very costly due to the many regulatory requirements concerning governance and reporting.

Privacy issues

High levels of regulatory scrutiny mean that companies are also required to divulge much more information that they would have to pre-IPO. Certain confidential details that the business may wish to keep under wraps may prove impossible.

Furthermore, because companies often attract more media attention when their shares trade on a stock exchange, any bad news can be more widely seen. This can have an impact a company’s ability to attract customers, employees, and so on.

Market volatility

Even if a company is performing strongly, its share price can fall sharply for a variety of external reasons. This can impact planning along with operational decisions (a business may decide, for instance, to use surplus cash to buy back shares to boost the share price).

Share price considerations also mean that a company can spend too much time thinking about the short-term. This can detrimentally impact its fortunes over a longer time horizon.

Loss of control

While IPOs attract significant amounts of new money, they also bring a much larger number of investors into the fold. This affects decision making as company owners must take on board the wishes of a large collective of stakeholders.

The pressure for a company to perform is also much greater for listed companies, and especially so if activist investors come along to rock the boat.

The IPO landscape today

Launching an IPO is more challenging in 2023 than usual as high inflation, rising interest rates, and huge economic and geopolitical uncertainty persist. It’s a challenge that is affecting startups and larger, more mature businesses alike.

According to EY Club, 18 companies listed their shares on the London Stock Exchange in the first half of 2023. This was down from the 26 that launched IPOs a year earlier.

The amount raised, meanwhile, was basically flat from the same 2022 period at £593 million. It was also significantly lower than the £9.4 billion printed in the record-breaking first half of 2021 when 47 businesses launched on the London stock market.

On the Alternative Investment Market (AIM) – a unit of small, high-growth companies – there were six IPOs between January and June, with an equal weighting of offerings in quarters one and two.

IPO listings on AIM in recent years. From EY Club’s “IPO Eye” report

Companies raised a total of £16 million on AIM in the last quarter, with Fadel Partners raising the most amount of capital. The company – which develops digital rights management and royalty accounting software – raised £8 million through its IPO.

Scott McCubbin, leader of EY Club’s IPO team in the UK and Ireland, says that “the London IPO market continues to experience challenges with macroeconomic and geopolitical pressures having an adverse impact on businesses looking to list in the UK.”

However, he suggests that tough conditions in the IPO market today will likely be temporary.

McCubbin comments that “the long-term outlook looks more positive” for the market, with some larger IPOs scheduled for 2024 and a long pipeline. He adds that Financial Conduct Authority (FCA) plans to simplify listings rules in the UK “may also provide some impetus” if combined with wider reforms.