Methods of Raising Capital

When investors purchase a share of stock, they are essentially purchasing a share of ownership in the company; the more shares they buy, the more of the company they own. This is why this type of financing is called equity financing: it directly affects the equity held by shareholders. Deciding to "take a company public," as this method is sometimes referred to, requires that a company's managers and current owners be willing to give up at least some control of the organization. With a public company, the organization will be subject not only to oversight by the Securities and Exchange Commission (SEC), but also by a board of directors elected by the stockholders. In addition, any company that goes public could be the target of a takeover down the road, something that cannot happen to privately held organizations.

Factors that Influence an IPO's Success Not all companies are candidates for raising capital in the public market. Companies that are good candidates are generally those that have a compelling product or service which can be "sold" to prospective investors. Specialty companies can be attractive to potential investors because the companies focus in a given market niche, which suggests they have the marketing acumen to excel in that niche. Companies that have successful IPOs are also characterized by an initial offering of a sufficient size to create investor interest and create an a Companies which have sound management and a proven track record can profit from an initial public offering, as can their owners. These companies are attractive to potential investors, and owners of the private company can realize strong returns on their initial investment if the IPO is successful.

Companies which participate in highly risky industries and which do not have strong track records may find that they are not able to go public successfully, with the result that money can actually be lost on the transaction, particularly if the aftermarket does not materialize for the stock. Callaway, Pat. "Going Public Means New Approach." Dallas Business Journal, 19 August 1994, 25. One of the most significant advantages to IPOs is that public investors, unlike venture capitalists, do not seek an immediate return on their investment. In fact, public investors can be less interested in dividend payments than in the stock's growth value, particularly when evaluating an IPO. This is an ideal situation for companies which can demonstrate slow but steady growth, as well as for companies which are participating in a market that is in the growth phase and which is characterized by strong increases in growth. The most obvious disadvantage with taking a company public is the cost of the IPO itself.

This is generally calculated to be approximately 10 percent of the amount of capital raised in the IPO. However, the fee paid to the underwriters represents the bulk of this cost, and is paid only if the deal closes. Other costs, such as legal and accounting services, accumulate as preparation for the offering and represent sunk costs. In addition to start-up costs, there are ongoing costs associated with complying with the SEC regulations and preparing audited financial statements using generally accepted accounting principles.

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