Advantages and Disadvantages of an IPO

Weekly Assignment - Week 7

In this essay we will expose one of the most important moment in a firms lifestyle, the IPO.
IPO is the abbreviation for Initial Public Offer, i.e. its when companies make their first
stock sale in the market to the public. Its usually make by young companies looking not
only for capital to grow or expand but also for the capital ventures sell their part and close
the initial investment for instance. In the IPOs the companies also have to decide if theyll
issue only common stock or preferred stock also.
Clarifying and introducing our main essay theme, when the companies make their equity
sale they are looking for capital in order to invest but this kind of strategy brings a lot of
changes in the structure of the company also.
So these changes can both take advantages and disadvantages, we will start with the good
ones:
Access to a new way of financing, as we explain above, the IPO brings to the
company a new way of financing their investments having the opportunity to sell
their equity or issuing a new one in order to have more capital. After an IPO, the
company has the opportunity to have their stock in the market for future equity
based financing strategies.
Independent and objective valuation of the company by the market, with
the market entrance, the company starts to have their movements, choices,
investments being evaluated by all the investors, and considering an efficient
market, the search for this stock will make the share price increase or decrease and
that will make the company market value the most closest of the real value.
Allows changes in ownership structure, the company can decide if the share
that came to the public is new issue shares and with this they will change the
structure of the company or just sell the existing shares maintaining the existing
structure between debt and equity.
Best corporate governance practices, All the companies has a corporate
governance but it could be good or as bad as we can imagine. So the company starts
to have their evolution being watched and evaluated by the market, the company
will have to improve their corporate governance in order to achieve the markets
standards so they cannot be harmed.
Risk diversification, with the entrance in the market the company starts to have
a new way of financing witch have big differences from for instance debt and
internal funds. This ways of financing are uncorrelated, not completely but with this
new entrance the diversification increases and the company wealth too.
Prestige, its also good to have the company in the market, this kind of name,
brings the company a possibility to have better conditions in banks, suppliers and
other third party.

Corporate Finance | Saul Ferreira Costa | 200801331

But the IPO brings also some disadvantages as:

Underpricing, many authors investigate this phenomenon because it happens
almost in all IPOs. It represents the opportunity loss that the first shareholders lost
witch is the difference between the opening price and the first day close price.
Greenshoe, this is the opportunity given to the lead manager, to increase the
number of shares issued in the IPO. This can be used to maintain the start price
during the first day of the sale.
Loss of control, with the entrance in the market, the number of shareholders
increase and dispersed and so the founders and first equity owners loss the control of
the company.
Loss of confidentiality, the entrance in the market brings the company the
responsibility to have a clear and transparent communication with the market
giving all the information about their state of nature, future goals and investments
for instance. All of this makes part of the market regulation.
Costs increases, as the company gets bigger and makes their IPO, the costs of this
evolution also increases: Issuing costs, Auditing costs and market information costs
for instance. Most of this costs increase due to improve the communication to the
investors. i.e. being in the market is a responsibility that the companies have to lead
in accordance with ethic and transparent information and to do that they have to
incur in many new and higher costs.

Concluding this essay, the IPO is the break point for many companies which have the
opportunity to evolve and learn with new shareholders and all the market standards which
commonly are better than when the company has not the market evaluation. This entrance
in the market can bring a lot of advantages but the disadvantages can bring the company
to an end, and thats why this new step must be thought out!

Bibliography
Ross, Stephen A., Randolph W. Westerfield and Jeffrey Jaffe; Corporate Finance, McGrawHill / Irwin, 2010. ISBN: 978-0-07-338233-7.
Corporate finance lecture summary and slides
www.investopedia.com

Corporate Finance | Saul Ferreira Costa | 200801331