Going public is getting a bit of a bad rap these days. Not as many privately owned companies are deciding to conduct an initial public offering (IPO), and as a result there are fewer public companies for the general investing public to consider when buying equities for their portfolios. According to the National Bureau of Economic Research, the number of public companies in the U.S. decreased by nearly 50% in the period from 1996 to 2014. And the number of IPOs has dropped from an average of 436 in the 1990s to only 120 in 2015. Why is this happening, and should investors be worried?
First, let’s look at the reasons that companies decide to have an IPO. The biggest advantage that public companies have over privately held companies is their access to capital. Going public allows a company to tap into a variety of sources for capital among banks, institutional investors and retail investors, rather than relying on the ebb and flow of funds from a small number of private investors or private equity funds. While the company’s share price will dictate the quantity of capital that can be obtained, the immediate and direct access capital for the business can be a significant advantage, especially for a capital-intensive business that depends on expensive machinery, vehicles or other very expensive items.
Being a publicly traded company is beneficial from a governance standpoint as well. Shareholders are able to engage with company management about a variety issues, from the board of directors to compensation structures to environment and social factors. With the right shareholder base, a company is positioned to adopt best practices as their standards for conducting business.
There are, however, drawbacks to consider. Public shareholders can be fickle and focused on short-term results at the expense of long-term success. Being beholden to them can cause managers’ focus to shift towards quick fixes as well, instead of looking at the best ways to move a company forward regardless of timeframe. Activist investors may also push a company in the direction of a short-term solution instead of looking at the range of possibilities that might exist.
But times are changing, and staying privately owned has increased in popularity. Many of the world’s most successful companies are technology companies that have no need for large outlays of capital in order to be successful. And with increased scrutiny from regulators, there is even less of an incentive to become a publicly traded firm.