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What is this so-called “stock market” almost every news reporter in the country is worried about? It sounds so simple yet so complicated at the same time. In this article we discuss not the share-trading side of the stock market that we may have seen or heard of, but about how companies actually get listed and traded on the stock market – and why they would do so.
What exactly is the stock market?
The stock market can be defined as a marketplace where buyers and sellers meet to exchange stocks, or shares in companies. A share or stock represents a unit of equity ownership of an organisation. Many businesses, especially before stock markets, were funded solely by investments from an individual or a small group of people. Many businesses even today are “privately held” by one or a handful of individuals investing often significant sums of money.
With the emergence of larger businesses, and the rapid development of economies, privately held companies alone were no longer able to keep up with greater risks, and capital requirements required, to achieve the massive scale required to take on new challenges and competitors. Therefore, the concept of Public Companies was born. Organisations started offering a specified Share of their ownership to the general public for a specific price. Depending on how many of these shares an individual owned, he or she would have a varying visibility into, and ability to influence decisions within, the organisation. Today with greater transparency and regulation, the system is more advanced and coordinated.
Who can do a public offering?
Not everybody with a business can register themselves in the stock market and sell their shares to the public. Can the “isso-wade” seller at Galle Face list shares on the stock exchange? No, he cannot. In Sri Lanka, an organisation has to be registered as a “Public Limited Company (PLC)” in order to sell its shares to the public. However, the registration process of a PLC is quite difficult and requires a lot of paperwork and additional checks and balances within the companies to manage the company’s presence on the stock market. After you register yourself as a PLC, you are eligible to conduct an IPO.
What is an IPO? (and also, a bit about SPOs)
An IPO (Initial Public Offering) is when an organisation offers its shares to the public for the first time. Prior to an IPO, an organisation is “private” where the ownership of the organisation is in the private domain.
You may have seen business news coverage of large privately held companies “going public”, often with great excitement among the press and investors. This is the IPO. It is an opportunity for the initial private investors to exchange their existing ownership, for cash from new investors coming in to “buy them out” of the publicly listed portion of shares. Often, share prices on the day of an IPO may be many multiples what they were initially valued at, meaning a tidy profit for the founder, early employee or investor who sold their shares – and also explaining most of the excitement around any IPO.
This is not the only time or only method that companies may offer more shares to individuals or to the public. Any public offering that takes place after the Initial Public Offering is considered a SPO (Secondary Public Offering). This will result in further dilution of the company ownership among the public.
There are strict rules around company ownership and public offerings, mostly to prevent fraud and to protect small-time investors. Companies have to already exist and satisfy regulators that they are viable economic entities before they can qualify for public offerings. Even with all this, you will realise, there are many companies that do not offer shares to the public. Why, you may wonder.
Why is going public not an option for everyone?
For most the organisations, going public is the last financing option, because it is one of the most “expensive” capital generation methods. What that means is, compared to other ways of raising financing, which do not also require dilution of ownership, public share listings have all kinds of costs attached, particularly to the underwriters who manage the whole process.
More significantly, it dilutes the initial owners’ power in the decision-making process. So, the initial vision on which your organisation was founded might differ from what the wider ownership, who also have some representation in decision-making, wishes to see it work towards.
Nevertheless, if you feel like you are ready to take these risks, going public is a very public way to float a share of your company in exchange for what can be significantly more than it was valued at before. Being an entrepreneur is all about taking, but managing, the risks involved, right? Take your time to think about it. Further to that, going public means multiplying the regulatory burden you have, as you will have to maintain compliance with a lot of rules, regulations, standards and best practices like never before; your legal and compliance costs, as well as regulatory burden, will grow very fast. You should discuss with your management team and current shareholders, and thoroughly research the cost and effort involved with the process – in comparison to the quick cash-out and visibility of that IPO.
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