What is "Going Public?"
Initial Public Offerings (IPOs), Special Purpose Acquisition Companies (SPACs), and Direct Public Offerings (DPOs) (10min read)
TL;DR:
"Going public" is the process a company goes through to raise money from public market investors. Everyone is eligible to invest in and become an owner of a publicly traded company.
An Initial Public Offering (IPOs) is the most common way to achieve this, however Direct Public Offerings (DPOs) and Special Purpose Acquisition Companies (SPACs) are becoming popular. The main difference between these three mechanisms is: Who gets to buy the stock first directly from the company? Otherwise known as the "middle man."
"Going public" is hard. Regulatory requirements for going public require a shift in company ownership, responsibility, reporting requirements, and accountability. Because anyone can own a small piece of the company, the US government wants to make sure every investor has equal access to information.
What is Going Public?
Last time we talked about the stock market.
Today, we're talking about three ways a company can “go public”. We'll cover IPOs, DPOs, and SPACs.
The outcome for IPOs, DPOs, and SPACs is the same; a company sells a portion of their company ("stock") to investors in exchange for cash, and it becomes a publicly traded company on the stock market. Once the company is public, anyone can buy shares of the company on the stock market. The US government - specifically, the Securities & Exchange Commission (SEC) - makes sure every investor has equal access to information, so a company must undergo extensive reporting, governance, and oversight requirements to go public. Companies work with teams, both internal and external, to manage the complexity.
Most importantly, companies work with a "middle man" to go through this process.
The middle man does two key things:
Buys stock directly from the company and then sells it to investors in the stock market.
In exchange for this risk, the middle man makes money on the price difference, sometimes called the "stock pop." The middle man, also called an "intermediary," is paid a fee.
A middle man can give a company certainty as to how much capital it can raise, from whom, and at what price.
The key difference among IPOs, SPACs, and DPOs is whom (or what!) constitutes the middle man.
IPOs:
In an IPO, a company sells a certain number of shares to an investment bank (usually multiple banks and their investor clients) at a negotiated price. Then, the investment banks sells those shares to investors on the stock market.
An investment bank provides a company capital certainty—how much money the company will raise, how much it will cost the company; and from which long term, public market investors. In exchange, the investment bank is compensated for providing the company that certainty.
Investment banks are in the business of raising money through the public market. There is value in working with the experience an investment bank provides a company's executive team.
The middle man, in this case the investment bank, makes money in three ways:
A one time fee to the company based on a % of the capital raised
Gains on selling stocks to the market for more than the investment bank bought it for (called a "stock pop")
A fee charged to investors who buy the stock from the investment bank
It pays to be in the middle.
SPACs:
If a company goes public via a SPAC, the SPAC is the middle man.
The SPAC creates a shortcut for a company to become publicly traded. The SPAC is a publicly traded company that anyone can invest in...just without the company part.
Here's how it works. The SPAC fund manager raises money from public market investors in an IPO (see above) and from long term, large ("institutional") investors (usually via a Public Investment in Private equity). The SPAC investors trust the SPAC fund manager will buy a private company, capitalize it, and help it grow in value.
The company sells all of their shares to the SPAC. The SPAC investors now own the company by proxy. The SPAC investors, who took the risk of investing before the SPAC bought a company, benefit from the "stock pop."
The company is now public, just without all of the paperwork (to be fair, that comes later).
DPOs:
In a DPO, the company cuts out the middle man.
A company's existing investors (usually venture capital and private equity firms) sell shares they already own to investors in the stock market. The general public can invest in the company, and investors get cash for stock (or a "return on their investment").
Crucially, in a DPO, the company is not raising money. Instead, the company's existing investors kind of act like the middle man. These investors invest money before the company goes public, and they benefit from the "stock pop," rather than an investment bank or SPAC investors.
Today, only well-capitalized private companies are likely to use DPOs. The SEC has said it will update DPOs so that a company, as well as its existing investors, can raise money (i.e., sell shares).
The middle man is still alive and well.
Why does it matter?
It's hard to become a public company.
The middle man plays an important role, and new mechanisms like IPOs, SPACs, and DPOs attempt to make the process of going public easier. The intermediary is a powerful role. It takes on the risk that the company's value will go up over time, and in exchange it hopes to see a financial return for the security it provides a company.
In the US, we have half the number of public companies compared to 10 years ago. When companies are private, only certain people (by definition people who are already a little rich ) can invest. When companies are public, anyone can invest (though only about 50% of the US population invests in the stock market today).
Today, going public usually demands a middle man.
You might be wondering...will there always be intermediaries in the process of going public? The widely available information on the internet has disrupted intermediaries in every industry, why not this one?
There's likely always going to be a middle man, but this intermediary has already begun to change shape.
Technology platforms like Carta and Long Term Stock Exchange are are in a position to provide markets for selling stock. There's talk of decentralized peer to peer public listings on the regulated stock exchanges, kind of like Initial Coin Offerings.
Dutch Auctions, liked Google used in its 2004 IPO, apply an algorithm to find a more efficient price for the stock on a company's first trading day. The IPO price is based on the stock price that the most investors are willing to pay. Recently, the SEC issued new guidance on changing DPOs to allow both the company and existing investors to sell stock, which would let the company raise money and sell shares.
More public companies means more opportunities to build wealth for everyday investors. The argument among IPOs vs. DPOs vs. SPACs is really about who is in a position to make the most money by getting access to the company's stock the earliest.
But here's the thing. It doesn't really matter how the company goes public so long as the company is public.
Public companies are a service to our economy. The earlier the general public can invest in a high-growth company, the more individuals might be able to own. The more they might be able to own, the more wealth they can build. While there's no guarantee even a public company will succeed, public companies remain one of the few opportunities for everyone to build wealth.
Additional Resources:
Closing the Gap - McKinsey & Co
Companies Can Pick Their Investors
Invest Like The Best on Direct Listings vs. IPO with Bill Gurley
Special thanks to Leah and Laura for their help in the process of writing this post!