IPO vs Acquisition: Advantages and Disadvantages
An IPO is an initial public offering, when a company makes its shares available for public trading, and it’s quite different from an acquisition. IPOs are synonymous with entering the public market, while an acquisition is typically when a larger company takes over a smaller target company.
What does IPO mean vs. an acquisition for investors? When a company applies for an IPO, it enters into the traditional process to be listed on a public exchange and get funding. In an acquisition, or takeover, the target company may not survive — or it may thrive, but only as part of the newly combined organization.
Investors contemplating companies at these two different stages would do well to think through the benefits and risks.
Key Points
• IPOs, or Initial Public Offerings, allow private companies to offer shares to the public to raise capital and enhance visibility.
• An acquisition occurs when one company buys a significant part, or all, of another company, taking control over its assets and operations.
• IPOs involve going public to raise funds and gain publicity, while acquisitions entail one company taking over another, potentially merging their resources and strategies.
• IPOs can provide substantial funds and publicity but involve high costs, stringent regulations, and expose companies to market volatility.
• Acquisitions can foster growth and innovation but may lead to conflicting priorities, strained partnerships, and brand reputation risks.
How IPOs Work
When companies go public, that’s when a private company decides to sell its shares to investors, to raise capital to fund growth opportunities for the company; create more awareness about the company; or to acquire other businesses, among many other possible reasons.
The IPO is the process of selling securities to the public. The company decides how many shares it wants to offer. The price of the company shares are determined by the company’s valuation and the number of shares at listing, and the funds raised by the IPO are considered IPO proceeds.
Once the IPO is approved, the company is then listed on a public stock exchange where qualified investors can buy shares of the IPO stock. Because IPO stock is highly volatile, it can be risky for retail investors to plunge into IPO investing, so doing the usual due diligence for investing in any type of security is wise.
💡 Quick Tip: IPO stocks can get a lot of media hype. But savvy investors know that where there’s buzz there can also be higher-than-warranted valuations. IPO shares might spike or plunge (or both), so investing in IPOs may not be suitable for investors with short time horizons.
Advantages of Going Public
What are the advantages of going public? There can be many, which is why companies aspire to go through what can be an arduous, time-consuming, and expensive process.
Capital for Investment
The biggest advantage associated with an IPO is fundraising. Once investors start buying IPO stocks, the proceeds from an IPO can be substantial. The company then takes this capital and typically uses it toward internal investments and expansion.
The company can use the funds it raises for research and development, to hire more staff, or expand its operations in other states or countries. There are a variety of ways this new capital can be deployed to benefit the company.
Publicity
In some cases, IPOs generate publicity. This, in turn, can drive more attention to the company and make investors interested in purchasing shares of its stock. IPOs are frequently covered in business news, which adds to the IPO buzz.
However, if there is too much hype, that can contribute to high expectations for the stock, which can also create volatility after the IPO.
Valuation
Some companies that go public can end up having higher valuations. Certainly, that is a hoped-for result of the IPO process. Because the public company has access to more capital and steadily grows its business, the shares of the company can increase in price over time, but they can also lose value — a common occurrence.
Disadvantages of Going Public
What are the disadvantages of going public? There are a series of steps and regulations companies must adhere to in order to have a successful IPO — and the process can be time consuming and difficult.
High Cost
The first factor a company must consider is cost. The company needs to work with an investment bank, which will charge underwriting fees — one of the largest costs associated with an IPO.
Underwriting is mandatory to review the company’s business, management, and overall operations. Legal counsel is also required to help guide the company through the IPO. There are also costs associated with account and financial reporting. Companies will also accrue fees for applying to be listed on the exchange.
Not Enough Information for Investors
From an investor’s perspective, investing in an IPO can also be a challenge. In many cases, individual investors don’t have enough information or historical data on the company’s performance to make a determination on whether an IPO is a sound investment.
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Stock Market Stress
Once a company goes public, it is now part of the public market. This means it is subject to scrutiny, market volatility, and investor sentiment. Every move and decision the company makes, such as a corporate restructuring, merger and acquisition, change in leadership, or release of earnings reports, will be reviewed closely by industry analysts and investors, who will provide their own opinions on whether the company is operating well or not.
While the company’s leadership may not have had to worry about these aspects when it was private, a public company needs to keep these market pressures top of mind.
What Is an Acquisition?
What does it mean for a company to be acquired? Similar to a merger, an acquisition is when one company buys a portion or the whole of another company and all its assets. An acquisition is the process of the acquiring company taking full control of the target company.
If the acquiring company takes more than 50% of the target firm’s shares, this gives the acquiring company control over decision making regarding the target company’s assets. While acquisitions of well-known and larger companies occur and are covered by the news, companies of any size can be the acquiring company or target company.
Advantages of Being Acquired
Being acquired doesn’t have to signal the end of a company — sometimes it can be a lifeline.
Growth
An acquisition can be a strategy for a company to grow into new markets and quickly become a leader in its industry. If the company is working in a competitive landscape, an acquisition helps increase its value and can add to a company gaining more market strength.
Innovation
When one company acquires another, this allows resources and experiences to come together. This may enable the new company to innovate new ideas and strategies that may eventually help grow the company’s earnings. This new partnership can bring together a new team of specialists and experts that can allow the company to develop and reach its goals.
More Capital
When an acquisition occurs, this will increase the cash holdings and assets of the acquiring company and usually allows for more investment in the newly formed company.
Disadvantages of Being Acquired
It’s hard to avoid the negative implications of an acquisition, and investors need to consider these as well.
Conflicting Priorities
In some acquisition scenarios, there may be competing priorities between the two companies that come together. The acquiring company and target company prior to the acquisition were used to working as individual entities. Now, as a newly formed company, both sides must work together to be successful, which is easier said than done. If there isn’t alignment on the goals of the organization as a whole, then there is a possibility that the acquisition may fail, or the transition could be rocky and prolonged.
Pressure on Existing Partnerships
When an acquisition occurs, the newly formed company becomes bigger and it is likely that their goals will grow as well. In the case where the company wants to develop more products to expand into new markets, this could require their suppliers to figure out how they are going to ramp up production to meet the demand.
For example, this could mean the supplier would need more capital to hire staff or purchase additional equipment and supplies to prevent production issues.
Brand Risk
Depending on which companies come together, if one has a poor reputation in their industry, the acquisition could put the other company’s brand at risk. In this case, both of the companies’ identities could be evaluated to decide whether they come together under one brand or are marketed as separate brands.
The Takeaway
Initial public offerings (IPOs) and acquisitions often get a lot of media and investor attention because they can offer opportunities for investors. That said, these two events are quite different.
An IPO is when a private company decides to go public and sell its shares to investors, whereas an acquisition is when a company buys out another, target company. In this case the acquiring company may gain certain market advantages, and the target company will typically lose its decision-making privileges since it is no longer an individual company.
There are a number of pros and cons to IPOs, just as there are advantages and disadvantages to a company being acquired. IPOs can provide a newly minted public company with a lot of growth opportunities — but the IPO process is expensive and time consuming, and being beholden to regulators and investor sentiment is never a picnic.
Acquisitions can be a lifeline to a company that’s struggling in a competitive market. While the takeover can effectively eliminate the target company as an independent entity, its products or brand may continue to exist.
Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.
FAQ
Is an acquisition an IPO?
An acquisition is not an IPO. An acquisition is when an acquiring company purchases part of or all of a target company to form one new company.
What is the difference between an IPO and a takeover?
An IPO is when a private company decides to go public and sell its shares to individual investors, whereas a takeover is when a company buys out another company.
Is a takeover the same as an acquisition?
An acquisition can be a takeover. This is when two companies decide to come together and become one entity. All the assets of both companies are now part of a newly formed combined company.
Photo credit: iStock/Yuri_Arcurs
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