By Jonny Lupsha, Wondrium Staff Writer
Cryptocurrencies had a wild week on the stock market when Coinbase went public. Coinbase debuted on Wednesday, soaring to great heights before settling down; while Bitcoin and Ether declined over the weekend. Why do companies offer shares on Wall Street?
Investors are used to their stock portfolios rising and falling due to current events, public earnings reports, product announcements, and even the weather. However, as the cryptocurrency niche saw last week, an initial public offering (IPO) of a competitor can cause stormy seas for competitors. Most notably, after the digital currency Coinbase had begun trading publicly on the stock exchange on April 14, Bitcoin fell approximately 15% the following Sunday, recovering some losses since then.
IPOs are some of the least predictable events on the stock market. Compared to stocks that are already trading, anything can happen with the value of a brand-new offering.
In his video series How the Stock Market Works, Dr. Ramon P. DeGennaro, CBA Professor in Banking and Finance at The University of Tennessee, Knoxville, said if we can understand why companies go public, we can much better assess the risks and benefits of investing in IPOs.
What Is an IPO?
As mentioned above, IPO stands for “initial public offering.” Dr. DeGennaro clarified its name a little further.
“‘Initial’ means ‘first’; ‘public’ means that whatever is going on isn’t restricted to some select group of people,” he said. “‘Offering’ sounds as if the company is selling something. An IPO is the first sale of stock by a privately held company to the public.”
According to Dr. DeGennaro, an IPO is usually introduced by a small and/or new company who would like to grow more rapidly than they are, but without tapping into a new source of funds like a loan or a grant. Often, an IPO is introduced when the majority of a company is still owned by the person or people who started it, who may be looking to free up some money so they won’t be so tightly tied up into their role as primary shareholders.
Why Go Public?
Aside from helping the founders of the company sleep at night regarding their stake, why do companies launch an IPO?
“Another reason firms go public is to make it easy to offer many employees a stake in the company’s future,” Dr. DeGennaro said. “Sure, you could hire a team of lawyers to handle the documents to sell a small part of your holdings to your employees every time you needed to do that, but it just doesn’t make sense. It’d be too expensive and time-consuming.
“Going public solves that problem.”
According to Dr. DeGennaro, when a company reaches around 500 shareholders, it has to start filing a lot more documents with the SEC. Some companies figure if they’re going to incur the cost of that anyway, they might as well go public, which is why Google did so in 2004. There is one more reason to have an IPO, and it’s the big one.
“Suppose that business is good and you could probably double earnings over the next couple of years if you could open a branch office and manufacturing facility in another part of the country,” he said. “That sort of expansion isn’t cheap; where are you going to come up with, say, $300 million?
“This is probably the main reason for having an IPO: to raise funds and have better access to capital markets going forward.”
Whichever reason Coinbase chose for their IPO, it seems to be working out for them.