Does the owner of a company effectively "give up" a portion of his company on IPO?

Question

I’ve been trying to understand IPOs by reading some questions about it on this forum.

As I understand it, if I’m the owner of 100% of the company and decide to go public with, say 10% of my company, I’m effectively “giving up” that chunk of the pie because the money raised through an IPO goes to the company, not to me (unless, of course, a certain portion of the stock was designated to me during the underwriting).

Would it be fair to say that the wager a current owner makes is that the increase in company value from the extra capital would far outweigh any disadvantages of giving up a portion of the company to the public? For instance, if I went public with 10% of my house and said “instead of giving the money to me in exchange for that portion of the home, please put it in the home itself; I’ll benefit from the other 90% having improved in value”.

Bonus question – is it possible for a company to go public in such a way that all the money goes to the current owner and none to the company itself?

Answer 1

I’m effectively “giving up” that chunk of the pie because the money raised through an IPO goes to the company

This is true, which is why an IPO is a method of raising capital for the company to use. It's the same concept as private funding rounds.

Would it be fair to say that the wager a current owner makes is that the increase in company value from the extra capital would far outweigh any disadvantages of giving up a portion company to the public?

Yes. An owner wouldn't give up a portion of their company if they didn't have the expectation (or hope) that their new, smaller percentage of ownership would be worth more in the future.

Bonus question – is it possible for a company to go public in such a way that all the money goes to the current owner and none to the company itself?

A direct listing accomplishes this, since only existing shares are sold and no new money is raised. See Spotify as an example, which wanted to be listed on the public markets (after numerous private funding rounds) but didn't need/want additional capital for the company to use. The shareholders who sold shares, and not Spotify, received the proceeds from the direct listing.

Answer 2

Let’s say you are the 100% owner of a company worth $1,000,000. You sell shares to the public for $1,000,000. The company is the same except there is $1,000,000 in its bank account, so it is now worth $2,000,000. So how many percent of the $2,000,000 should you own? You used to own 100% of one million, and now you own 50% of two million.

So why would you do that? If you think it is hard for your small company to grow. If you think you can’t grow a million dollar company to 1.5 million because you have no money to invest, but you can grow a two million company to three million. Or if you want to put your company on the stock market, try to grow the share price, and sell your 50% bit by but for a million or more.

Answer 3

Traditionally, the reason for going public was to raise money to expand the company, figuring that a smaller percentage of a company that was much more profitable would produce more income for the original owner(s), more quickly, than trying to grow without that assistance. Same reason one might accept a venture capitalist as a partner earlier in the process; which also involves giving up part of your ownership.

But that was back when the market was mostly about investing, and the primary way owners (including stockholders) took profit out of a company was through dividends, as a percentage of the company's income. (Sometimes referred to as "clipping coupons".) Alternatively, folks could do a buyout, or accept partnership as a partial buyout, and take a larger chunk of cash immediately while giving up part of their future income.

When everyone and her cousins jumped into the market a few decades ago, the focus shifted from owning and dividends to trading. Folks started demanding that companies grow as fast as possible so their holdings increased in value rapidly, and that lead to an environment where more of the profit is fed back into the company and dividends are smaller. In this environment, the way folks take most of their profit out of a company is by selling shares, and that can apply to the owners too. If your million dollar company has grown 10%, you can sell $100k worth of stock and still own a million dollars worth of the company. And these days even a small mom-and-pop operation may be worth $1M, so you're usually talking about much larger numbers. Selling stock now can raise the kinds of money that used to require a buyout or partnership, and can be done incrementally in smaller units as well as large transactions. And a thousand small stockholders don't meddle in the company's day to day management as much as one major investor will want to.

So, yes, it's a mechanism for turning part of the company's paper wealth into cash. For an IPO, how much goes to the owners/stockholders (as increased dividends, increased executive wages, whatever) and how much is used to grow the company is a case by case decision by the company's board.

Of course once the stock is on the public market, trading doesn't affect the company's operation... but again, if the stock increases in value that makes the company's retained ownership worth more if they decide to sell more stock, which also makes it possible for them to borrow more or borrow at better rates, so indirectly an increased stock price does still benefit the company. Which is where the pressure to raise stock value rather than issue dividends feeds back into their decisions.