Key ingredients for a successful Initial Public Offering
The initial public offering journey can be an arduous path, involving months and even a year plus of pre-planning in advance.
Assuming an IPO is the right thing to do, after all options have been thoroughly deliberated on and it is on the board agenda to make it happen, a well thought out business strategy is required, where all relevant company personnel need to chip in for it to be successful.
Vital Early Action Steps:
A business plan is required containing both operational and strategic priorities that will entail identifying the objectives and the plan itself, this is likely to go through various iterations and reviews until a final plan is created. Main components of the plan will typically cover off executive summary, market analysis, company description, marketing and sales strategy, products and services, operational techniques and strategies, management and ownership, financial information, etc.…
Do not understand estimate the importance of this particular piece of work as real homework will be invaluable to tell the story to investment bankers, underwriters and investors. It will definitely save time, money and effort if it is done in good time where down the line the preparation for the IPO and registration process can kick off.
Speed and agility is required to accelerate the strategic element of the plan before the IPO event. Stepping up to the mark and delivering major milestones in the strategic roadmap, will create greater credibility and get institutional investors and analyst on side by displaying good management qualities to get the job over the line. Some tactics seen include: product launches, R&D milestone achieved, acquisition and integration of key targets, etc.…
Undoubtedly, whatever the initiatives are, accelerating goals over the next 12 months be it systems, processes and the people agenda too by having an action plan will stand the company in good stead ahead of the big IPO event.
Transaction Strategy:
Going public is not every company’s cup of tea. The stakes are high and the pitfalls can be numerous. Bad timing or lack of real adequate planning and preparation in the vital first steps will hinder the IPO. Conversely, on a more cheerful note, the benefits can be: better financial condition- not having repay the money back to shareholders immediately; increased share value- shares normally command a higher price on offering; capital to build growth- be it for working capital, repay debt, acquire a new target, improvement and modernisation plans; improved future financing- where debt-equity gearing improves to enable access to debt financing at reduced rates; Enhanced corporate image- where free publicity and investor advertising will help, not to mention a boost to employee morale and loyalty.
There are drawbacks unfortunately too in terms of loss of control- depending on what is sold to the public, i.e., greater than 51% of the shares allotted; Sharing the success- investors wanting dividend payments; public records and disclosures- loss of privacy; Financial reporting- the need for extensive and more timely reporting, better systems and more accountants; Initial and ongoing costs- underwriters fees and external professional costs will be material; Belligerent shareholders- they are demanding let’s face it, so don’t expect an easy ride at the AGM; Fiduciary obligations- where conflicts of interest and related party connections need to be looked at with the utmost caution.
Enhance the success of the IPO¹ :
An IPO must be from a position of strength, comprising the overall transaction strategy, not the IPO itself. What happens if the company is not ready or market timing is not there? Sustaining the company will be crucial as a stop gap if there is trouble ahead.
A solution frequently come across is to use bridge financing, from either venture capitalists, private placements, mezzanine finance, joint ventures or recapitalisations.
Venture capitalist: Want to see their cash in five to seven years. They may play an active or passive role, often requiring ordinary shares or convertibles debt (resulting in unfavourable accounting implications under IFRS9).
Private placements: Selling stock to basically institutional investors, where the controlling rights can be engineered. Debt security affords the ability to create payment schedules, kickers like enhancement margins, or equity options (which are not a favourite of mine) which will inevitably cause dilution down the line.
Mezzanine: A subordinated debt instrument characterised normally with a fixed rate of interest, often accompanied by a profit-in-kind margin and/ or a conversion equity element.
JV and strategic alliances: Whatever you want to label it as. It success is dependent on both parties being demonstrably committed to its success, where often these alliances fall apart due to conflict of interest, lack of congruent expectations, personality clashes and fights over who is funding what and when.
Recapitalisations: Meaning leveraged recapitalisation; involving the simultaneous sale of a segment of the business to a third party (in return for a fee, say 5%) and then borrowing and repurchasing the shares back. Then using the IPO proceeds on the big day, to repay the debt. This is better than asking the public for money upfront, which does not go down too well. This is a typical transaction accepted and understood by the market.
The IPO building block¹ :
The agenda:
Taking stock of what has been achieved to date and what still needs to be achieved in the months preceding the IPO is an important task, not to be underestimated. Reviewing what milestone, improvements or transactions have been completed is one topic that will appear on the board agenda. Including, what are the IPO proceeds going to be used for; and have we tidied up our house in terms of housekeeping.
Housekeeping:
It means exactly that, tidy up and get it shipshape. This can be an involved area that can be varied to my mind, requiring forethought, planning, regimented execution and having an excellent in-house IPO team in hand. My brief bucket list of some of the nitty gritty work required include:
Capital Structure: Review of gearing/ optimal capital structure, requires an element of tax planning to avoid missing any tax benefits from debt financing via allowable interest cost tax deductions. Gearing will also be impacted by IFRS16 as leases come onto the balance sheet. So what should our ideal gearing and WACC be?.
Authorised Share Capital: Upping the maximum authorised share capital at companies house is a must, especially with the lead up to the IPO.
Stock Split: to improve the marketability of the share where the EV of the share is very high, which can sometimes deters investors from investing in the company’s shares. Seeking counsel from the underwriter so that the offer price is within a particular price range is worth considering. A stock split is not EPS dilutive and the shareholders will not have their shareholding impacted.
Amalgamation of internal business units: In other words, 1 + 1 = 3. This is food for thought, especially where divisions can be merged into one or even product and services under one roof. Investors could find this more attractive, commanding a higher offer price on listing.
Company Registrar: Get a reputable company to do this work preferably both pre and post IPO.
Related Party Transactions: Never a good sign and often frowned upon, especially where there are conflicts of interest. Legal audit will help flush this out and by using an investor relations/ PR company to dig up also unwanted information from the internet.
Contractual agreements: Be it sales or employees may need reviewing.
Stock Options: Does this need setting up and who will do the administration?. Understanding IFRS2 share based payments will definitely help.
Financial reporting- processes and systems:
Financial reporting is extremely important. Ensuring there are strong robust systems and internal financial controls over the financial reporting process for timely and accurate reporting, further characterised by adhering to tight reporting deadlines to the city is a must and truly priceless.
On the other hand, having witnessed through experience and via the media, where the FRC (Financial Reporting Council) will have a field day on any incorrect reporting, fraud, misstatements and poor internal controls over often manual accounting processes. Rightly or wrongly, this creates chaos and mayhem for listed companies. Highly embarrassing for the individual’s involved and major damage caused to the company’s reputation, with shareholders and institutional investors screaming blue murder and even the odd rotten tomato being pelted at the culprit’s private residence.
Looking at this on its head with some cheer and gleeful optimism, there are a few mitigating strategies that can be put in place to avoid these problems in the first place, apart from being organised and having a well-developed business plan for the IPO. These include the following:
Internal Controls:
The auditor is your best friend, really, take heed and ask for additional observations and comments for improvement from audits. Especially around currents controls to ensure they are being applied as prescribed in the day to day transactional processing. Segregation of duties, 4 eyes principles and financial reviews of the income statement and balance sheet with detailed reconciliation sign off on balances is good practice. Standard operating procedures, process documentation, mapping and the alike are required under the COSO and SoX framework. So any work that can be done before the IPO would be good advice.
Systems:
Lack of systems congruency and manual work arounds due to system defects in the ERP system are never good. Establishing standard repeatable processes that are efficient and effective by using the full functionality of the ERP or introducing a group wide ERP system role out has its obvious benefits too. Often granularity to produce disclosure notes require spreadsheets, but having a good consolidation tool be it, self-contained within the ERP or stand alone will help produce group consolidated results quickly. Having a group congruent ERP system helps with audit planning and the fine line between the costs involved in compliance and substantive audit testing.
Understanding how you are being measured:
How analysts measure a company’s performance is an invaluable guide to ensure close attention is paid to those KPI’s and metrics and also what variables go into ascertaining those metrics. Aligning what the analyst uses to track the performance and replicate it internally in the company is sound advice. Key industry standard ratios are also a big must to ensure the company stacks up to their competitors to helps drive continuous improvement, especially when performance falls short.
With the investment analyst watching the company like a hawk, the selection and application of IFRS accounting standards is also an important area to bring up, especially where potential quick wins can be made. I have seen private companies ignore this at their peril, for whatever reasons, resulting in some problems further down the line, with devastating consequences. With a shopping list of various IASB standards, often inextricably linked, a subject matter expert on technical accounting standards is a must. Fatal howlers seen in practice include:
IAS2: inventories impacts COGS, especially more so when there are under or over recovery of overheads, whilst ignoring the true up exercise between actuals versus forecasted standard costs implicit in the cost of finished goods.
IFRS9 and IFRS7: One of the most difficult accounting standards ever to comprehend with extensive disclosures required, coupled with how to engineer the correct accounting syntax for economic hedges at group and legal entity level, without causing one-sided volatility in the financial statements. This is further exasperated by the interaction of IAS 21 on functional and presentation currency.
Refer to my article on IFRS9 (in my corporate blog), where potential guidance is given on corporate hedge accounting rules.
IFRS15: Lack of planning of this standard on recognising revenue in advance of the implementation date and ignoring the mirroring of the cash flow profile with the contractual performance obligations. Misinterpreting how milestone payments should be treated versus operational/ commercial work plans. Including, unbundling of total contracts and the correct allocation of price, discounts and deferred payment terms. Impact: under or over stating revenue is a cardinal sin.
IFRS16: Planning around data capture, KPI targets, debt covenants, judgement on policy as far as practical expedients on exemptions and transition options go, whilst giving little forethought on what the incremental cost of borrowing should really be on adoption. Including, ignoring impact calculations on all options and exemptions available. This standard will pose a real challenge when gearing increases post adoption where future debt funding is required.
IAS36 and IAS38: The identification and valuation of intangibles and the calculation of goodwill arising on consolidation and the impairment of these items based on simplistic models which just give rise to impairments. Although these are non-cash items, the impact can be material, impacting EPS. Use of sophisticated NPV models and flexing the variables contained in the discount rate akin to the CGU’s systematic risk with sensible long-term growth rates is worth looking into.
IAS 19: Applying the asset upper limit to achieve recovery of pension surplus is often a missed trick.
IAS23: When to use the standard and how it can reduce the income statement interest cost line is also another missed trick. An analyst won’t be fooled as there is a disclosure note, but it is worth thinking about.
IAS 33: being cognisant of the interaction of other IASB standards on basic and dilutive EPS, i.e., due to convertible debt, rights issue, share options and ESOP. P/E ratios are dependent on EPS, which is one of the reasons I do not favour convertible debt for this reason alone.
Of course I could go on, but I draw the line on the usual IASB standards to avoid making this article too accounting orientated.
The IPO Event:
The big day is not far away. Preparation for presentations is now required, having a shopping list of selling points about the company that you want the press and analysts to know will focus effort. Not to mention all possible objections that analysts might raise about the current situation requires forethought, to avoid not having a succinct and powerful answer, which kills the question dead.
The roadshow is an opportunity to tell the story to the underwriters and their syndicate and influence potential investors (mainly big institutional pension funds).
The audience will tend to be sophisticated and sceptical, where they have been there and got the t-shirt. The challenge will be to capture their imagination whilst upping the excitement and passion about the company and trying to sell it. Illustrating a balanced view of the business with competitors and selling the positives is the best course of action. No one can ever really cover off and pre-empt all possible questions, but by doing the best you can will always help.
The IPO event generally lasts about 90 to 120 days, involving preparing and filling statements for the registration process. A quick overview of the registration timeline will normally entail: An all hands meeting; draft prospectus; directors questionnaires; review and sign off on various legal information; subsequent events review; comment letters; selection of registrar and transfer agent; due diligence meetings; comfort letters; underwriters agreement; price offering and finally close out.
An IPO is never going to be easy, but having a comprehensive understanding of the key ingredients for success is a good starting point for any company contemplating a listing anytime soon...²
Dee Singh Kothari is a senior partner in Kothari Partners ¹ Ideas expressed and/ or methodologies in this article are solely of the authors. The author nor Kothari Partner’s accept any liability for the incorrect application of these ideas either used by companies, employees or other individuals alike.
² At Kothari Partners, we have worked with various UK and overseas listed and PE/ VC backed clients across various industries to consider how their business and finance services can bring them both cost reductions and performance improvement. Our approach is to help our clients understand their current situation, identify the value and decide on the scope, vision and set of strategies for what they could achieve for their business. We help plan their implementation and support them and deliver the solution/ change needed, so it is properly and permanently embedded in their organisation. We aim to help past and future clients by delivering high-quality work to their organisation, generate real efficiencies and free up time to support better business decisions.
For a confidential discussion please free to contact us, via our corporate website: https://dipakagkothari.wixsite.com/website