To float or not?

Some of the fastest-growing companies on both sides of the Atlantic have opted to stay in private hands, forgoing the markets during a crucial growth stage
by Bethan Rees

Deciding whether to float a company on a stock market is an important decision that a privately-owned business might consider at a certain point in its development. 

For example, at the time of writing, the biggest initial public offering (IPO – when a private company or corporation raises investment capital by offering its stock to the public for the first time) in the world is Alibaba Group Holding, an ecommerce company which listed on the New York Stock Exchange in September 2014, and to date has raised approximately US$21.77bn, according to Statista

But what exactly is a fast-growth business? Opinions and definitions differ. Umerah Akram, head of ELITE UK, London Stock Exchange Group’s international business support and capital raising programme, says that a fast-growing business can be defined as “a company that has at least £5m in revenue”, although this isn’t the only criteria. “We also look at the historic revenue growth, and also what the expected growth is going to be and what the ambition is.”  

She says: “ELITE helps support fast-growing businesses to achieve growth and professionalises companies in terms of scaling up, but also helps them get ready for investment. We give companies exposure to a whole range of experts, as well as the investor community. That could be private equity or public markets, and we also give them access to business leaders, so CEOs of listed companies who have been there and done that. The whole ELITE initiative gives companies access to the wide network but also aspirational, practical things to implement and inspiration to drive business forward.”

The types of businesses ELITE “typically accepts” have either £5m+ turnover, or have raised “significant investment”, according to Umerah. On its programme, it has nearly 1,000 companies globally, operating in London Stock Exchange Group’s home markets including the UK and Italy, and outside of the home markets it operates a licensing model where it partners with local stock exchanges, or a similar institute – these include Casablanca Stock Exchange, Saudi SME Authority and Shenzhen Stock Exchange.

Companies that have been supported through the ELITE programme include Brewdog, Mumsnet and Graze, and the programme lasts for 12 months. After this, companies remain a part of ELITE indefinitely and can continue accessing the benefits of the programme as an alumnus. Umerah explains why it’s such an important initiative. “ELITE strongly believes that access to appropriate capital, skills and networks are essential tools in supporting business to scale up. This in turn allows them to innovate, create jobs and ultimately drive economic growth.
Who is staying private?According to a Q2 2018 report by EY on Global IPO trends, “figures for the first half of 2018 dipped by volume compared with the same period in 2017, despite higher valuations on some of the world’s largest markets”, but it expects “a resurgence in IPO activity during the second half of 2018” because of encouraging economic conditions, high equity valuations, and low interest rates.
According to Hutchison, there are more types of investors in private companies now, and the existing investors have expanded their offeringsAirbnb, an online marketplace for people wanting to rent out their spare rooms or properties, is a company that has stayed in private hands. In 2017, the business exceeded projections, ending its financial year with US$93m in profit and US$2.6bn in revenue. Airbnb’s CEO Brian Chesky said at the Code Conference in May 2018 that the company will “be ready to IPO next year” but didn’t know whether he would follow through with this. It’s reported he wants to make sure it’s a major benefit to the company to go public, and said he had “no issues” with it at all. The reasons why Chesky has kept Airbnb private are not publicly known.

In October 2018, Chinese music streaming company Tencent Music Entertainment Group postponed its hotly anticipated IPO. According to a Reuters report, the firm wants to wait for global stock markets to stabilise. 
Why are they staying private? In February 2017, the US Securities and Exchange Commission (SEC) held an advisory committee on small and emerging companies. At the meeting, global law firm Goodwin hosted a presentation. Jamie Hutchinson, partner in the firm’s private equity group, spoke about Why are more companies staying private? A simple answer to this is: because they can afford to. 

According to Hutchison, there are more types of investors in private companies now, and the existing investors have expanded their offerings. For example, venture capitalist funds are investing further across the lifetime of a company; traditional private equity houses are no longer focused on just buyouts; hedge funds now have large private mandates; the introduction of state-owned sovereign wealth funds and family offices.  
“Family offices that used to invest in property are also now investing in private businesses"Debbie Clarke, director at board advisory firm New Clarke Ventures and CISI non-executive director, believes there is more private money available to firms looking to raise capital, which means they are able to look at the option of an IPO later. “Ten to 15 years ago, there wasn’t as much private money available to businesses, but in the past five to ten years, especially the past five, there has been a lot of private money looking for a home. This is due to a large number of PE funds being raised and increase in VCT funds and could also be due to a swathe of entrepreneurs who are reinvesting the money they made on their businesses into other private businesses,” says Debbie. “Family offices that used to invest in property are also now investing in private businesses as well as property. Generally, funds and people are looking at diversifying their investments more than they ever have.”

Hutchison says that companies are also staying private for longer – using data from McKinsey & Company to back up his point – for example, the average age of the US technology company that went public in 1999 was four years, and in 2014 this increased to eleven years. McKinsey & Co’s report titled Grow fast or die slow: why unicorns are staying private, published in May 2016, says that the increase in companies staying private could be because of poor performance post-IPO by many tech companies.

The EY Global IPO trends report gives a reason as to why IPOs may not be performing too well. “Increasing economic and political uncertainty has issuers and investors taking more of a wait-and-see approach toward IPOs. Issuers willing to take a multitrack approach to their IPO preparations would have the strongest chance for transaction success.” 
Employees could also be a factor in the decision to stay private. When a company makes its IPO, often employees are given the opportunity to buy a limited number of shares in the companyOne of the most publicised IPOs in recent years is Snap Inc, the parent company of social media platform Snapchat. It debuted in March 2017 with a share price of US$24, which climbed to US$28.17 the following day. However, it has been tumultuous since; at one point it dropped down to US$10.52 in May 2018, and at the time of writing, Snap Inc shares have dropped further, trading at US$7.29. This is hardly the success story they were hoping for. 

Employees could also be a factor in the decision to stay private. When a company makes its IPO, often employees are given the opportunity to buy a limited number of shares in the company. However, according to Hutchison’s presentation, private liquidity programmes – an alternative way to unlock liquidity for employees are becoming more common, removing employee demand for shares as a reason to float. 

Clive Garston, consultant and transactional lawyer at international law firm DAC Beachcroft, also chairman of the CISI corporate finance forum, thinks that the increase in public scrutiny may affect a firm’s decision in staying private. “It’s quite a big change for a business and its owner(s) if they’ve never worked in a public company environment. Some entrepreneurs might find it difficult that they have to report to a chairman and a board who don’t run the company, but challenge the decisions the executives take,” he says.  
The decision

Although there could be an ego-driven side to an IPO and a want for the prestige that is thought to come with it, Debbie explains that there is a more functional reason why a company might seek an IPO. “Firms often seek this route for liquidity, as they may have raised private funding previously, and now need to change shareholders as some funders can only hold an investment for a set period of time or may be pressurising the board to capitalise on their investment. So, there will always be a natural time where the company is looking for replacement capital, to pay back some or all of its investors,” she says.

Whether you should float and the timing comes down to a range of factors, according to Umerah from ELITE. “What is the business currently doing? What is the current investor base? What does the business ultimately want to achieve? For capital intensive industries and projects and businesses that are looking for that permanent access to capital, public markets offer the most suitable form of funding. It is important to recognise that globally, equity capital markets may have different strengths and characteristics. For example, in addition to supporting the world’s largest global businesses, the UK market has developed a vibrant ecosystem of fund managers and intermediaries who have a specific understanding of the needs of smaller quoted companies.” 
"It is important to recognise that globally, equity capital markets may have different strengths and characteristics"Management is another consideration. “Sometimes a company might not want to have one or two investors in their business who have a defined investment strategy or may have fixed life funds because they want the existing management team to drive a certain strategy. The public markets allow you to have a disperse set of investors who are not going to have the same active role that a private equity house would,” Umerah continues. So, a company should think about ambitions, its structure, and who it wants making decisions, before considering venture capital, private equity or IPO. 

Although the ELITE development course can help a business get in the right position to IPO, Umerah says that it is by no means a pre-IPO programme. “I think if we said that, we would get very few companies joining. ELITE is about giving management tools and the know-how to figure out what is right for the business and to drive their financial strategy in the right direction.

“IPOs come in to conversation when discussing access to finance. We also give companies access to businesses that have floated on the market and have been successful, such as IntegraFin. They are one of the 16 companies that have gone to market through ELITE,” Umerah says. 

Public scrutiny is not a reason not to float, according to Umerah: “A company is going to be evaluated whether it’s by a private equity house or public market investors. You still have to go through an extensive due diligence process regardless of which route you choose.”  

Clive adds that having public status could be a route to attracting more esteemed employees. “It may be easier in some way to attract high flying talent to the company with an IPO, as you can give them big share incentives in the form of tradeable securities. On the other hand, private equity can offer attractive sweet equity, outside of the public arena,” he says.
Costs of going publicThe IPO process may also be expensive and time-consuming – there are quite a lot of hoops to jump through to become a public company. 

A business must have a trading certificate from Companies House, at least two directors (a private company only requires one), a company secretary must be appointed (not required for private), accounts must be produced within six months of the end of the financial year (nine for private companies), annual general meetings must be held and there are various restrictions on the company’s share capital and limits on pre-emption rights and dividends. However, most of these measures are good governance practices, contribute to the higher credibility associated with public companies, and are also likely to be required by private capital providers. 

According to Hutchison, in 2011, EY estimated that a new US-listed public company can expect to spend, on average, an additional US$2.5m annually post-IPO, and increased costs can be attached to management salary increases, expansion of the board and new investments in technology, all linked with floating. 
"If you already have your financial and legal structures in order, it will cost you less. But rather than focusing on the cost of raising that money, the focus should be on what the benefits are and what the cost of capital is"A November 2017 report by PwC says that underwriting contributes to the largest cost component of an IPO. “This includes fees associated with an investment bank that underwrites the stock and helps brings the company public. Based on public registration statements, on average, companies incur an underwriter fee equal to 4% to 7% of gross proceeds,” it says. 

Umerah says the cost is dependent on the company. “If you already have your financial and legal structures in order, it will cost you less. But rather than focusing on the cost of raising that money, the focus should be on what the benefits are and what the cost of capital is, rather than what the cost of raising the capital is (ie, just the transaction cost). These are two very distinct points – an IPO gives you the rigor and prestige of being a public company and access to follow-on capital relatively easily. It is important to think about the long-term cost of capital.” 

Clive explains that there are costs associated with both private equity deals and an IPO. “I don’t think there’s a huge difference in the cost, but it does depend how much money is raised. With an IPO, you have to pay ‘professional fees’, which are quite big, plus roughly 4–5% of the cost of the money raised. With a private equity deal, they charge big investment arrangement fees and annual monitoring fees, which could be equivalent to those of an IPO,” he says. “So I don’t think cost is a pro or con for either."
Be preparedWhile the number of global IPOs remain relatively low, there has been an increase in London, according to EY’s latest IPO Eye report. It shows that Q2 2018 saw 23 IPOs, seven more than in Q1 2018 and 12 more than Q2 2017. 

Umerah has noticed a change in the type of businesses coming to public markets, in particular London Stock Exchange’s growth market AIM.  “What we’re seeing now is more mature businesses, with larger market capitalisations at admission and raising more money.” 

Better preparation is key, with companies taking the time to weigh up the pros of going public, such as a large influx of cash, more influence and keeping control of the business, versus the cons, such as a high cost of listing, more public scrutiny and a raw deal for existing investors. Floating might not be the best option for all types of businesses, but it does provide permanent access to capital for those that need it. 

Seen a blog, news story or discussion online that you think might interest CISI members? Email
Published: 06 Nov 2018
  • Wealth Management
  • The Review
  • Capital Markets & Corporate Finance
  • private equity
  • London Stock Exchange
  • IPO
  • Financial markets
  • capital markets

No Comments

Sign in to leave a comment

Leave a comment