This is the third in a series of posts: The Ins and Outs of Preparing for an IPO -What Your Company Needs to Know.
Phase I – Preparing for an IPO
Two weeks ago, we bullet-pointed out the advantages and disadvantages of an IPO. Beyond these considerations, the management team also needs to evaluate the company’s overall financial suitability and position in the market. This circles back to the necessity of acting like a public company to adequately demonstrate to potential investors that your company has an attractive track record with prospects for maintaining strong earnings growth.
Therefore, a company should begin by determining if it has:
- An attractive product or service to offer
- An experienced management team in place
- Favorable financial prospects
- A positive trend of financial results
According to PwC, “Many companies that have successfully gone public have illustrated market support for their product or service that would sustain an increasing annual growth rate over a period of time.” These companies often can use historical sales data to confirm that their products or services are of interest to the consuming and investing public.
Another key to a successful IPO is understanding the critical success factors that institutional investors seek out when making buy or sell decisions in their portfolios. These investors can typically buy anywhere from 70 percent to 80 percent of an IPO stock allocation. As a recent survey shows, this has changed significantly since the financial crisis of 2008. Investors now give a 60/40 ratio of financial to nonfinancial metrics when weighing the attractiveness of a company’s valuation. Debt-to-equity ratio and management credibility are the two most important IPO financial and nonfinancial success factors that investors consider in their assessments.
Going public is not the only means to access capital. A company may consider strategic alternatives to meet its capital and growth objectives, such as private placements, leveraged buyouts, accessing the bond market, joint ventures or traditional debt vehicles.
According to Deloitte, however, even if a company chooses to remain private following a pre-IPO assessment, efforts made during the pre-IPO process can help a company improve capabilities. “With public company processes established, companies that choose to remain private often find it easier to obtain private capital, attract venture partners and expand or improve supplier relationships.”
Choosing an exchange and timing the market
The choice of a stock exchange will have deep implications on the organizational structure and internal processes of a company. While there is no specific methodology for selecting the right exchange, executives must consider the unique characteristics of each stock market—its structure, quality, size and scope—to identify the one that best fits their IPO.
Each stock market has specific entry requirements, such as earnings history, shareholders’ equity, market capitalization, number of expected shareholders and corporate governance.
A company’s investment banking advisers play an important role in the selection process, as they can provide in-depth information on the investor base in each market and the market’s likely appetite for the company’s shares.
Beyond the financial criteria for choosing exchange, there are also a set of nonfinancial benefits to consider. According to McKinsey, these can include “ease of access, regional proximity, or the expertise of the analyst and investor community in a specific location.”
Timing and the ability to be flexible are essential components of the IPO process. There are many factors that can have an impact on the demand for IPOs, such as the strength of the economy and overall market and the market’s appetite for IPOs.
While bull markets tend to favor IPOs, should a company find itself preparing to offer during a bear market, they many not be as fortunate. In addition, different industries have different periods of buying sprees. Recognizing the role the market will play in your IPO is paramount. Missing an IPO window by as little as a few weeks can result in a postponed or withdrawn IPO, or even a lower market valuation.
A lot of preparation goes into the IPO process, but market volatility is a variable factor that may deter initial plans. Companies must be flexible with their IPO plans. Understanding that market conditions may not be conducive to a company’s initial plan, companies must be prepared to adjust their timetable for when it makes the most sense.
Gauging investor appetite
Investor interest in IPOs is often an indicator of the liquidity of a capital market, which will impact a company’s initial valuation. In markets with low liquidity, investors are either unwilling or unable to free up capital to purchase new shares. Some markets tend to have a fairly high appetite for initial offerings, whereas others may be warier about placing bets on new listings.
One must always remember, however, that investor appetite is notoriously fickle, and often focuses on a handful of hot, trendy sectors. IPO candidates should not choose an exchange based solely on which sectors are attracting investor attention in the short term
PHASE TWO, PART A WILL BE POSTED NEXT WEEK