What Management Teams May Not Realise About IPOs
fdu’s guest blogger, David Tilston is a Chartered Accountant, a Fellow of The Association of Corporate Treasurers and a member of The Institute for Turnaround. He has held CFO roles in both listed PLC and PE-backed companies and has experience of 3 IPO situations.
If you have not been a director of a listed PLC before and considering an IPO there will be many aspects with which you will be unfamiliar. This article tries to highlight some.
The attractions of an IPO can be many and varied. It can help you access a new group of shareholders to raise equity capital to fuel growth. It can provide liquidity so existing investors can sell their stakes. It may provide an opportunity to issue share option arrangements to lock in existing employees and attract external talent. The public listing may raise the company’s profile generally, particularly with customers and suppliers.
This does however come with obligations the company needs to comply with, and these vary depending on whether the route chosen is to list on the FTSE Main Market, on the AIM market, or some other market as each has their own regulations and expectations.
A typical management team experience
Completing an IPO can be pretty hard work. As well as running the business there is a huge IPO workload. This is typically borne by the CEO and CFO, aided by other internal staff and additional temporary resource. External advisors, lawyers and accountants (some of whom may be working on a contingent fee basis) will generate a barrage of requests for information and will have an almost insatiable appetite for CEO and CFO time. Their focus understandably will be on getting an IPO over the line as quickly as reasonably possible whilst the markets are receptive and so they can collect their fee.
barrage of requests for information …………..insatiable appetite for CEO and CFO time
The shares will be listed, the champagne corks will pop, and the following day the management team will emerge into a new world for which some have not necessarily been prepared.
Life on the Stock Market
Company prospects and price sensitive information
Whichever stock market is chosen there will be a requirement to keep the market abreast of all price sensitive information so this is available to investors as they buy and sell shares and the share price reflects all relevant information.
At IPO, where a prospectus is issued, the content of the prospectus essentially covers this requirement. The advisors and lawyers will ensure (with the management team) that all relevant information is published and appropriately disclosed. The lawyers will drive a verification process to check that each important statement can be backed up and documented, where possible with external evidence. Phrases like “the best thing since sliced bread” will have been exorcised and replaced by statements of fact. Risk factors (normally voluminous) will be outlined in detail so potential investors will be aware of the wide range of factors that might impact growth prospects and future performance.
Phrases like “the best thing since sliced bread” will have been exorcised
Once the company’s shares are listed relevant update information of a material nature, which might drive a change in investor perceptions and hence the share price, will need to be published on a timely manner (often in hours). Consultation with advisors will be ongoing as to matters which might require announcement but a significant change in profit expectations (and a 10%+ change would definitely fall into this category), major contract awards and acquisitions would potentially trigger the requirement for an announcement. Matters which require confidentially (for example discussions which may or may not lead to an acquisition) may not need to be announced as they are not certain, but advisor input will be sought.
Failures are public and can be damaging
In a privately owned company if the management team conclude they will not hit their profit budget then this is not a matter for public discourse (although the owners may be unhappy). Unfortunately this is not the case for listed companies.
In a privately owned company if the management team conclude they will not hit their profit budget then this is not a matter for public discourse
If profits are likely to materially undershoot expectations held on average by investors then an announcement will be required. There is typically an asynchronous bias in the market where (for example) a 10-20% shortfall in expected profits can lead to a severe fall in the share price, whereas a 10-20% outperformance does not normally generate a similar scale of share price increase.
Information of a profits downgrade is available for all to see, including customers, suppliers and employees. This would not be the case in a privately owned company. There can be a significant communication requirement to certain groups of stakeholders. For example if you are reliant upon a highly talented workforce which is effectively locked in by the use of share options, and the share price falls below the strike price, then attractions to staff of the share options could disappear. The company could become vulnerable to potential poaching of its scarce and most important assets. This would not necessarily be the case if the company was not listed and this is one area where NEDs with PLC experience can make a valuable contribution.
Information of a profits downgrade is available for all to see
Setting the IPO price too high/setting profit expectations too aggressively
Setting the IPO price and initial profit expectations may be quite a difficult challenge for management teams as there can be conflicting interests between various stakeholders. The valuation will be decided at the last minute, with advisors, based on the demand from potential investors following an IPO marketing roadshow. Those shareholders who are selling will naturally push the management team to be as bullish with their profit and growth expectations as possible. There will inevitably be a range of possible profit outcomes, and there will be pressure to set expectations at the bullish end of the range (which may effectively be a poisoned chalice that the management team needs to bear post IPO). Similarly exiting investors will push the advisors to try to set the IPO issue price as high as possible to maximise their personal return.
there can be conflicting interests between various stakeholders
The danger about this is that, if the share price falls, the new shareholders who have invested in the hope of benefitting from growth in the share price over time will immediately be sitting on a loss (as the recent IPOs of Deliveroo and Alphawave IP Group have demonstrated). They are less likely to be supportive of the company and there will be increased pressure on the management team to deliver performance and get the share price up. Further equity issue requests might not be supported at anything but disappointingly low prices.
I believe management teams should aim to ensure they avoid (as far as possible) missing their profit expectations over the first couple of years post IPO as they establish their credentials for delivering what they say they will do. This will generally bring longer term benefit, even if at the expense of a lower IPO price at the outset. Fund managers have very long memories!
they establish their credentials for delivering what they say they will do
Corporate Governance, internal controls and remuneration
Finally I would note that there are potentially significant changes afoot in the UK as BEIS consultation on restoring trust in audit and corporate governance (following collapses such as Carillion and Patisserie Valerie) concludes and new legislation is subsequently passed. The burden of new requirements is not yet clear but an increased focus on internal controls looks likely, even if only for larger companies.
In addition remuneration arrangements for senior executives are also subject to increasing scrutiny by investors and the ability to increase executive salaries above that seen by the wider workforce is a subject which can lead to investor challenge at AGMs in the current environment.
they are prepared for the new reality
It is worth management teams understanding well before an IPO the additional pressures they are likely to face as a public listed company, so they are prepared for the new reality.
Image sourced from Pexels.