Is it time for your company to go public? Justin Audcent looks at the benefits, drawbacks and complexities of listing on a stock exchange.
Listing on a stock exchange is a significant step in the life of a company. 450 Australian companies have gone public in the last three years.
The listing process can be costly and disruptive and, once listed, the business is subject to an increased level of reporting requirements and public scrutiny, as well as pressure from shareholders to meet earnings and dividend forecasts and maintain a rising share price. So why do so many smaller businesses aspire to float on a stock exchange, and how do you determine whether such a step is the best option for you?
An IPO (initial public offering) involves listing a company on a stock exchange and raising new capital through an issue of shares to the public. An IPO can be of benefit both to the company and its shareholders, and it is important to ensure that their interests are aligned.
Benefits to shareholders typically include:
Greater marketability: Shares in unlisted companies are usually not readily converted to cash, particularly for minority shareholders. Once listed, shareholders benefit from a readily accessible market for their shares, and can make decisions to buy, hold, or sell shares independently of other shareholders, although restrictions may apply to directors and substantial shareholders.
Increased market value: Generally the value of a company increases significantly on a public listing. As a result, the raising of capital through an IPO is usually less ‘dilutive’ to existing shareholders than a private equity raising or unlisted public offer–that is, less likely to dilute the ownership percentage of current shareholders.
Diversification of personal portfolios: Many business owners have most of their wealth tied up in the business. An IPO provides the opportunity to progressively realise this investment with a view to releasing cash and diversifying one’s investment portfolio.
Benefits to the company generally include:
Access to long-term capital: In addition to funds raised through the IPO, listed companies have the opportunity to raise further funds through secondary raisings, such as rights issues and share placements.
Improved financial condition: Not only do funds raised increase a company’s cash reserves or reduce its net debt, but the increased value of the company and the transparency associated with being a listed company generally enable it to secure a higher level of borrowings and negotiate more favourable terms with its bankers.
Enhanced corporate image and credibility: Listed companies enjoy an increased public profile through media coverage and analyst reports, while the knowledge that the company is required to comply with rigorous disclosure and governance requirements can enhance its credibility in the eyes of customers, suppliers, and financiers.
Employee incentivisation: Employee share schemes, designed to attract, retain and motivate staff, can be more effectively implemented by listed companies, whose shares and options have a readily ascertainable value and trade in a liquid market.
Currency for mergers and acquisitions: Acquisitive companies have the opportunity to issue shares for all or part of the consideration for acquisitions, enabling cash to be retained to fund future growth.
Business owners often view an IPO as their preferred exit strategy, but it’s rarely as ‘clean’ as that offered by a trade sale. Generally, business owners can sell down a portion of their shares on IPO, although this can be viewed negatively by incoming investors, while their remaining shares are likely to be escrowed for 12 or even 24 months, meaning that they can’t be sold in the market. Even after expiry of this period, there will be both practical and regulatory limitations on trading by directors. On the other hand, the need to ‘drip feed’ shares into the market can provide the opportunity for increased value to be realised if the company’s share price rises.
Key Criteria
Management continuity is also important to investors in a newly listed company. If one of your primary objectives is retirement, a trade sale to a strategic buyer with a tie-in period of 12 or 18 months may provide for an earlier exit.
Becoming an IPO is not for everyone. Many companies choose to remain in the private arena because of concerns about loss of control, restrictions on management flexibility, and the transparency required of a listed company.
Listed companies have to meet tight reporting deadlines and extensive disclosure obligations—your customers, suppliers, competitors and employees will all have access to this information. And while you can benefit from an enhanced corporate profile, the downside is that there is no place to hide, any bad news will be in the public eye, too.
The extra burden on management should also not be underestimated, with additional obligations in relation to financial reporting, corporate governance, and investor relations.
All stock exchanges set eligibility criteria for companies on listing. Key criteria generally include those relating to the size of the company and its shareholder base, which are aimed at ensuring an adequate market for trading in the company’s shares. For example, the ASX requires companies to meet either a profits test (aggregated profit of at least $1 million from the same business in the last three years, and profit from continuing operations of at least $400,000 in the last 12 months) or an assets test (net tangible assets of at least $2 million—after IPO costs—or market capitalisation of at least $10 million, with less than half of net tangible assets being held in cash).
The ASX also requires the company to have at least 500 shareholders each holding a parcel of shares worth at least $2,000. A lower threshold of 400 shareholders applies if at least 25 percent of the shares are in public hands. In either case, the practical implication is that a company can’t raise capital solely from institutions, but requires substantial support from retail investors.
However, simply meeting the minimum eligibility requirements does not mean your business is suitable for an IPO. Generally, companies should either be able to demonstrate a strong, sustainable track record of earnings growth or, for early stage technology-based companies, very high growth potential backed by well-protected intellectual property.
Your business should also have a strong competitive position within your market segment and a clear strategic plan to deliver medium-term growth. And to convince investors that you are able to meet both your strategic goals and the reporting and regulatory requirements of a listed company, you will need to demonstrate a capable and committed management team, robust management information systems, and an effective board and corporate governance structure.
While the ASX sets a minimum market capitalisation of $10 million on listing, most companies of this size suffer from a lack of liquidity, while the costs and reporting requirements associated with being a listed company are heavy. We generally recommend companies have a minimum capitalisation of around $30 million. As a rough guide, this would typically imply annual post-tax profits of around $3 million.
The cost of an IPO can vary significantly, dependent on the size and complexity of the company, the amount of new funds raised, whether the offer is underwritten, and the amount of pre-IPO restructuring required. The largest single cost is generally the broking fee, which is usually a percentage of the funds raised—5 percent or more for a smaller compa
ny, reducing to 2-3 percent for a very large offering. You will also incur the costs of other advisers—lawyers, accountants, corporate advisers, and public relations advisers—as well as listing fees and ancillary costs, such as share registry and the printing of the prospectus.
As a guide, total IPO costs in 2006 for companies capitalised at $10-50 million were generally in the range of eight to 10 percent of the amount raised.
It is important to spend time upfront considering carefully whether an IPO is the most appropriate option. This depends on the key objectives of the company and its shareholders, and should involve consideration of alternatives. Your accountants or other advisers may be able to assist by facilitating this discussion, providing an independent view and highlighting the pros and cons of each option.
If you decide to take the IPO route, start your preparations early—ideally at least 12 months before listing—with a clear strategic plan for the business. And talk to two or three brokers. They will advise on whether your business is likely to be attractive to the market, and will highlight key issues that need to be dealt with ahead of an IPO.
* Justin Audcent is a partner with business advisers and finance firm, HLB Mann Judd, Sydney.
Case Study: Listing on a Stock Exchange
One of the most exclusive locations in the real estate of retail shelf space is that found in hair salons. "A salon can only stock so many products," says Nick Ghattas, managing director of Soda Brands, distributors and parent company of the Salon Only range of hair care products. "We are up against some of the most major pharmaceutical and consumer goods companies. And in the past 10 to 15 years they’ve just kept buying and buying the big brands."
To help compete, and give the brand more room for growth, the Soda Brands team decided to go public, and the company launched on the National Stock Exchange (formerly the Newcastle Stock Exchange) in January this year.
"It gives us a little bit more exposure, and a lot more credibility in the eyes of salon owners," Ghattas says. "They might be small businesses but they are dealing with some of the biggest multinationals in the world."
But there’s a twist. In what Ghattas claims is a first for the salon-only market, the company is offering its stockists shares in the company based on their yearly sales. "They’ve got to reach certain purchase targets, then they get rewarded with up to 10 percent of what they spend in that year in shares." Ghattas says. "We hope to get to a situation where a percentage of our shareholders are the people who use and recommend the product."
The company chose the National Stock Exchange (NSX) because it’s more accessible for small businesses, he says, with less onerous requirements than the Australian Stock Exchange (ASX). The reporting involved, tests imposed, and number of shareholders required, is more manageable for small business, he says. Cheaper ongoing costs and the NSX policy of getting listed companies to nominate an adviser for ongoing assistance, also makes it more attractive. "Our company is basically not big enough to go to the ASX, but it is big enough to meet the conditions of the NSX."
Ghattas warns businesses to be prepared for the work involved in going public. "It does take away, to a certain extent, from focusing on the core day-to-day tasks of the business," he says, adding that if he did it again he would enlist an extra pair of hands to handle the paperwork. Getting some good legal help and advice from the company’s merchant bank also played a big part in the process.
However, he’s not complaining. Although it’s a bit of a waiting game—the company expects it to take about six months before any major movement occurs on the exchange—initial reaction has been good, and the learning experience invaluable. "It’s given me the means to fulfil my plan and also the expertise to actually do it."
—Cameron Bayley.
