One of the primary reasons for flotation is as a means to raise capital. A flotation provides the company with access to a wider investment base from which capital can be raised. As well as the initial equity raised at IPO, it is common for further capital to be raised thereafter by way of rights issue or placing, and the market is usually open to this provided that IPO milestones have been met and there are sensible reasons for an additional finance requirement.
Once listed, a company not only has the capital raised on flotation at its disposal but it can also use its tradable paper as currency, for example to buy other busi- nesses. This of course will entail dilution of existing shareholdings but can be an effective means of financing growth by acquisition.
State of the market
The success of an IPO will be highly dependent on the state of the market, and also the current market perception of specific sectors. If the IPO market is liquid and sector valuations currently attractive, existing shareholders will realize value on the IPO. However, an IPO typically takes about four months, and it is only at the end of the process that a company really knows what price it will get or indeed whether the shares can be sold. The market, particularly the Alternative Investment Market (AIM), can be fickle, with windows of opportunity opening and closing relatively quickly, such that an adverse and potentially unforeseeable change in the market may result in the IPO having to be scaled back or even postponed.
Once listed, price and liquidity of shares may well be influenced by market conditions beyond the company’s control. Market rumour, economic developments and sector trends are all factors that can play a part in the valuation and liquidity of listed shares.
It is also worth noting that a valuation at IPO will not reflect any premium for control that may be payable by a trade purchaser.
Flotation as an exit route
Flotation provides existing shareholders with a publicly traded security, enabling them to trade their interest in securities at a ‘market value’. As a minimum, there is a requirement on EU regulated markets for there to be 25 per cent of shares in public hands, so selling shareholders are forced to make this amount available (although for AIM, which is not an EU regulated market, there is no minimum requirement).
A flotation provides shareholders with the opportunity to manage their exit over a prolonged period; after the initial IPO there is the option to sell further tranches of shares in the future, although lock-ups are nearly always put in place both on shares retained by the selling shareholder and on management’s holdings, typically for six months to a year.
However, a flotation should not be viewed as an opportunity for shareholders to exit their investment completely: investors are usually unwilling to put in cash if management is looking to sell out, and we would typically expect management to retain a meaningful stake in the business on IPO.
It can also be the case that liquidity in the shares – particularly on AIM – may be limited, making it difficult to sell large holdings and increasing volatility in the share price. Smaller stocks are often little researched, and can be overlooked by the investment community. Therefore, some of the perceived advantages of having a public quote may not always be realized.
Of course, even a partial exit involves ceding some degree of management control to outside shareholders, carrying with it the risk of an unwelcome takeover in future.
Enhanced corporate profile
Flotation brings with it all the pros and cons of being in the public eye. A listing provides greater visibility of the company and can certainly enhance its public image, the benefits of which may flow through in a number of ways. The company may improve its prospects in competing for contracts, since listed companies will often be perceived by customers and suppliers as being more financially secure and reliable; this in turn may accelerate sales growth and enhance profitability by heightening public awareness of the company and its products. A listed company is better able to publicize its strategy and intentions, and may consequently gain access to corporate transactions that previously would not have hit its radar. There may even be the prospect of a potential takeover at a premium.
However, the pressures that come with life in the public domain are not to be underestimated. Management may feel constrained by short-term performance demands rather than long-term goals, to satisfy new shareholders’ demand for a quick return on their investment. The City can be particularly unforgiving of unforeseen fluctuations in profit trends, resulting in sharp share price movements and unwelcome press coverage, with all the adverse implications that brings for the business. At best, this can result in loss of management flexibility; at worst, it may lead to management compromising the long-term success of the company through short-term decision making.
A public company is expected to behave as such, and therefore any previously blurred boundaries between company and personal affairs must be clearly drawn.
Directors will also have to grapple with the potential conflict between protecting commercial interests and fulfilling their obligation to keep the market informed of price-sensitive information.
Key people incentivization
The effective incentivization of staff is critical to the success of a growing business, and flotation provides an opportunity to put in place plans that will attract and retain talented personnel. The liquidity of listed shares enhances the attractiveness of
share option plans, such that employees have a transparent view of their company’s value and can share in its success.
Companies need to take great care with the design of their share plans to manage the level of charge against profits under International Financial Reporting Standard (IFRS) 2. Typically, fast-growing companies will deliver more value to their employees using a leveraged share plan, such as options or share appreciation rights (SARs), rather than an unleveraged plan that awards free shares to employees.
Conversely, a company with modest growth expectations will deliver more value with an unleveraged plan.
Companies also need to be mindful of dilution. The Association of British Insurers (ABI), which represents insurance companies as investors, recommends dilution of no more than 10 per cent of share capital over 10 years. Whilst options can be very dilutive, SARs deliver exactly the same economic value for much lower dilution.
Costs of listing and ongoing compliance
A company will incur significant expense in pursuing a flotation, including brokers’
commissions (a percentage of funds raised) and professional fees. The latter will be higher for a Main Market listing than for admission to AIM. The overall cost of capital typically falls in the range of 7–12 per cent of funds raised, although it will rise for complex IPOs (eg carve-outs from existing businesses, or overseas busi- nesses) and (in relative terms) where the amount of capital raised is low. As well as external costs, there is a price to be paid in terms of the considerable management time and effort that will necessarily be expended in discussions with professional advisers, drafting and verification of prospectus/admission documents and presen- tations to investors.
Once listed, a company and its directors are subject to ongoing obligations, reflecting the new responsibilities they have as the stewards of outside investors’
money. Requirements will vary by country and by exchange, and further details are provided in Part IV of this book, but in summary a listed company may need to retain the services of brokers, investor relations advisers, non-executive directors, registrars and so on. Compliance with listed company reporting requirements also comes at a cost – in terms of internal time spent on such areas as interim reporting, corporate governance and enhanced disclosure requirements, as well as higher external audit fees.
Of course, whilst it is true that the process of listing and the ongoing responsibil- ities of a listed company can be expensive, the benefits of a successful flotation to a company, its employees and shareholders should outweigh the cost.
Personal considerations
The process of successfully completing a flotation is intense, and running a listed company may well entail a significant lifestyle change. Board-level departures in the public eye can have an impact on investor confidence, with a knock-on effect on
share price, so anyone taking a business public ought to be thinking in terms of several years of commitment.
Table 3.1 Summary of advantages and disadvantages of flotation Advantages Disadvantages Access to long- 9 Provides the company
8
Dilution of existing term capital with access to a wider shareholdings.investor base from which
8
Valuation will not reflect any capital can be raised premium for control that may (eg for acquisitions). be payable by a tradepurchaser.
State of the market 9 Opportunity to realize a
8
Price and volume of placing is premium in a buoyant, uncertain and subject to liquid market. changing market conditions.Exit route 9 Provides existing
8
Only represents a partial exit shareholders with a for shareholders; management publicly traded security. expected to retain ameaningful stake.
8
Continuing shareholders (including management) will be subject to a ‘lock-up’.Enhanced corporate 9 Provides greater visibility
8
Pressure on short-term profile and enhances the company’s performance at expense ofcorporate image. long-term success.
9 Prospect of potential
8
Directors’ responsibilities takeover at a premium. increased.Key people 9 Liquidity of shares enhances
8
Options/long-term incentive incentivization attractiveness of stock plans (LTIPs) limited tooption plans (often with 10 per cent of share capital tax advantages), enabling (ABI guidelines) and subject the company to attract and to performance criteria.
retain talented personnel.
8
Potential profit and loss Employees can visibly share charge under IFRS 2.in the company’s success.
Costs of listing/ 9 Net cost may be lower than
8
Company is likely to incur ongoing compliance private equity funding. expense in pursuing an IPO.8
Considerable management time and effort.8
Compliance with listed company reportingrequirements, including interim reporting, corporate
governance and the EU Transparency Directive.
Tax (see Chapter 26) 9 Share values eligible for
8
LTIPs and share options treated business asset taper relief. as taxable income.9 Tax-efficient share option
8
AIM company shares retainschemes. exemption from inheritance
tax, but not Main Market shares.