Flotation
Part 4: Risks of flotation
At all stages, the primary risk to a flotation is the state of the stock market and investor sentiment towards the sector that a company is seeking to join. If the stock market as a whole, or if the sector specifi- cally, is weak then this may cause downward pressure on the price at which the flotation can be achieved, or halt the flotation altogether.
Pulling out of a flotation is very much the last resort. However, market conditions do change over time, sometimes quickly and sometimes slowly. Given that the flotation exercise can be a protracted one, it must be accepted as a commercial risk that there is potential for such a change to take effect at some time in that process.
The important factor here is an on-going dialogue between the existing shareholders and management of the flotation candidate and the stockbrokers to the float. From the perspective of the existing
shareholders and management, they will wish to know on a regular basis what the chance of a successful flotation is in order that they can plan the company’s future. It is no good for the stockbroker to be appointed at the beginning of the process, only to be brought in at the end to market the shares if, during the flotation process, had the stockbroker been asked, it would have said that the flotation was no longer a realistic alternative. In that scenario, significant costs would have been incurred which might not have been incurred had there been an on-going dialogue with the stockbroker. However, if a flotation is to be halted at all, it is best that this happens prior to any marketing or any press coverage of the potential flotation. This way the company can seek to float at a later time and not be seen by potential investors as having failed earlier.
Another area that may halt a flotation, regardless of the state of the market, is ‘due diligence’. It is in the company’s best interests and, therefore, the interests of both existing shareholders and management, for the advisers to be fully conversant with both the prospects and the risks, comprised within the business. This will allow them to formulate a realistic and balanced marketing strategy prior to seeking new investors at flotation, and, additionally, investors will be comforted by the knowledge that the company has been examined in detail.
In order to attain a position where the company’s advisers are in possession of the relevant facts to assess the prospects and risks, there must be a considerable due diligence exercise undertaken as described in Part 3. It may be that, at this stage, something is discovered which makes the company inappropriate for flotation in the short term and the problem needs to be addressed prior to a delayed flotation date.
This delay may mean that the company misses out on the opportunity it was seeking to access by attaining the flotation. The likelihood of this happening can be lessened by working with the company’s advisers from an early stage and informing them that flotation is a real prospect in the view of management and existing shareholders. Advice can then be given with a possible flotation in mind.
A less documented risk of flotation is the detrimental effect it may have on the business. This may occur where either management’s attention is distracted by the flotation process away from the running of the business, or management see flotation as an end in itself and relax their efforts following flotation because of this. Either way, the business may suffer or slow down as a function of management’s ‘eye being off the ball’. The first year as a quoted company is arguably the 126 Public Equity
most important year. It is the year in which the company has to prove that it can sustain its historic growth, prove that the prospects against which it persuaded new investors to invest are there, or the acquisi- tions that it said were available are delivered. If a company does not perform to expectations in its first year and falls out of favour with investors then it may take some time to regain credibility in the eyes of the investors. It is important not to promise too much about the company’s prospects in the future or to play down the risks attached to such prospects, and therefore not to be greedy in pricing an issue thus leaving little for new investors to benefit from in the future.
Instead, it is vital to be realistic in order to establish the company as having a credible perception with investors, with the goal of estab- lishing a profitable relationship in the future for all investors, new and old. After all, it should be remembered that a key advantage of a flotation is the future use of quoted equity to make acquisitions and to raise money.
A further risk, which may well befall a company with a disap- pointing performance in their early years, is the risk of the company itself being taken over. As a quoted company, there is an increased requirement to publish information about results, trading, prospects, etc. and therefore competitors will be more easily aware of the performance of a quoted company over that of an unquoted company.
How widely the equity of a company is owned will also affect the risk of a take-over. If, for example, management have retained more than half of the equity, a bid is unlikely, but if the equity is widely spread, a hostile approach may become reality.
The final risk covered here again relates to the requirements on a quoted company to publish more information and more often than an unquoted company. This might lead to competitors taking commercial advantage of that position without resorting to make a take-over.
What happens then if the flotation has to be halted? Depending on the other factors influencing a company, there are a number of alter- native routes open to the company if a flotation is halted. There are a number of companies that have successfully floated at the second attempt, so to wait for better market conditions is a very real alter- native. If the company does require equity in the shorter term, a private placing may be an option or indeed venture or development capital. If an exit for existing shareholders was one of the primary driving forces behind flotation, then the sale of the entire company may be an appropriate alternative route.