How to make an Initial Public Offering on the London Stock Exchange in 10 steps
21 min read
17 December 2014
If a company wants to sell stock shares to the general public, it conducts an IPO. But it takes months of preparation and, if done wrong, will lead you to retract your IPO. So here are ten steps to IPO readiness.
1. When to consider an IPO
The wonder that is the IPO was designed to bring in equity to fund growth, as well as establish an efficient market for the company’s shares.
In this case, it is often said that IPOs are best for companies that are large or have retained rapid growth. This is mostly because companies that don’t meet the growth criteria will not attract sufficient interest to maintain a strong valuation.
According to Glenn Solomon, partner at GGV Capital, banker’s generally expect businesses who have hit the $100m (£63.86m) mark to consider going public – and only then.
But it seems that everything should really revolve around predictability and visibility.
“As a junior banker at Goldman Sachs in the early 1990’s, we were weaned on the conventional wisdom that growth companies were ready to go public when they reached $100m in annualised revenue and had at least two quarters of profitability under their belts,” he explained.
“This theory was based on the idea that a company must be large enough to both: (a) withstand competitive pressures and (b) earn a large enough market value to enable the company to sell enough stock to institutional buyers in its IPO, without suffering massive dilution in the process.”
Controversially, however, he suggests that “this theory makes no sense, despite the fact that many bankers and VCs still cling to it like religion.”
“If your business is $50m (£31.93m) in revenue but you know with high precision what next quarter, or even next year, is going to look like, you pass the test,” said Soloman. “On the other hand, even if your business is $200m (£127.71m) in revenue, and you can’t reliably predict what’s around the corner, watch out.
“The stakes are high — take the time you need to ensure that you have built predictability into your company before your IPO.”
However, there are a few requirements:
- The expected market value of the securities must be at least £700,000 in the case of shares and depositary receipts; and
- The securities must be freely transferable.
2. Pre-IPO preparation
Generally, businesses begin preparing for an IPO well in advance. This can typically take four to six months, but has been known to last longer.
In an EY study, ‘Measures that Matter’, it found that for 95 per cent of investors, the most important non-financial performance measure in their decision making “is the quality of management credibility and experience.”
The company’s management team are essential as they need to explain the business, their strategy and are believed to be a key metric in seizing up a company’s ability to retain and recruit top talent in senior roles.
A business plan also needs to be set up, setting out your products, markets and growth objectives. Essentially, you need a clear vision of future performance. This will help you find out whether your customer base is unsuitable for an IPO.
You also need to be able to show investors consistent top and bottom line growth, as well as a solid balance sheet.
And how do you plan to raise funds? This can often take the form of:
- Raising additional capital by issuing new shares to exiting shareholders;
- For existing shareholders to sell their shares to other existing or new shareholders (In this case you need to know the likely quantum early on); or
- All of the above.
And if your company raised new capital, what will it be used for? Generally, new capital is used for expansion plans or to pay off debt.
In addition, you will need to start making preparations for your future sponsor’s written confirmation to the UKLA that all proper financials controls are in place.
In many cases, companies take this as their chance to reorganise the group. After all, “change may be necessary to optimise a group’s tax position, or to remove businesses or assets that are nor part of the group to be floated”, says the London Stock Exchange.
But that’s not all, many companies also start reviewing the amount of equity owned by their top executives and employees and a crucial thought for any firm is what to do with controlling shareholders after the IPO has taken place.
It is also at this point when you decide whether you want a premium listing or standard listing, as well as whether being listed on AIM might be a better option for you.
3. Choosing a Premium or Standard Listing
Although the two are quite similar, they do have their differences.
Generally speaking, a Standard Listing is easier to apply for since it features lessmandatory corporate governance standards and, once listed, your company will havefewer continuing obligations after the float.
But to apply you require:
- At least 25 per cent of shares to be held in public hands in the EuropeanEconomic Area at the time of your admission;
- The value of the securities to be listed must be at least £700,00 in share receipts;and
- The company must be approved by the UKLA and the Main Market of theExchange alike.
In the case of a Premium Listing, you need:
- A sponsor;
- To comply with the Listing principles;
- To maintain financial reporting procedures; and
- To prepare audited accounts for the last three years.
There is a definite advantage to a Premium Listing. Although you need to comply to requirements higher than the EU minimum standard, investors will have more confidence your business.
4. Choosing a sponsor
Possibly the most important step in the IPO process is choosing yourself an ‘underwriter’. Underwriters raise money for companies using public equity markets.
You can find a full list of sponsors on the Financial Services Authority’s (FSA) website. Another way to find yourself a sponsor is to hold a ‘beauty parade’. This will allow you to ask them a series of questions in order to get a feel of what working with them would be like. However, this is a two-way system, with underwriters looking to understand what makes your business tick before they agree to take on the listing.
According to the London Stock Exchange: “They will be required to submit an eligibility letter to the UKLA setting out how the company satisfies a number of the Listing Rules” and will be obliged to consider “whether the admission of the equity shares would be detrimental to investors’ interests.”
Companies should be wary, and keep experience and, perhaps, reputation at the forefront of their minds as these investment banks will often hold a number of shares in the company in order to create a market for the stock. This will make sure that any significant investors are in it for the long-run and not just merely looking for short-term wins.
The process also includes the buying of stock from the issuer and then selling the stock to the public and ensuring that all Listing Authority and Stock Exchange rules are met, as well as them being placed in control of contacting institutions to place shares.
Essentially, they should be able to pull together a syndicate of investors to back the offering.
Russ Shaw, founder of Tech London Advocates, suggests that the best investors “understand that companies need time to grow. Entrepreneurs need to make sure investors agree on a long-term growth strategy.
“It is entirely pointless to aim for profitability in three years time if resource could be better invested in attracting users and growing the company. Reaching profitability in seven or ten years is not a sign of failure, but the sign of a company aiming for a more successful IPO.”
But ‘bookrunners’ and lawyers should also be added to your IPO team at this point.
5. Negotiating a deal
Once you’ve chosen a sponsor, its time for an initial meeting, or rather, spending a day negotiating a deal. This face-to-face meeting is held so as to insure that everyone understands the structure of the transaction and the process involved. The sponsor usually brings along an organisation book outlining any relevant issues.
And absolutely everyone will be expected to join, such as auditors, lawyers, underwriters and, of course, management.
will often involve topics such as the amount of money a company can raise, determining the timing for the filing and details in the underwriting agreement.
There are several deals that can be made:
- Firm commitment: The underwriters will be responsible for any unsold inventory. They guarantee that a certain amount will be raised;
- Best effort commitment: This deal will limit the underwriter’s risk, but also means it will gain a flat fee for its services. Essentially, they will sell securities for the company, but won’t be able to guarantee the amount raised; and
- Underwriting syndicate: One their worried about the possible risk of the offering, they could instead form a syndicate of underwriters. This would involve having a group of investment banks working together to issue new stock, while having one bank take the lead as manager. If they are unsuccessful, then the syndicate breaks up.
And, to make sure everyone remains on track, such meetings will continue each week either through conference calls or a meet up.
As stated by the London Stock Exchange: “An admission of securities onto the official list and the main market of the London Stock Exchange requires the production of an approved prospectus.”
So, after the meeting, the lawyers and bankers involved will be doing a lot of due diligence in order to write up the lengthy document known as the prospectus.
This process can take several weeks and will, more often than not, require all your advisors.
The purpose of the due diligence is to make sure that you’re being accurate and truthful. This will include a history of the company’s performance and competitive position.
This document, featuring company financials, reasons for the IPO and about the offer itself, will also be presented to potential investors.
And, more often than not, the decision to invest in your IPO will be made on the basis of prospectus. So it comes as no surprise that many believe the prospectus to be a helpful marketing tool.
Although your lawyer’s will be responsible for drafting it, the sponsor and bookrunner(s) often assist in creating a marketing story.
It is then the sponsor’s job to hand the draft to the UKLA.
Note that it is only after the prospectus has been reviewed and approved by the UKLA, the name used by the Financial Services Authority (FCA) when it acts as the head of authority for listings, that your company will be eligible to float on the market.
This could mean writing up several drafts. In fact, large IPOs have been known to rewrite their prospectus at least five times.
The UKLA will aim to review and comment on the document within ten working days.
As a rule of thumb, be prepared for this timeframe to take up six to eight weeks.
7. Public phase
At this point it is advisable for your company’s lawyers to put in place approval procedures for information that is made public before you are listed. This will include making sure that, although you focus on marketing, that there is no heightened level of publicity.
When your company is ready to confirm plans of its IPO, it is normally by public announcement, otherwise known as the Announcement of Intention to Float (AITF).
And it is during this stage that marketing, often lead by the bookrunner, will begin taking place. Of course, you could also leave this to a PR company.
This is also when a draft prospectus (also called a Pathfinder prospectus) is made available to prospective investors.
“This document is an almost final version of the prospectus,” explains the London Stock Exchange. “Apart from details of the precise size of the IPO and the subscription price of the new shares offered, it should include all other relevant details”.
The sponsor will start contacting a number of investors to raise interest in your company and get everything sorted for the road show (in more detail below).
More often than not, this is also when analysts “market the story to investors using the research they have written.”
8. Road show
In an EY study it was was found that 82 per cent of investors worldwide cited the quality of the road show as a key measure to their buying decisions as well. Indeed, this step is crucial as it is perhaps the only time where investor’s will meet your senior staff face-to-face.
On a road show, underwriters will take your senior staff on a ‘tour’ to introduce you to key and potential investors for your business. This typically spans over a two week period. At each stop, your staff will be expected to tell them about your company and sing its merits.
This will also allow them to put skeptics in their place and win over a few more investors.
Although it may take some time to visit the all, it is vital that your company message stay the same throughout. This could mean coaching some of your staff in advance to make sure they’re prepared. Staff members should meet every now and then for rehearsals just in case.
For example, road shows often include something akin to an elevator pitch, a presentation most likely given by the CEO and/or the CFO.
9. Pricing meeting
Once that is all done and dusted, the order book is finally closed. At this point, the management team will meet the sponsor and decide on the final price of the deal based on the orders that they received.
The two main pricing methods are known as the fixed price offer, whereby the price of the securities is fixed in the prospectus, and the book-build (possibly the most common method in the UK), which allows potential investors to bid for the securities before the price and size of the offer have been determined.
Once all bids have been received, the company and sponsor can gauge the level of demand and work out and appropriate price range.
Essentially, Mergers & Inquisitions Nicole Lee explains that “if a deal is over-subscribed, the company will price the company at the high end of the range and will do the opposite for under-subscribed deals.
“Sometimes management will deliberately price the company at a lower price (leaving some money on the table) so the stock can trade up on the first day of trading – always a positive indicator to the market.
“Usually companies that tank after the first day of trading have a hard time recovering and getting back to their initial price.”
10. Impact day
The impact day is often the day referred to after the pricing and subsequent completion meeting. It is at this time that the availability of your prospectus will be advertised. The listing of your business will also be officially announced.
However, in order for this to happen, your prospectus needs to be submitted to the UKLA in its final form. This will include the pricing and size information that hadn’t been added to the document before.
Then… you wait for their approval.
Alongside your prospectus, they will require any supporting documents referred to in your document, as well as any audited accounts.
And, at least 48 hours before your admission, a formal application for a listing is submitted to the UKLA as well. At the same time, an application for admission to trade needs to be submitted to the Exchange.
When you’ve reached this point then your company’s shares will be admitted to listing and the shares publicly traded on the Main Market.