Often a business will reach a fork in the road on a well-trodden path. The road travelled tells us that the future of many businesses could be great but this is often limited by the availability of finance. The fork opens to two visible routes, do you travel the road of debt or of equity?
Whilst debt may be inviting in a time of low interest rates and (supposedly) readily available credit from countless lenders, it does leave the business servicing repayment obligations whilst normally leveraging the assets of the business as security. Whilst it is currently cheap, will debt always be cheap and when the interest rates change (as they will one day), how quickly will this change cripple the margin generated by a business?
An alternative route to using debt is to raise equity. The concept of equity is in itself another series of options. Do you:
(1) Raise funds from friends, contacts and family?
Whilst attractive, this does have its limitations. More often than not a business will have already explored this avenue before and perhaps the proverbial pockets are now empty.
(2) Use external private equity investment?
There are many funds that operate to invest in businesses which have the potential for growth. The question will be who controls the destiny of the business and is that destiny one the founders wish to share?
(3) Undertake an initial public offer (IPO)?
This involves listing the shares of the business onto a stock exchange such as the London Stock Exchange Main Market (the Premium List or Standard List) or AIM or alternative exchanges (such as NEX). An IPO will allow the business to raise funds by offering its shares to the public in order to advance the business strategy.
Whilst options one and two might work for many, it will not work for all.
There are many tales of the limitations of private equity for some businesses. Businesses may find that private equity fails to open the avenues which were originally hoped for. With the money comes reports (often commissioned with “specialist” external advisors) to fund managers and representatives considering the viability of projects which have been proposed after months of research by those in the business. Decisions are weighed over projections and market data, considered by the board and ultimately vetted by the fund representatives.
The decision making and the consequences of those decisions rest with the board, but their autonomy is limited by what the fund thinks is best for its investors. This spiral of ever-decreasing circles can become infuriating for those who want to lead on the decision-making process and act when they think the time is right. When this is all done, and the fund wants to sell (or even complete an IPO) to exit, the other shareholders must follow them and will be the ones giving the warranties.
An IPO, on the other hand, can allow a board to stay intact. It may be the case that the board will need to be supplemented by an additional non-executive director to bring some listed experience into the fold, but generally the people managing the business pre-IPO will be those managing it post-IPO.
An IPO generally has 3 stages:
The business is structured and “de-risked” if necessary. The business effectively undergoes voluntary due diligence to ensure it is not susceptible to major risks (such as key management not being locked-in). The business will conduct investor road shows to gauge the market appetite for the company’s shares
The offer is made to the public and investors commit to subscribe for shares and those shares are listed.
The operations of the business and the on-going reporting obligations to investors and the chosen stock market commence.
Each stage is critical to ensure a good market capital for the business and the likelihood of a successful fundraise.
Whilst it is true that an IPO will commit management to “locking-in” their shares and being retained by the business following the IPO (this is not a “clean break” and ride off into the horizon), is this really any worse than the lengthy service contracts and restrictive covenants for directors in a private equity deal?
When considering which market to list on there are many (further) options to be considered, decisions which hopefully will be made with advisors who have experience of the pros and cons of each market. However, each market has its own codes and governing documents which let the directors know their reporting obligations so they can satisfy their on-going legal obligations for shareholders.
In the end it is a case of what is worse, living by a code that is available for all to see or living by the discretion of a fund manager?
Ian Gillis is head of Manchester corporate at Hill Dickinson and Michael Bennett is a corporate partner in Hill Dickinson’s London office.
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