Are You Ready to IPO?

While a slowdown in IPOs is to be expected given the volatility in the global economy, plenty of chief executives will be keeping their options open over the course of 2016. Should they decide to go public, current market conditions serve to reinforce the need for a business to be in the best possible shape.

Although the number of IPOs on the London Stock Exchange in 2015 (92) didn’t match the highs of 2014 (137), there were plenty of significant flotations. It shows that investors will continue to back companies provided the fundamentals are in place, such as a strong growth story, sensible pricing and a good blend of skills and knowledge between the executive and non-executive team.

As ever, sound preparation ahead of a flotation is going to make a world of difference in terms of business performance. Tom Beedham, Director of Programme Management at Criticaleye, says: “In the 12-18 months prior to a listing, the executive team needs to be fully aligned and aware of what it takes to go through the IPO process. Certainly, securing an experienced non-executive chairman and creating an effective board will also help to fill any of the executives’ gaps in knowledge about what it’s really like to run a Plc.”

Here, a number of leaders share advice based on their own recent experiences of conducting an IPO:

Work hard on investor relations
Ron Kalifa
Vice Chairman and Executive Director 
Worldpay

The payments processor joined the London Stock Exchange in October 2015. It was the UK’s largest IPO of the year and the largest ever Fintech IPO. It floated at £2.40 a share with a market value of £5 billion and £2 billion in proceeds. 

Investor relations are critical and it’s important to start planning well in advance of the IPO. Being a carve out of a bank, we were little understood and not very visible, so it was crucial that we spent time and resources telling investors what we do.

We set very clear objectives in terms of the investor relations strategy to promote the company’s activity and reputation to external stakeholders, helping them to understand how the business would be run post-IPO.
In the build up to the IPO we met with about 400 potential investors, which seems a lot but because the business was little known on a global stage it was really important we did that.

One way we communicated well with our stakeholders was by producing a range of data and corporate information on Worldpay – factsheets for the media, presentations for the analysts and a very regular and intense set of commercial updates to highlight our drivers and business performance.

We then started to anticipate the needs of the stakeholders, which was key. We spent time with all of our analysts and investors to ensure we knew their expectations of us, and how we can have the right data and content to address any specific questions they have. It’s a case of being prepared for the issues that may emerge in the process of the IPO.

Build momentum in your growth story
Richard Segal
Chairman
On the Beach Group

The short-haul package holiday firm, On the Beach, floated on the London Stock Exchange in September 2015. The listing valued the company at £240 million and raised £90 million at £1.84 a share.

Our business has a first rate management team with a proven track record, so my key task as Chairman was to ensure there was no cap on their ambition. It was about making sure the management team took the business to a higher level as quickly and efficiently as possible.

On the Beach had grown at a very exciting rate and on the back of that, a number of banks started approaching the private equity owner, Inflexion, saying that it was ripe for the capital markets.

The market then came alive with IPOs of digitally disruptive businesses such as Just Eat and AO World, and the capital markets were putting attractive valuations on businesses.

We’d only been under Inflexion ownership for about a year. We spoke to advisors more seriously towards the end of 2014 and agreed to have a limited number of introductory and educational meetings with selected investors. Based on the feedback, we concluded it would be slightly premature in going to the market. So, we put our head down and focused on delivering impressive financial results and expanding the business.

Come 2015, after a strong performance, we re-engaged with our advisors. It was clear that the business had achieved a lot in that period. Our performance was ahead of what we had told investors we would achieve and we had a highly compelling story. That gave the board the confidence to fire the starting pistole

Select the right help
Mark Payton
CEO 
Mercia Technologies 

Mercia provides seed capital to support high-growth UK technology businesses. It listed on AIM in December 2014 at £0.50 per share, raising £70 million to expand the business and had a market capitalisation of £106 million.

There are a number of planets that you hope will align to make your transition to the public markets smooth, and ours had thoroughly aligned. We had the dream team in terms of advisors, a perfect share register and the capital markets were open.
I had quite a large shopping list of ‘must haves’ to ensure the IPO happened.

Based on the context that we were going onto AIM, we were looking for a best-in-class Nomad and broker. Somebody who had an excellent reputation of raising capital and supporting businesses as they prepared to come to market was fundamental.

Second was the accountancy firm. Moving from a limited liability to a Plc requires the implementation of a raft of new accountancy standards, so we needed a top-tier firm in that regard.

We required a legal company that was absolutely cognisant of the needs of our share register, the City, our business model and aspirations of the management team. We picked the very best of all our advisors from an extensive beauty parade.

We also needed to build our share register wisely; we wanted shareholders that understood our business and our model, and were with us for the long-term as we started the next phase of our growth story.

If we couldn’t have achieved the level of capital raised from such a high quality share register, we wouldn’t have floated – and we wouldn’t have those shareholders without our advisors.

Motivate and manage your team
Nicola Pattimore
HR Director 
Equiniti

Equiniti, which provides payment solutions, was carved out from Lloyds Banking Group in 2007. It floated in October 2015 at £1.65 a share, netting around £315 million and giving it a market capitalisation of £495 million. 

The right leadership team is crucial to the successful sale of the business. If you’ve got leaders with the right drive and ambition they will naturally want to – and be able to – do a good job.

They need to be resilient because they’ll be working really hard to juggle the IPO with business as usual. Don’t underestimate how tough it’s going to be. The ability to prioritise is key. Understand in advance how intense the process will be so that you can prepare your team and loved ones at home for what’s coming.

Everyone focuses on the IPO but actually what comes after can be even more critical. Depending on the timing of the sale you may have a really intense three or four months after the IPO. You’re fully back in the business and need to focus on performance and delivering the year-end numbers you’ve committed to your shareholders.

You need to motivate your team, not just through a successful IPO, but to maintain a successful business after you’ve floated.

If you’re looking at incentive and reward arrangements for the senior team, they absolutely have to align with the shareholder value. You also need a balance of reward for today and a lock in for tomorrow.

Read more on recent AIM activity following its 20th anniversary 

Or, find out more from EY’s Q4 2015 IPO report. 
By Mary-Anne Baldwin, Editor, Corporate

What are your thoughts on IPOs? If you have an opinion that you’d like to share, please email Mary-Anne on: maryanne@criticaleye.com

https://twitter.com/criticaleyeuk

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How to Exit as a PE CEO

The key to planning a successful exit is to focus on the potential buyer, says Adam Hodges, former CEO of gaming company Playnation. He advises: “Work backwards. Ask who’s going to buy the business. What do they want it to look like? What would make it interesting to them?”

Adam should know. After conducting a private equity-backed management buy-out in 2013, he recently sold the business − which operates 20,000 amusement and entertainment machines over 1,700  UK sites − to Austrian gaming company Novomatic Group.

But like many PE-backed CEOs, during the two years before the sale, Adam had to rethink his exit strategy, draw up new plans and adapt as the circumstances for potential buyers changed.

It’s important to do your research. Assess whether a trade sale, secondary buyout or even an IPO are right for your business, but don’t be afraid to adapt if that alters.

Study the market 

Although the global IPO market cooled in 2015, exits via trade sales and secondaries remain strong. According to research by Big Four firm EY, PE houses have sold 625 companies via M&A this year, with an aggregate value of $262 billion (£174 billion), which is roughly in line with last year. Strategic M&A has been particularly active, accounting for 72 per cent of PE sales, the highest proportion in more than a decade.

Charlie Johnstone, Partner at PE firm ECI, notes: “There’s a lot of money globally and that’s feeding into higher prices across all sectors, from houses through to companies.” Unsurprisingly, he says the tech sector continues to attract the highest multiples and that the three tech businesses ECI sold in the last 18 months − CarTrawler, Fourth and Wireless Logic – each attracted a premium pricing of 17 to 20x their profit.

As ever, buyers want to see the magic combination of predictable income and scale. Ewa Bielecka Rigby, Investment Director at LDC, says: “Management needs to understand the size of their addressable market and where future growth will come from. A track record of sales and profit will be vital for potential buyers, together with predictable, high-recurring revenue and a forward pipeline of earnings, preferably backed by long-term contracts.”

Tell your growth story

When Roger Taylor took the CEO role at PE-backed Quadriga Worldwide in 2011, it was two years into the Great Recession, annual new contract signings had fallen from €120 million (£85 million) to €30 million (£21 million), and the business, which provides technology to hotels, had no product roadmap.

“We realised we had to come up with the growth story because my top line was falling away and the rationale for the product and business was dying,” Roger explains.

It was also his first operational role after a career in M&A advisory and PE investment. He recommends the first point in any exit strategy is to understand the reality of the business. In the case of Quadriga, this meant determining the company’s mission so that it could be easily communicated to staff, customers and potential buyers.

“If I were going into another situation, that would be the first thing I’d look to create. It’s the anchor by which you can align your vision with the board,” says Roger, who left when the company was sold earlier this year to software development and professional services organisation Exceptional Innovation.

Ewa agrees with his advice, adding: “In an exit situation, the same story delivered in a consistent way by different management team members builds trust with potential buyers, especially when backed by facts and a good track record for the delivery of results.”

Right-size the business

Adam had to go back to square one when he was told his initial exit route for Playnation was no longer viable. After assessing various options, he chose to make the strategic acquisition of FunHouse Leisure as it allowed the company to move into a new sector.

“We doubled the size of that business in 12 months,” he says, adding that it wasn’t just a cash grab. “It was about exposure into that market space, which meant that it was more scalable for an acquirer.”

Grand exit strategies won’t count for much if business performance drops. In such instances, raw pragmatism is required to get the company back on track.

This is something Criticaleye Board Mentor John Allbrook has experienced first-hand. Until recently, he was the Executive Chairman of Syscap, a PE-backed specialty finance company. After joining in 2010, John undertook a significant turnaround as revenue had fallen from around £160 million to £60 million per annum.

“We identified one market where we really felt there was an opportunity and that was providing bespoke lending facilities to smaller legal partnerships,” he explains. “This initiative proved hugely successful and was instrumental in our recovery plan as revenues once more climbed north of £150 million.

“Our situation was too challenged to say: ‘We won’t chase that opportunity because it doesn’t fit with the exit strategy.’ We needed to cut cost, redefine the growth strategy and quickly become cash-flow positive. But once the strategy started to work it became extremely clear who the buyers were likely to be, because they were the companies we were competing against.”

Build your team

Investing in the right employees and a strong succession plan can only benefit the business. “Don’t underestimate the value your staff holds,” says James Boot, Senior Relationship Manager at Criticaleye. “High employee retention rates, clear and functioning incentive plans and a positive workforce can be very attractive to the right buyer, perhaps to the extent of an extra multiple.”

A good team will mean the CEO can delegate operational responsibility as they devote more time to the exit strategy and deal itself.
Ewa recommends: “Plan for senior executives to be totally absorbed by the process, therefore the operational team needs to focus on keeping the results going, which is vital to good exit metrics.”

This is precisely what John did for the exit he led at Syscap. “The sale process was handled predominantly by myself and the CFO. Other members of the management team focused on the day-to-day running of the business. Of course we had to bring them into management presentations to prospective buyers and parts of the diligence process, but we kept it tightly managed to minimise distraction,” he explains.

Agree the equity spread  

Suspicion and sniping within the senior management team about the equity spread is in nobody’s interest.

As James notes: “Being clear to potential buyers about the management’s equity expectations is key. Therefore when writing the investment memorandum put the current equity spread, and who is set to make what type of return from the exit, on the first page.”

Similarly, it’s essential that when a management team originally takes on PE investment, they fully understand the terms of the transaction so they can remain incentivised. ECI’s Charlie warns: “If you’re going in with a high valuation it’s harder to generate returns and the management team, as the deliverer of that shareholder value, is under more pressure. But I’d say the biggest risk is taking on excess debt commensurate with the high price.

“If you can, steer the deal towards someone who is willing to pay the right price but still willing to put in less debt and be more collaborative with the team. There are some parties that will put their loan notes to rank ahead of management, put exit fees in and do all sorts of things that will be very detrimental to management teams.”

It’s one of the reasons why a CEO should take care when deciding which PE house to bring in. Adam spoke to about 15 PE houses before agreeing a sponsor for his MBO − it wasn’t the highest bid, but it was the best fit. He explains: “What was most important was that they [the sponsor allowed] me to get on and run the business myself; they wouldn’t micromanage me”.

By Mary-Anne Baldwin, Editor, Corporate

Do you have a view on this subject? If you have an opinion that you’d like to share, please email Mary-Anne at: maryanne@criticaleye.com

Hear more on PE at the next Private Equity Breakfast, where Nicola Pattimore HR Director at Equniti will share her experiences of the company’s recent IPO.

https://twitter.com/criticaleyeuk

 

 

The Landscape for Private Equity

All exit options are open for private equity-backed businesses in 2015. Expect acquisitions, corporate carve-outs, IPOs and the continuing carousel of secondary and tertiary transactions. It means that PE firms can count on the competition hotting-up for quality assets, while the management teams of high-growth companies should be in a strong position to make operational improvements and increase market share.

The general opinion among those in private equity is that businesses should be able to build on the momentum that was gained in 2014. Criticaleye spoke to a range of executives, advisors and PE houses to identify the five trends that will shape the space in the year ahead:

1) A Mountain of Dry Powder

The biggest factor impacting the PE space in 2015 will be the availability of capital. As a result of quantitative easing programmes in North America and Europe, as well as the increasing influence of Asian funds, the market has been flooded with capital, which is inflating the price of assets.

Bridget Walsh, Head of Private Equity for UK & Ireland and Greater China Business Services Leader at EY, comments: “The industry now has $470 billion of dry powder. This is unprecedented… for the industry but investors are certainly choosy about selecting quality assets. That said, I think we’ll have a very busy start to the year, the capital is there to do deals and there’s going to be a lot more M&A activity – we’ve seen some large corporate divestments announced.”

With competition increasing, sponsors may have to work a little harder. Simon Tilley, Managing Director of corporate finance firm DC Advisory, says: “The valuation gap is still there, which is frustrating deal-making. Firms might need to be a bit more creative: it might be that they have to pay a little bit more for an opportunity that really is in their sweet spot.”

For Steve Parkin, CEO of 3i backed FMCG concern Mayborn Group, management teams looking for investment need to demonstrate a growth trajectory and a strategy that’s resilient to macro volatility. “We’ve got an election in the UK, the dollar rate is tumbling down and there’s instability in some of the Eurozone.

“Private equity firms will be looking for quality of earnings and businesses that can show they are able to weather some of these challenging conditions. Very high-performing assets will go at a decent multiple but those that are in that mushy middle will continue to struggle.”

2) An International Outlook

A global perspective is sweeping through the PE space and, while international expansion is hard to get right, the scope to open up new markets is unrivalled. Bridget comments: “If you take European GDP levels, top line growth isn’t going to be achieved by simply looking at the domestic market. I think management teams need to be very mindful of emerging markets and operational improvements.”

Gary Favell, CEO of Bathstore, which is backed by American billionaire Warren Stephens, says: “More and more PE houses are looking for that international development, a brand that travels internationally. We’re working to get into either the emerging markets or those markets that are very liquid: the Arab States, India and so on.”

Of course, there are plenty of opportunities across Europe too. Justin Ash, CEO of Bridgepoint backed Oasis Healthcare, a provider of dental care in the UK and Ireland, says: “More than ever, international expansion [should] be seen a good opportunity. Obviously it’s complicated, so it’s not to be taken for granted, but our acquisition of Smiles Dental in 2014 took us into Ireland and has proved to be very successful. It’s good to have a market with different dynamics.

“Our market is a growth market in most parts of the world and we tend to benefit from environments where there has been a lack of consolidation and a lack of branding. So for us, that’s what a new market needs to have to make it attractive.”

3) Where’s the Exit?

Both trade and secondary exit options are open, and despite a subdued Q4 the IPO market is likely to pick up once again. This means 2015 will be a year of decision-making because there is no longer any excuse for firms to ‘sit’ on assets.

Paul Brennan, Chairman of OnApp, a cloud infrastructure software provider which is backed by LDC, says: “I think everyone’s looking at what is a possible exit strategy or the dilution strategy in the context of where the market is. PE houses are asking, ‘You know what, do we double down re-invest, or do we look at perhaps letting other people lead the next round of funding?’

“I’m not seeing everyone going: ‘Oh, we don’t want to invest,’ but they’re not all saying: ‘Yes, let’s put loads of money into these businesses,’ either.”

Martin Balaam, CEO of Jigsaw24, an IT services company backed by Northedge Capital, adds: “There will be pressure on PE houses to start to show some realised gains before they look to raise their next funds towards the back end of 2015, so yes I would anticipate a few exits. I also feel that there is more corporate activity starting to happen so there will be an increasing number of trade sales.”

Foreign buyers are definitely on the lookout for deals and they’re prepared to pay a fulsome price. Charlie Johnstone, Partner at private equity firm ECI, says: “If you are a business in North America… looking for a launch pad in Europe, you understand the language, the legal system is not too dissimilar and there’s a huge degree of trust that what you’re investing in is what you think it is. The UK is a great place to be buying a business and that will continue.

“You’ve then got US private equity firms coming over here that pay 13 times for a business and think that’s cheap. We’re looking at the same business and would probably pay ten times, but they’d have to pay 15 in the US. That arbitrage, from their point of view, is available, and we’ll see more of that. As such, we know we have to match them on the best investment opportunities.”

Following a bumper year for sponsor backed IPOs, raising over $104 billion (Q3 2014 YTD), the public markets are set to remain a credible exit route. Tim Farazmand, Managing Director of mid-market private equity firm LDC and Chairman of the British Venture Capital Association, says: “The IPO market has been buoyant for much of 2014, with a number of PE-backed companies floating, including one of our own portfolio, Fever Tree, which is a premium mixers business.

“More recently, economic concerns have weighed down on the IPO market but hopefully, with a more benign economic environment… it will open up again.”

4) Taking the Sustainable Approach

As a result of slow growth and potential buyers taking extra care with due diligence, PE firms have had to embrace a more mature, long-term approach to strategy. Gary says: “I don’t think you can go in anymore and just say, ‘Look, we’ll take the cost out, strip it back and then move it on.’ People are coming in looking for a sustainable plan.

“You’ve got to be able to show that the business you want to sell has a robust platform for growth, fully supported by both a strategic and operational plan.”

For sponsors, it’s a case of becoming more creative around the services they provide. “There is certainly a longer-term view in the industry,” says Bridget. “A number of private equity funds have invested in good operational teams which means they can identify assets that may be operationally challenged… and can really help turn it around.”

According to Charlie, ECI has had particular success with this approach. It set up a Commercial Team six-years ago which acts as resource for management teams to draw on when they need guidance with difficult operational dilemmas: “The number of projects they run for our portfolio is huge and the results have been impressive – putting our growth at 20 per cent per annum, that’s an underlying earnings growth well above GDP.”

5) All Important Alignment

Given it’s not so easy for financial engineering to gain a quick win, many PE firms have had to adjust to that longer-term view on how to drive growth. It’s made the role of the chairman even more important in terms of managing expectations around the exit between the executives and sponsor.

Paul comments: “When I’m talking to PE houses about my role as a chairman, what I am finding is they are increasingly asking about how I can be that bridge between the management team and the PE house.

“They are very happy for me to go in there and try to help bring them and the management team together. I think chairmen need to be more hands-on now than they have ever had to in the past.”

Sam Ferguson, Group CEO and President of EDM, an information management provider which is backed by LDC, says: “Too many people do deals just because somebody comes along with money…

“My experience tells me that you have to be able to work as a team, and… you must share common directional agreement. There’s nothing more frustrating than having aspirations or a certain direction for [the company] but not getting the backing from the investment group.”

***

Expect 2015 to be a busy year for private equity. Firms have a huge quantity of funds to invest and they will be on the hunt for buy-outs and acquisitions. Global trade buyers will also be in the mix, seeking to capitalise on cheaper finance. As Simon says: “2015 will be progressive – there’s more confidence and hopefully we can continue to build on that.”

I hope to see you soon

Matthew

www.twitter.com/criticaleyeuk

The Global Outlook for 2015

A resilient global economy means the signs look positive for businesses across a range of sectors over the coming year. With rising employment in the US driving consumption, China’s $3.89 trillion of exchange reserves being used as a war chest for investments, and a pro-business Government in India seeking to kick-start its economy, there are plenty of reasons to feel optimistic about opportunities for growth.

Of course, while the macro-economic situation may be broadly robust, the impact of geopolitics, such as in North Africa, the Middle East, Russia and Eastern Ukraine, and the South China Sea, cannot be ignored. “2015 will be a mixed bag,” says Mark Spelman, Global Managing Director and Global Head of Strategy at Accenture. “The key message for business leaders is to stay agile and watch for short-term signals in the light of longer-term trends.”

The three low performers, according to Mark, will be the Eurozone, Russia and Brazil: “Expect the Eurozone to muddle along in 2015 with political storm clouds crowding in on structural reform; Russia will go into recession with sanctions and weak oil and gas prices undermining economic performance, which will hinder Eurozone growth. Expect a tough year for Brazil; it needs a Prime Minister like Narendra Modi but chose a second term for Dilma Rousseff.”

Dominic Emery, Vice President of Long-Term Planning for BP, comments: “As you would expect, we’re keeping a very close eye on the oil price… The portfolio of the company is pretty robust in relation to oil price scenarios, but there is the challenge of managing this during periods of uncertainty.”

Leaders need to be cognisant of changes to the global political landscape. “We have to ensure that we manage our portfolio accordingly,” says Dominic. “I think the opportunities lie in maybe acquiring assets with a lower oil price… It also provides us the chance to rethink some of our business models, to make them more responsive.”

Supply and demand 

There are plenty of sectors which seem set for rapid growth. Tim Farazmand, Managing Director of mid-market private equity firm LDC and Chairman of the British Venture Capital Association (BVCA), says: “Given the likelihood of strong economic growth next year, we’re positive about virtually all sectors but the three we expect to outperform in 2015 are TMT, industrials and the consumer sectors.

“The TMT sector has recorded strong growth this year, and with the technology and digital revolution continuing to sweep the economy, this trend will only accelerate in 2015. Innovation is the driver, particularly in areas such as mobile and cloud computing.”

Healthcare is another area where growth can be expected. Jane Griffiths, Company Group Chairman for EMEA at Janssen, the pharmaceutical division of Johnson & Johnson, sees plenty of opportunities to form partnerships in countries that are serious about building their healthcare infrastructure, such as the Gulf states in the Middle East and in Africa.

There also remains an urgent need for innovation. “One of the things that’s so expensive in the delivery of healthcare is the bricks and mortar of hospitals,” says Jane. “So, if you can care for people remotely using innovative pharmaceutical and digital technology, you can potentially take costs out of the healthcare system and allow people to be treated at home.”

The expectation is for there to be significant deal-activity among private equity firms across these sectors. Simon Tilley, Managing Director of corporate finance firm DC Advisory, says: “Private equity portfolio managers are feeling a lot more confident about their companies. The opportunity, I think, ought to be to drive growth not just organically, but also through add-on acquisitions…

“The environment now is actually quite conducive to that. You’ve got buoyant credit markets; you’ve got companies that have stabilised, with strong management teams that have got private equity backers with money to deploy again.”

Provided pricing expectations become more reasonable, the hope is that M&A activity starts to pick up. Simon comments: “There are international trade players that are interested in the industrial, tech and consumer space. They’re coming from Asia and the US; there are definitely US private equity investors looking at the UK and Europe more confidently…

“There are also US corporates with cash to spend. They have a lot of cash in Europe as they can’t repatriate it without incurring significant tax liabilities. So, I think, there is a desire on the part of cash-rich US corporates to deploy that money in an accretive way, rather than suffer significant dilution by taking it back out.”

In 2014 there was an increased appetite for Asian PE houses acquiring Western companies, and according to Simon, this will continue. “Examples included Hony Capital acquiring Pizza Express and Baring PE Asia taking a significant stake in Cath Kidston. The motive is to bring technology and brands back to Asia to tap into local demand… The next step we’re likely to see is more Asian PE houses looking to partner with European firms,” he adds.

The public markets are predicted to pick-up again in the first quarter. John Millar, Head of Primary Markets at the London Stock Exchange, says: “We’ve seen a lot of momentum build up in 2014. It was a great first three quarters of the year for trading volumes, IPOs and capital raised… However, in August, the geopolitical situation got a little more uncertain and, what with the Scottish Referendum, we saw the market take a pause.”

Clearly business leaders should be keeping an eye on the political landscape, while also looking at how convergence is reshaping customer behaviour. Steve Parkin, Chief Executive Officer of Mayborn Group, which makes products for babies and children, says both “political instability and consumer promiscuity” need to be watched closely.

Paul McNamara, Group Chief Executive of financial services company IFG Group, comments: “Right across 2015, I think it’s going to be a year of further adoption of technology; customers are using new technologies very rapidly. And their expectations are rising.”

There is a sense that companies are very much on the attack. Howard Kerr, Chief Executive of business standards company BSI Group, says: “We’re keeping an eye out for our competitors. A lot of companies kept their heads down in the last four or five years, retrenching, right-sizing, adjusting their models based on the tough business environment.

“Now that people are a little bit more bullish, they’re are going to innovate, they’re going to invest and they’re going to try and be a bit more creative.”

It’s the businesses with agile leaders at the helm who are watchful, constantly planning and ready to seize opportunities that will establish successful growth in 2015.

I hope to see you soon

Matthew

www.twitter.com/criticaleyeuk

Planning for the Best Exit

Comm update_22 October2

The expected frenzy of private-equity deals in 2014 hasn’t quite come to pass. For CEOs with an eye on the exit, a secondary buy-out remains the likeliest route, with many opting to roll with a deal so they can keep building the business. While the opening up of the public markets is certainly another welcome option, trade buyers are continuing to show caution due to perceived overpricing.

Indeed, with the availability of debt back at levels seen in 2006 and 2007, valuations have been the sticking point for a number of transactions. “Pricing expectations are high,” says Stuart Coventry, Partner at corporate finance firm Jamieson. “Bids often come in below where the sale-side expectations were set, and those expectations have probably been built on the back of a very bubbly IPO market earlier in the year.”

To maximise the value of a sale, the CEO and management team need to stay focused on the fundamentals. Rob Crossland, Chief Executive of employment services company Optionis, which completed a secondary buy-out through MML Capital earlier this year, says that “in any kind of exit you need to demonstrate how the business has grown under your tenure but, equally, why there is more growth to come”.

The potential for scale is what drives value, often through global expansion. Simon Tilley, Managing Director at corporate finance firm DC Advisory, says: “[PE investors] are getting much more excited about opportunities where there’s either a UK business that operates overseas already, or there’s an opportunity to take it overseas and get more international exposure.”

Grant Berry, Managing Partner at private equity firm NorthEdge Capital LLP, comments: “Nobody wants to buy a business at the top of the market, so it’s important that when someone is coming in on the buy side they are confident about the business being able to grow in the medium to long term.”

Fit for the Future

From the outset, the management team should be assessing the market and deciding upon who the potential buyers might be. Catherine Wall, Non-executive Director at investment management firm Mobeus Income and Growth VCT, says: “What is the totally compelling story for their business? Does this acquisition give [a buyer] entry to innovative or fast growing markets, products or customers? Does it give them new skills or capabilities?”

Ian Edmondson, Chairman and Managing Director of Dunlop Aircraft Tyres, says: “Understanding the likely interest of different potential owners will help to define the exit. This needs to be done by exploring, networking and developing a range of relationships…

“In some cases there may be equally interested future owners from different backgrounds, meaning a possible secondary buy-out might be just as likely as a trade sale. If the current owner wants a complete 100 per cent exit at a point in time, then an IPO is not usually the favoured option.”

Douglas Quinn, Chairman of homecare provider Baywater Healthcare, comments: “You want to end up with a strategy that is very portable. Thinking through all the options and having a range of scenarios depending on the circumstances is very helpful.”

The chairman, usually appointed by the sponsor, certainly has a role to play here in ensuring there is alignment on the exit strategy. Ian Stuart, Chairman of four mid-market PE-backed companies, including manufacturing concern Aspen Pumps, says: “It’s about getting people around the table to talk together and be honest about what they want, and achieve a compromise.

“Specifically, if private equity wants to exit later and the management want to go earlier, you will generally arrive at some sort of incentive arrangement for management to stay longer.”

Of course, preferred exit routes won’t count for much unless the management can demonstrate strong performance, good governance and show there are no nasty surprises for buyers, such as big ticket customer contracts coming up for renewal, leasing issues or weak intellectual property. “You can’t dream those up at the last minute,” says Gerry Brown, Criticaleye Board Mentor and Chairman of logistics concern NFT.

The importance of succession cannot be underestimated. “We worked on the buy side of a deal that fell through over the summer, where the owner CEO wanted to exit but there was no work put into succession planning – it’s just awful when you see that happen,” says Simon. “It’s partly down to the value, because you won’t get the same price as if you’ve got a strong management team solution in place, but it also comes down to deliverability and, in this case, they couldn’t get the deal [finalised].”

It comes back to having a long-term approach so that the business is an attractive proposition. Tania Howarth, Chief Operating Officer of frozen food company Iglo, says: “Any PE-backed CEO has to balance exit considerations with the need to focus on building a strong, sustainable business…

“From the beginning, a CEO needs a strategy to build a better business and then understand where on that journey his or her current investor will exit, so that the business evolution can be tied into the investor goals.”

Every step must be taken to eradicate easily avoidable mistakes that either damage a valuation or scupper a deal. After all, the exit process will be demanding enough for a management team, without them having to address deep-rooted issues in the business at the last minute. Ian Stuart says: “Don’t get so distracted by the exit that the company goes haywire in the meantime. You’ll then almost certainly have a bad exit if results fall away.”

According to Rob, it’s important to keep having conversations around the exit. “Having done it twice now, [I know] you need to be discussing it sooner rather than later. It should definitely be on the strategic schedule for review at regular points as, if this isn’t the case, there’s the danger of becoming misaligned and unclear about the future.

“Private equity, I think, has a bit of a challenge, because initially they don’t want people talking about exit… They want them focused on the day job. If they let that continue, I think that can create some difficulties down the line.”

Timing has a part to play in any sale and that’s not necessarily something that can be controlled. Pardip Khroud, Investment Manager at private equity firm LDC, comments that political and economic uncertainty can suddenly have a significant impact on the behaviour of buyers. “It makes businesses far more difficult to value and deters potential buyers from committing,” she says.

The nightmares of private equity occur when communication breaks down between sponsor and management team, resulting in misguided assumptions. It largely falls on the CEO to ensure this doesn’t happen, so there is a healthy focus on performance – short and long term – which is what will matter the most when a potential buyer does come along.

As ever, a little luck always comes in handy too.

I hope to see you soon

Matthew

www.twitter.com/criticaleyeuk

How to Achieve a High-Flying IPO

Comm update_13 OctoberChief executives looking to conduct an IPO have a gruelling checklist. Create a compelling growth story. Build a robust board. Prepare the business for a new reporting regime. Assess whether the rest of the management team are match fit. Such are the demands of the process that business performance can dip, resulting in that fatal mistake of missing your first set of numbers once you’ve gone public.

None of this seems to have dampened the enthusiasm of management teams considering a float. According to Big Four firm EY’s latest research, in the first nine months of the year there were 851 IPOs, raising $186.6 billion (£115 billion), a 49 per cent increase in volume and a 94 per cent increase in capital raised for the equivalent period in 2013.

The US leads the race for most capital raised, buoyed by Alibaba’s record $25 billion (£15.7 billion) listing last month. In Mainland China, a rush of IPOs at the beginning of the year propelled the region to the top of the deal rankings in the first quarter. Indeed, Asia Pacific saw more IPOs (217) in the first half of 2014 than any other region.

Martin Steinbach, IPO and Listing Services Leader at EY, comments: “Many European brands, like Prada for instance, have been looking to Asia Pacific, specifically the Hong Kong Stock Exchange, because of the wealthy and growing consumer base in China. By contrast, if you are an Asian-based technology company, you’d be looking to Wall Street.”

In the UK, there were 109 new floats registered on the London Stock Exchange from January to the end of September, an increase of 73 per cent on the same period last year, with £15.5 billion funds raised (up 163 per cent on 2013). John Millar, Head of Primary Markets at London Stock Exchange, says: “Improved valuation of the market has been key, with many world indices now trading at or close to record highs.

“Investor flows, too, have been important as, following many years of investors suffering net outflows from their funds, there has been a turnaround which has given fund managers new capital to invest in the markets.”

Criticaleye examines the six key areas for management teams to master if they’re to take full advantage of the wealth of funds now available to back businesses:

1) Get the Company in Shape

Every part of the business will need reviewing thoroughly before announcing the intention to IPO. “You need to be running the business as if you were a public company, governance and accounting especially, for at least two quarters and probably a year,” says David Harding, Chairman of Radius Equity Partners and former CEO of betting concern William Hill.

Others recommend a longer run-up. Caroline Brown, CFO and COO of engineering consultancy Penspen, and Non-executive Director of Intelligent Energy, which floated on the Main Market in July this year, comments: “I think about 18 months prior to IPO is a sensible timeframe to start planning because the company, if it is a traditional private company, will not have the skills internally to face the market.

“They will not have the systems and processes in place and it is likely to fall, at the very first hurdle, in terms of delivering its financial forecasts. It is a very difficult process and, once launched, it is quite hard to stop. So, build in resilience, build your systems and your people well in advance.”

Peter Williams, Chairman of online fashion retailer Boohoo, which listed on AIM in March, says: “Before you even start the process, the company has to do a sense check as to whether it’s got all its legal documentation in place and whether its systems are robust enough to be able to deal with all the information you have to share as a public company.”

2) Create an Effective Board

A common mistake made by CEOs is to only start thinking about appointing non-executive directors at the eleventh hour. Roger McDowell, Chairman of AIM-listed engineering company Avingtrans, comments: “All the governance requirements need to be met and the composition of the board needs to be appropriate for the business; investors need to be sure the NEDs will be engaged and working on their behalf.”

Choosing the right chairman is absolutely vital. Stephen Davis, Criticaleye Thought Leader and Associate Director and Senior Fellow of Harvard Law School Programs on Corporate Governance and Institutional Investors, says: “They’ll be able to guide the management team through that transition and make sure that the culture of the company is sensitive to the new types of accountability that exist within the context of a public market.”

Aside from knowing how to deal with investors and advisors and, of course, running a board, Peter notes that the chairman “needs to act as a mentor to the CEO and the CFO, and indeed the other people in the business, to explain what’s going on in the run up to IPO”.

3) Seek Wise Counsel

Those who have successfully conducted an IPO will talk about how crucial it is to appoint good advisors. David comments: “The key thing with all advisors – bankers, PR, lawyers, accountants – is to make sure that whoever they choose as the lead has done it before.”

Costs will have to be watched closely. “You need to put a cap on the legal and accounting [fees],” says Rod Webster, CEO of AIM-listed mining concern Weatherly International. “At the same time put someone in charge of co-ordinating the process; bringing [it] to a close quickly is the best way to control the cost.”

4) Tell a Good Story

Investor roadshows will be where the strengths and weakness of your ambitions for an IPO come to the surface. The CEO and CFO must be able to explain the finances and create a story for growth which sets the business apart.

“People are making investment decisions based on their analysis of the numbers and so on, but it’s also about their one-to-one interactions with the CEO and CFO and how they rate those two people in particular,” says Peter.

“The business will be a more attractive proposition for investors if the CEO and CFO come across well… Remember, investors have loads of choice as to where they put their money and the easiest decision they can make is not to invest.”

Rod comments: “It’s important to understand the person you’re presenting to [during investor roadshows]; the broker, if he’s switched on, should know what the investors are looking for. If it’s a generalist fund, the presentation needs to be at that level: simple, succinct and without technical jargon.

“If it’s a specialist fund then you need to go into more detail… It’s always useful having someone else with you, a chairman, CFO or company secretary, who can take over some of the talking and give you a bit of a break or to help reinforce a point.”

5) Be Sensible on Pricing

It’s inevitable that some IPOs will be pulled due to disagreements over pricing. David says: “Unconnected analysts and commentators will look to make money shorting and can always find a credible story as to why the issue was overpriced and that will always spook some into selling…

“It’s another reason why not getting suckered into bullish forecasts is so important, that way your first set of results will steady the ship.”

Martin comments: “If you are an entrepreneur looking to IPO, you should have your own idea of a valuation… [with] a price-to-earnings multiple that enables you to have a feeling about the fair price range for the business.

“Armed with this knowledge as background, you then need to convince the bank and the analysts that you have the right peer group and a proper forecasting system, which is reliable and that will continue to meet their expectations. You also need an equity story that is timed well for the market.”

Think carefully about the blend of investors too. Jamie Pike, Chairman of FTSE 250-listed plastics manufacturer RPC Group, says: “One of the critical success factors in any IPO is that you have genuine liquidity after a float. You must be able to create a market for people to buy and sell your shares… [because] if there’s a lack of liquidity people have no idea whether they’ve been given an accurate price.”

6) Hit Those Numbers

The performance of the business cannot be allowed to drop-off in the run-up to flotation, yet it can easily happen.

“A significant challenge for companies is to continue the day-to-day running of the business, while at the same time conducting an intensive IPO process,” says John. “Banks and independent advisers can help lighten the execution load, but it is still a demanding time for a company’s executive team.”

David says: “[It’s] a real issue as the IPO takes the CEO and CFO out of day-to-day management for three months. It helps if there’s a COO but, if not, it’s obviously important that no big operational events are planned during that period. [During the William Hill float] I made sure each of my direct reports sent me a short daily ‘exceptions’ report and were exhorted that ‘no surprises’ was the order of the day.”
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For CEOs thinking about the move, it’s a case of taking the time to put every piece in place so the business is performing to the highest level. After all, while a successful flotation is to be commended, there’s no bedding-in period once a company goes public.

“Time and again I think management teams regard a successful IPO as the end of the journey, but it’s actually just the start,” says Caroline.

I hope to see you soon

Matthew

www.twitter.com/criticaleyeuk

The Role of the Chairman in an IPO

Community Update Faces - 25 june 2013Why companies leave the appointment of a chairman until the last minute of an IPO is a mystery. It’s the key hire for a business, greatly enhancing the prospect of success as the chairman is tasked with building an effective board, coaching the senior management team and calling on years of experience to ensure the story a company sells to the market is both compelling and real.

“A company has to figure out what it wants in a chair,” says Stephen Davis, Criticaleye Thought Leader and Associate Director and Senior Fellow of Harvard Law School Programs on Corporate Governance and Institutional Investors. “The decision should be a part of the ordinary process of planning an IPO but frankly it’s usually an afterthought or comes late in the process.”

As IPO activity picks up, it’ll be interesting to see if the new issues have learned from the mistakes of their predecessors. John Allan, Chairman of Dixons Retail and global card processing company WorldPay, says: “It could easily take a year for a chairman or chairman designate – as he doesn’t necessarily need to be identified in the role of chairman straight away – to build a public company board. If it’s going to be compliant, it should be headed towards a majority of independent non-executive directors whereas a typical private company often doesn’t have any.”

There is plenty for an incoming chair to put in place, assess and, where necessary, fix. David Vaughan, UK&I Head of IPOs at Big Four firm Ernst & Young, says that “the task for the chairman is to set the tone at the top and to say what you want the organisation to be, establishing good governance and making sure the business has the right corporate reputation in its community”.

Chip Goodyear, Non-executive Director of oil and gas concern Anadarko, says: “The chairman will need to have a collegiate personality and be somebody who can work well with a board. My view is you do want a board who will be able to challenge management but you want it to be done in a constructive way; somebody who can bring that together is very valuable. You also want somebody who is not trying to be CEO and is comfortable in the role of chairman.”

There will be sectors where industry know-how is desirable, such as defence, financial services and oil and gas, but essentially it’s the knowledge and gravitas garnered from a stellar executive career, followed by being a seasoned Plc NED, that count the most. Jamie Pike, Non-executive Chairman of plastics manufacturer RPC Group, comments: “In general, I would say chairmen are fairly interchangeable but there are special industries where a lack of knowledge could frankly prove pretty risky. You would certainly want the chairman to have Plc experience, such as dealing with the institutional investors.”

Debbie Hewitt, Non-executive Chairman of Moss Bros, comments: “As well as complementing the executive team, the experience of the chair probably needs to reflect the timing of the IPO. The closer the IPO the more important his/her industry knowledge is. If it is some way off, an experienced chairman will have the time and capability to get to know a sector. No matter what the timing, the City and institutional investor experience are vital.”

It’s categorically not a role for the uninitiated NED, even if they are a big name. “You need an excellent board and the chairman has to make sure the governance is absolutely right,” says Dame Helen Alexander, Non-executive Chairman of media company UBM. “The last thing an IPO needs to focus on is the make-up of the board or the quality of governance. The selling process should be about the business – potential shareholders shouldn’t need to ask about compliance.”

Built to last

The chairman will have to decide if the management team, particularly the CEO and CFO, are fit to take a company public. Mike Turner, Non-executive Chairman at engineering concern GKN, says: “In the first three months, you should be comfortable with whether the CEO and CFO are up to leading the business but equally important is to get a sense of whether they can convince the City.

“They will have to spend a lot of time going round the City, which is something you don’t do in a private company, and they will need to be convincing about the strategy of the business and its future.”

If they do have what it takes, the chairman ought to prep them for investor roadshows and what to expect once public. Chip says: “For the chairman, there is always an element of coaching of the senior leadership team. But with regard to the public side, particularly if the chairman has had that experience, being a counsel to the management team would certainly be an important thing.”

Remuneration will have to be examined via the hire of an excellent Remco Chair together with the recruitment of an Audit Committee Chair, along with succession planning and an assessment of the quality of the people in the organisation. “It is very important that the chairman goes round the senior management team, especially at the executive committee level, to see what it’s like and that there is good bench strength,” says Mike. “You need to know what talent is available below the level of the CEO and CFO.”

The quality of the advisors has to be watched too. According to Helen, if a chairman comes in and they’re not happy with those already appointed, he/she should have the power of veto to bring in ones who are of the right calibre.

This is where reputation and prior knowledge make a difference. “A chairman has to understand the capital markets and listed vehicles and it certainly helps to have strong contacts and a network of tried and trusted advisors,” says Debbie.

It means treading a fine line as a non-executive. “It’s helpful if the chairman does know how to communicate and deal with advisors, brokers and investment banks, especially if it’s a company where the CEO doesn’t have much experience… Again, it’s important that they’re not seen to be able to try and lead the company,” says Chip.

Behind the scenes, the pricing of the business will be sense-checked too. A canny chairman will figure out who might profit by shorting on the IPO, making it difficult for game players to mess around with the stock but at the same time making sure the investor mix will generate enough liquidity.

Jamie says: “Liquidity in markets is very important. Therefore, if you’re buying and selling, you need people who will be selling the day after they’ve bought shares on flotation. I had this drummed into me during an IPO some years ago as it’s easy to get on your high horse but the market does need liquidity and that means buyers and sellers…

“What people often fail to understand is that when you float a business you are selling it and bringing new owners in; some of them may be short term while others may be longer but they do have rights. You cannot mess the market around and these owners must be taken into account, meaning their needs and objectives are factored in to how you run the business.”

It will vary on a case-by-case basis, but the chairman of an IPO will have to get their hands dirty if the Prospectus is to be signed with confidence. Stephen says: “The chair coming into a new public company has to exercise different skills than one joining an on-going public company, since for the latter you don’t have to re-invent everything.”

Many chairmen swear by the recruitment of a company secretary as a safe pair of hands to deal with governance and risk management. The run-up to an IPO is frenzied, intense and reputations that have been established over the years can be decimated in a flash if it goes belly up.

That’s why you spend time finding the right chairman and bring them in early.

I hope to see you soon.

Matthew

https://twitter.com/criticaleyeuk 

Getting Management Ready for an IPO

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Dismiss the public markets at your peril. Institutional investors have significant funds at their disposal and companies are increasingly confident about raising capital and accelerating growth through a listing. The challenge for senior management teams is to be clear about why they want to IPO and whether they have the breadth of experience to handle the pressures of being in the public spotlight.

An IPO presents a rigorous examination of a business and its personnel. For any management team preparing to float, the following are essential:

  • Ensure the performance of the business doesn’t suffer during the IPO process
  • Give yourself a 12 to 24 month run-up 
  • Bring in a chairman as soon as you can
  • Identify and address weaknesses in the senior team 
  • Understand the key messages to deliver to the market.

As ever, this is easier said than done but complacency over any of these points can prove disastrous. Anthony Fry, Chairman of Dairy Crest Group, says: “It is not just the burden of the process which is time consuming, it’s this combined with making sure that the strategy for the listing and the appropriate shareholder profile is thought through properly and that the IPO team of advisors has been selected with great care… Above everything else, people sometimes forget that there is also a business to run – more forecasts are missed because management has taken its eye off the ball than any other single factor.”

Mike Tye, CEO of Spirit Pub Company, which listed on the London Stock Exchange after a demerger from Punch Taverns in 2011, comments: “The business has to perform brilliantly as you’re only as good as your first set of numbers; if you blow that it’s a hard recovery path. We brought in somebody to work with all of our external advisors, so the vast majority of the management team just did not get involved in the IPO. I would absolutely recommend it as it’s so easy to get distracted… when the critical thing is to serve customers and keep the team motivated. Without that, the rest is gone.”

Naturally, how early you start planning will depend on the composition of the board you already have as a private entity, but the general view is that the earlier you start acting like a public company, the better prepared you’ll be for crossing over to the other side.

Mike McTighe, Chairman of electrical cable maker Volex, comments: “For me, one of the critical steps for every director is to give personal warranties as part of the IPO prospectus as many boards don’t ensure early enough that they’ve a board that’s fit and compliant to conduct an IPO. Take private company boards, for instance, most have directors who are not independent because you have shareholders or founders around the table. You need to start early in order to hire the right people and get them up to speed so that when you put the prospectus together they all understand the business and can sign their representations off.”

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Good governance

Don’t underestimate what a well-respected and seasoned chairman will provide a business as it goes on the IPO journey. Alastair Walmsley, Head of Primary Markets at the London Stock Exchange, says: “Bringing in the right chairman can introduce a degree of rigour, both operationally and in terms of risk management, which will help that business be more successful in the long term. You need to do that as early as possible to get the chairman fully immersed in the business so they have run the board meetings and understand both the dynamics of the existing shareholder base and management team.”

Paul Staples, Head of Corporate Finance at BNP Paribas, comments: “The appointment of a chairman is a pivotal decision and forms an important dynamic within the IPO preparation process. He or she will exert influence on the shape and profile of this in the boardroom, together with achieving an appropriate balance between executive management and non-executive directors. Institutional investors will pay close attention to the reputation and track record of the chairman when considering the intrinsic appeal of any public offering during a pre-marketing exercise.”

Mike McTighe comments: “The key is always to ask whether you have a strong independent chairman. That would be the first person to hire and many businesses don’t… Really, you’re looking at planning an IPO at least 12 months in advance, but it’s more like 18 months because the chairman will have to assess the composition of the board, hire some independent non-executive directors and agree with others around the table when and how they will step down if they are not compliant, which is always the tricky bit.”

It’s crazy to think that companies rush this appointment. Linda Main, Head of UK Capital Markets at KPMG, comments: “It’s fairly common for a chairman to be brought on board quite close to an IPO date. That’s usually because companies underestimate how long it takes to find the right chairman. You need to allow upwards of six months to get someone.

“You need someone who’s got the right experience and is going to bring real benefit to the company whether the IPO goes ahead or not. That could be someone who’s an experienced executive or who has particular industry experience… essentially it’s someone who is used to chairing a board with strong personalities, which is often one of the main challenges.”

The question of whether or not industry expertise is required remains somewhat open. Mike Tye comments: “The critical thing is having the right reputation…The chairman we chose to appoint had no experience of the direct industry but had indirect experience and was well-known and regarded in the City. That is the critical thing. You are hiring reputation and experience, especially for a reasonably sized IPO.”

Anthony has a similar view. “Too often people think that the best chairs come from their own industry – sometimes it’s helpful but there are plenty of examples of chairs and CEOs clashing precisely because they both think they know ‘their’ industry better. The best chairs are sounding boards for their CEOs with long experience across managing businesses, running boards, mentoring executives and being independent of judgement and advice, which are worthwhile attributes for any business.”

In focus

The higher profile and ever increasing legal responsibilities of being a director will take newcomers by surprise. Bob Garratt, Criticaleye Associate and an advisor on board effectiveness and corporate governance, argues that management teams routinely fail to recognise the extra duties and liabilities that come with being a director as opposed to a private company manager.

He explains: “In preparing to become a public company, board directors must learn the seven statutory duties as required by the Companies Act and recognise that being a director as defined by the Act is markedly different from the recommendations of the Combined Code. The Act makes it quite clear that you are either a statutory director or not, and that there’s no such thing as a NED or Executive Director.

According to Bob, directors can have a hazy view of their role. He recommends that before embarking on an IPO, the directors, chairman and company secretary “get together for a long chat to really understand what it means to be a director of a publicly listed company”.

Dealing with investors, employees, analysts, brokers, advisors and the media requires a set of skills that won’t perhaps come easily to those who are familiar with running a private company. The Financial Director will certainly need to make the grade, as they will be working closely with the analysts and institutions, not to mention getting the accounts in order and fully compliant with IFRS.

Mike Tye recommends that directors are well rehearsed and drilled about what’s expected. “It doesn’t matter how much you describe to people what it’s going to be like, there’s no better reality than trying to create it ahead of time. For us, a number of people had the chance to stand up in front of investors and analysts and, in effect, knowing they were going to be at the front of the business, be judged as such.

“If they had not been in the spotlight in that way, they wouldn’t have known what hit them. You have to simulate it as much as you can. Explain to them, no matter what their expectations are, that they are underestimating it so you have to put them through the mincer.”

Neil Matthews, Partner & Head of Equity Capital Markets at law firm Eversheds, observes: “The management team must be comfortable in a public environment with all the scrutiny that it brings, and with the additional time spent with external shareholders and reporting requirements. It’s a great thing for companies to be able to raise capital, get a public profile and grow… but you have to be wary of the downsides and potential challenges associated with a listing.”

Alastair says that “the big difference from a management team perspective is clearly going to be the level of disclosure that you are required to make and ultimately the much greater emphasis on communication than you ever had in a private company context”.

Hit those targets

Executives must go into the IPO process with their eyes open. They’ve got to be able to explain why it is they want to list, what type of shareholder mix they need, how funds will be raised to develop the business, and to have given plenty of thought as to why another route of financing, such as private equity, isn’t appropriate for their business.

If management can’t tell the right story in a convincing and confident fashion, investors will walk. And calling off an IPO at the last minute will be expensive and acrimonious.

They also have to be realistic about ongoing questions around liquidity on the public markets and the consequences of missing the numbers once a float is away. There are, as Linda says, “plenty of examples of companies missing market expectations and getting their price absolutely hammered as a result”.

Being a public company today is all about operational delivery and balancing short and long term interests. Provided companies execute well, the rewards for being listed are there. Andy Pomfret, CEO of investment management firm Rathbone Brothers, comments: “A lot of people would say it’s costly and there’s a lot of bureaucracy with a plc. It is difficult, that’s true, but I think a lot of those things encourage good business practice and you do have a whole range of shareholders who are supportive of what you are trying do and, therefore, if you want to raise money and convince them of your story, it’s quite easy to get that level of support.”

Is 2013 going to herald a great return of the IPO? The answer is probably not as there continues to be too much economic uncertainty in the eurozone, the US and beyond. However, this has been going on for a while and for the right businesses, with well-prepared and seriously talented management teams who understand and believe in their business models, there will be more IPOs over the coming year than we’ve seen for some time.

What Makes for a Successful IPO?

The margins for error when taking a company public have always been slim. That’s truer than ever given the on-going market conditions, meaning that for those management teams considering an IPO, it’s vital to put in place a board that has pedigree and traction with investors, and to ensure the business is robust enough to hit the numbers post-flotation. Woolly fads and blue-sky ventures need not apply.

John Whybrow, Chairman of AZ Electronic Materials, says that if a new chairman is to be brought in, then they need to be involved three to four months before the actual float: “Typically, the new chairman will join the board as a director or chairman designate if the company is in the public domain; if it’s not then he will join as director. The chairman can then find out what is going on and start to set things up for when the company goes public.”

It’s generally agreed that the key elements to have in place pre-IPO include:

• Strong financial results

• A respected management team

• Experienced and influential non-executive directors

• Steady earnings (preferably with recurring revenue streams) in demonstrably high-growth sectors

• A sensibly priced business at IPO

AZ Electronic Materials, a private equity-backed concern which makes chemicals and materials for flat panel displays, LEDs and other devices, listed on the Main Market in October last year, raising just over £380 million and achieving a market cap of £914.2 million. “AZ is a classic flotation,” comments John. “It worked brilliantly – we floated at 240p and at the end of the first day were up 7 per cent. At the end of three months, we were 25 per cent up. The people who bought the shares felt good because they felt they had paid a reasonable price; equally, the private equity firms were not greedy as they didn’t maximise the price.”

Everyone felt they had gained from the transaction. At the moment, that’s quite a rare and distinguished feat as the reality of the new economy often means that expectations need to be lowered when it comes to valuations and estimated returns on investment. Nicholas Garrett, Head of IPO Executions at JP Morgan Cazenove, concedes that the public markets continue to be challenging: “A number of IPOs have been pulled in the last few weeks and the ones that got away haven’t traded particularly well. What will make a good IPO is a sound investment case for continued growth, priced at a sensible discount to peer group companies.”

A test of values

The issue of price has certainly been the sticking point for many potential M&A deals over the past 18 months. It’s the same problem which is causing potential floats to sink without a trace. “Unless vendors coming to market can be more realistic about valuations, I sense that the situation is going to be much the same in the near future,” adds Nicholas.

John states that this is where an incumbent chairman, certainly when PE firms are seeking a float as a full or partial exit, has a key role to play. The chairman can mediate with the firms and the banks and, to an extent, the management team, to make sure that “things happen sensibly” as the damage and loss of confidence in a company if the share price nosedives immediately after an IPO may be irrevocable.

The other, equally crucial task for the chairman-in-waiting is to find the right non-executives who have the appropriate knowledge and experience for steering a public company. “After the float, many of the directors will resign immediately,” says John. “As soon as you have a new chairman and a chairman of the audit committee, you have to build a board pretty fast – when we went to market there were three independent directors and I kept the two sponsors [PE firms], but they’re not independent, so I needed to recruit four non-executives pretty quickly. You also need a company secretary, otherwise the burden falls to the CFO.”

Charles “Chip” Goodyear, the former CEO of mining and resource giant BHP Billiton, recalls that the highest standards of governance were essential for an international company with listings in multiple countries. “Listing rules mean that you require a certain number of non-executives and independent directors, but that was not inconsistent with what we were doing anyway.

“What the company did do as a result of its listing in London and Australia, plus its publicly traded securities in the US, was to adopt the most rigorous standards in the markets we operated in. As we looked at policies and procedures, we determined to take the high ground where it existed across those jurisdictions.”

Chip claims that this didn’t pose a challenge at board level as everyone bought into the principles. “The bigger issues involved the integration of the organisation – once you have the framework of taking the high ground, then that’s the way it has to be… It was as important internally as it was externally for the company to make it clear that this was its position. So you had to be consistent with that as you were dealing with multiple cultures and histories across the organisation.”

Nicholas states that the question of governance and assembling a well-known and respected board is growing in importance: “We are seeing an increase in overseas companies coming to the London market. With some of these companies, where there is an overseas owner or founder who might be selling only 25 or 30 per cent of the company into the market, investors might be looking to the new board of directors to act as a protector or counterweight to the founder or owner of that business.”

Into the maelstrom

The reasons for floating a company must be watertight. If a management team hasn’t thought their strategy through, then in all likelihood they will be cruelly exposed when embarking on investor road shows. Robert Drummond, chairman of clean energy concern Acta and former chairman of the British Venture Capital Association, says: “Management needs to understand how to demonstrate their model in simplistic ways. They can have as many as a hundred presentations to large groups of people who have not got a day to hear about how a business works. Rather, there will be five minutes to explain the basic business model so any investor can understand it, and then there might be another 15 or 20 minutes to explain it in further detail. If they can’t do that, they’ve got problems.”

A lack of realism over numbers won’t be tolerated. Wiser heads in the City know that the best trick is to manage expectations by under promising and then over delivering, but it’s a lesson that many still find hard to learn. “New investors are looking for stability and growth,” says Robert. “That means they don’t want shocks; they want stable sectors and a business model that is easy to understand. Most IPOs tend to show tremendous growth prospects but, even if that’s achieved, it may not turn into profits.”

Robert states that the golden rule is not to go for an IPO “when the growth rate you are predicting is significantly greater than the growth rate you have achieved”. By this, he means that if a company has had 50 per cent growth for the last year-end, no-one is going to feel confident if a management team starts touting growth of 200 per cent for the year ahead.

Sam Smith, the Chief Executive of small-cap broker, finnCap, which works with sub-£100 million market cap companies primarily on the Alternative Investment Market (AIM), insists that rushing into an IPO is a mistake: “The management has to be certain they are putting forecasts into the market for a year and maybe even two years and hit them. What you can’t do is miss your numbers in your first year. Credibility, as we all know, takes a long time to recover.”

Naturally, the experience of the management team and the balance of the non-executive directors need to be right, but it’s the financial shape of the business that investors will scrutinise. Nicholas says: “The market capacity to invest in companies and the volatility of the market are two areas which hold back IPOs… I don’t think that investors have a mass surplus of cash to invest in equity markets – when they are looking at IPOs, some investors are considering other stocks to sell in their portfolio to make way. That heightens the investment decision for them.”

Sam questions the behaviour of some advisors, primarily serving small-caps, who encourage early-stage companies to go public before they are ready for the sake of a fee. “What you don’t want to do is to agree to IPO when you don’t know the market and you don’t have the track record to deliver on your forecasts or have the right board in place. If you try to rush through an IPO in those circumstances, then something will go wrong.”

First and foremost, the company must be fit for purpose. Added to this, the business has to be robust enough to deal with the pressure and strain of the flotation process itself. “It’s very time-consuming for the management team to go through an IPO,” says Sam. “If you have your two key people, the chief executive and the financial director, spending three months writing documents, doing the due diligence, putting the processes in place and going on investor road shows for two to three weeks, it can put a huge strain on resources. At the small-cap end, where the market is only just recovering, trying to take that amount of time out to do an IPO is a big decision.”

Nic Snape is the CEO of mapping technology specialist 1Spatial. Rather than go for an orthodox listing, he took the opportunity to reverse onto AIM in 2010 through a shell company, IQ Holdings.  Although the initial plan to float back in 2008 was shelved as the global economy crashed, the management team did choose to keep in place the reporting processes and procedures for life as a public company. “We basically decided to operate as though we were a plc,” he comments, noting that they also adopted IFRS accounting.

Notwithstanding this preparation, Nic acknowledges that the switch from being a private to public company is dramatic. “We always took the attitude that all the money we earned we’d put back into the business,” he says. “So any profit was always paper anyway – but now it isn’t, it’s intrinsically connected to the value of the business. Whereas previously we’ve carried quite a lot of goodwill and capitalised software development and amortised it; that may not be the appropriate way to run the business [now we’re a public company]. We have sort of restructured the balance sheet and the finances so we can maximise the profitability going forward. It is different, without a doubt.”

No-one seriously expects the IPO market to pick up significantly in 2011. This is partly because investors and fund managers remain extremely wary about the quality of the trickle of companies being put forward by advisors given the low valuations (in short, why would you come to market at the moment?), and because private equity firms are currently paying top dollar to snap up the most promising, scalable businesses.

Looking ahead, 2012 may be an altogether busier time for market-makers. For those companies considering an IPO, the sooner they start preparing by slotting together the various pieces of the IPO jigsaw, the better they’ll be placed to raise meaningful sums to grow the business, make acquisitions and ultimately to deliver healthy returns to investors who showed the faith.

Please get in touch if you have any comments about the issues raised here.

I hope to see you soon

Matthew

www.twitter.com/criticaleyeuk

Private Equity Strategies

Two years of limited private equity exits have seemingly come to an end with Q2 this year seeing the highest number since Q1 two years ago. Research by Ernst & Young suggests that global exits are trending upwards with nearly twice as many exits over the first quarter of this year than the same period of last year.

The general economic mood and volatility in the global equity markets has stifled many exits, leaving no doubt that many firms are eagerly awaiting the appropriate time to exit investments.

“The numbers will tell you that there is a backlog of deals that have to happen, as the various funds that own them approach their end date,” says Neil Tregarthen, Chief Executive Officer, NES Engineering.

According to Tim Farazmand, Managing Director – Deal Origination at Lloyds Development Capital (LDC) there are three traditional exit routes for private equity investors – trade sales, secondary buy-outs and initial public offerings (IPOs).

“It is important to remember that, in order to maximise value, you should let the business/business model determine the most appropriate form of exit. For example there are some businesses (those with significant scale have strong visibility of future earnings with a well-respected management team) that will be perfect for IPO or secondary buy-outs. Whereas there are others that may have a more lumpy earnings profile but will excite trade buyers due to ease of integration, level of synergies available or strategic importance,” says Stephen Perkins, former CFO, Hawksmere.

Trade sales and secondary buy-outs have proved to be more popular among firms than IPOs as an exit mechanism, as uncertainty in the global equity markets continue to make pricing a challenge. Such volatility was evidenced last week with the worldwide equity market dips that took place after the respective announcements about the recovery by the US Federal Reserve and the Bank of England.

Trade sales

The only ‘true’ exit route – a trade sale – allows all management and institutional investors to be entirely cashed out.

Tim says, “Over the long-term, this is the exit route for private equity in the vast majority of cases.  A private equity investor needs to identify potential trade acquirers early on and work out a plan to engage with this buyer pool on a timely basis.  This is to enable the investor to understand the trade buyer’s acquisition criteria and help it position its investee company accordingly.”

Stephen says, “With debt leverage harder to come by, trade buyers have become more active and are looking to source value enhancing acquisitions. They will pay a fair price when they find them and will usually satisfy the price in cash.”

According to Robin Johnson, Partner at Eversheds, trade sales are still far more likely to go through than other types of purchases, as they offer more certainty.

Secondary buy-outs

Second, and sometimes third, round private equity buy-outs accounted for 35 per cent of the $101 billion of buy-outs completed worldwide so far this year.

Tim says, “Over the last 10-15 years, it has become increasingly common for private equity investee companies to exit via secondary buy-outs.  Typically, this is done on a company-by-company basis albeit there are a number of examples of ‘pools’ of investee companies being acquired from a single private equity investor.

“There is an expectation that the secondary buy-out market could be particularly positive in 2010/11 as there is a ‘wall of money’ that must be invested by private equity funds or else it will have to be returned to the fund investors.”

There is a risk with ‘pass-the-parcel’ type deals that the market will feel negatively about the company in question. However, organisations that end up in these deals may have experienced obstacles to IPOs or might not be in the right position to go to market.

Initial Public Offerings

Although still seen as a traditional exit strategy, an IPO is highly dependent on equity market liquidity and the markets are yet to ‘open up’ fully, making IPOs difficult at the moment.

“I have always espoused a very simplistic view of an IPO as an exit route.  If it delivers access to cheaper capital of quoted paper to help finance a consolidation strategy or accelerated organic growth, then it should be considered. If not, then it is best avoided,” says Tim.

Creativity

The build up of private equity investment mentioned earlier suggests that firms may be looking at more creative ways of exiting than dictated by tradition.

Neil explains, “In the halcyon days of private equity, you didn’t have to be too creative because trade buyers, tertiary PE buyers and stock market flotations were all happening at good multiples. The world post Lehman Brothers and the banking crisis is, however, a totally different place and now there is undoubtedly the necessity for creativity! The trouble is that firms are starting from zero in regard to a more creative approach, so it’s difficult to change your previous dominant logic about how you exit investments.

“Perhaps we’ll see partial exits with houses rolling over some of their investment via seller loan notes, or retaining a stake in a flotation situation and agreeing to sell it when there is an orderly market for the newly quoted shares in the future. Of late, we’ve even seen some houses doing all equity deals when buying from each other, thus putting a lot of their cash to work – albeit not at the likely stellar returns they generated in the good old days!”

Logistics

Tim says, “The key point is that a private equity investor needs to do a material amount of work on the future exit strategy ahead of investing.  If you don’t know how you ultimately are going to exit, then don’t invest!”

“On exit there is an interesting dynamic about who is responsible for the deal,” says David Cheyne, Chairman of Criticaleye. “The private equity manager believes it is their job, however they do not know the business as thoroughly as management. Common practice is to keep management focused on their day jobs but there is increasing evidence that having a senior member of the management team assisting the exit team leads to a smoother transaction and greater value for shareholders.”

Stephen says, “Successful exits (in my experience) come about when two things align: 1) Strategy – ie, it is the right time in the businesses evolution/business plan and 2) Management and investors all agree that a liquidity event should occur. If one (or both) of these factors are not in place, then pushing through an exit will be hard work.”
However, it is important for private-equity backed companies to remember that an exit may not always come when it is best for the company. Funds will often exit organisations for their own reasons – for example, as a result of pressure from their own shareholders or legislation. This is why it is vital to know and understand the funds, as well as the environment in which they are operating.

Please get in touch if you have any comments about the issues in today’s update.

I hope to see you soon

Matthew

www.twitter.com/criticaleyeuk