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Becoming investor ready in the context of an IPO

Fail to plan, plan to fail

Robin Stevens, Senior Advisor, Capital Markets
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There is a well used saying that hindsight is '20-20'. Unfortunately in the context of 2020, foresight currently requires massive polishing of the lens to see much beyond the end of the week.

In this environment, planning can be seen as at best challenging and at worst pointless other than as an academic exercise. Let's go with challenging for this purpose, as we know that even in the calmest of conditions forecasting the future is bound to be wrong. Normally we are too optimistic about future trends and opportunities and sometimes we are too pessimistic, but either way we are rarely correct. However, in the context of becoming 'investor-ready' as a prelude to raising private equity from a third party, or a public offering on a capital market such as AIM, we don't need 'correct', not even 'world beating correct', we just need to understand our business better, be in a stronger position to capitalise on opportunities when they arise and manage risks before they become major issues. No one expects perfection. An open mind, a willingness to learn and take informed advice and, above all perseverance, are much more important requirements. Taking time to critically assess the business on a continuing basis, where you are, what steps you need to take to survive, prosper and grow, and where you would like to be within a defined and realistic time scale are prerequisites for any really successful business. Serendipity is a nice surprise but it's only a successful strategy in hindsight.

There is no one size fits all when assessing the requirements of emerging companies to become 'investor ready'. There is a common theme linked to a need to improve the 'quality' of the company's profits, or even losses in some cases, but every company and every situation requires separate consideration depending on the specific nature of the business, its markets, the stage of development and the personalities involved. That said, for the purposes of discussion we can group the planning elements into four main groups around commercial considerations, people and management, financial and structure, and taking informed and independent advice.

Commercial considerations

Investors invest in the future, not the past, and a business that wants to survive, prosper and achieve longevity needs a strong base built on a scalable and profitable business model that within a reasonable period also generates cash. I'll return to the importance of cash below but, in terms of the model, it has to have the ability to demonstrate above average returns ideally now or in a relative short period of time. The time line might vary, but the further out the profit horizon the less the appeal and the lower the valuation. Growth may come from a mixture of organic expansion and acquisitions. However, acquisitions often require significant integration and a track record of successful past transactions is normally a prerequisite where acquisition or consolidation of market share is seen as a key growth strategy.

Any business seeking external capital must also seek to avoid over dependence within the key elements of the business, products, customers, supply chain and people. I will cover the people aspects below, but in essence the greater the level of commercial dependence the higher the perceived risk; the newer the valuation, the harder it is to attract investors, or even lenders. Where a company has one to two very profitable customers or one highly regarded product, it is rarely easy to reduce this dependence by looking elsewhere and perhaps missing opportunities with the core customers or product. That said, a failure to diversify can significantly impact access to external capital and will prejudice and limit an eventual sale of the business.

The quality of a business and its business model is often assessed in the context of its competitive market position and its ability to build and maintain barriers of entry to at least part of its activities in the jurisdictions in which it operates. Sometimes these are regulatory barriers, often technical advantages sometimes purely commercially based on scale and first mover advantage. Without a clearly defined 'edge', it is often difficult to effectively differentiate what might be a perfectly profitable company at the moment from its competitors.

Any pre investment or pre IPO review should also aim to ensure that the group has defendable rights over the intellectual property and other assetsthat it exploits, that any non core assets and activities, perhaps of a proprietorial nature are disposed of, and that all material trading arrangements with major customers and suppliers are properly documented.

People and management

With the possible ;exception of oil wells, mining resources, infrastructure projects and property, investors generally invest in the skills and experience of people and management teams rather than merely the underlying business. Accordingly, building and retaining a well balanced and effective management team in advance of an external fund raise is crucially important. There can be gaps to be filled at lower levels but the key roles of CEO and CFO must be in place together with strong and effective team members responsible for production, sales, distribution and marketing. Supporting areas such as IT/Technology and HR must also be adequately resourced, the extent to which depends on the nature of the business. In the case of pre IPO planning there should also be a relatively clear succession path within the wider management team and a commitment to appoint suitably qualified independent non executive directors to provide a suitable level of corporate governance to protect the interests of all shareholders.

For key members of the management team who were not part of the original founder team, it is also advisable for suitable share incentive arrangements to be in place to ensure as far as possible that the interests of management and shareholders are fully aligned.

Financial position and structure

While it is true to say that investors invest in the future and not the past, confidence in the reported historic results and financial position of a company seeking to raise finance is crucial. In the context of a potential capital market IPO or reverse takeover, this means that the last three years consolidated financial statements, or the period since incorporation if less, have to be prepared applying International or US financial reporting standards (or national equivalents) and should be audited in line with international audit standards. It is not unusual for fast growing family companies not to meet these requirements as they may not be required for public filing purposes and a limited company. In these circumstances the historic financial statements may need to be restated and re-audited as an important prelude to the intended transaction.

It is also common for internal reporting, forecasting and management information systems to be upgraded in the months leading up to the outside investment and sometimes for additional accounting staff to be recruited to provide support during the IPO and immediate IPO period. One area of particular importance with regards to management control and financial viability is the company's cash conversion rate, i.e. how much of the annual profit is translated into cash at the end of the year. A growing company will often invest profits into the business to grow further, which is to be fully expected. However, at some stage cash generation must flow through the model. Strong credit management procedures and well policed terms of trade with customers and suppliers not only generates cash, but demonstrates to investors that the business is being run efficiently.

A detailed tax review should also be undertaken in advance of a transaction commencing to identify potential issues that may impact the company, the management team and the shareholders. This is both an important part of historical due diligence exercise and an advisory role looking forward to ensure the group structure meets the commercial and financial requirements of the shareholders. The company or group's capital structure must be well understood, be practical and commercially justifiable in the face of any future tax review. Building substance into the future capital structure is crucial in avoiding future potential tax disputes and unwanted liabilities. It is normal for any potentially contentious tax issues to be the subject of a clearance process with the tax authorities in advance of the transaction starting in earnest.

Taking informed and independent advice

Most management teams and founding shareholders will only go through an IPO once. It is therefore important to try to ensure that they are advised by a team that can give the independent and objective advice required to allow the principals to be in the best position to make the right decisions. It can be easy to listen to people that will tell clients exactly what you want to hear regarding valuations, timing, the market's fundraising appetite and future exit routes. Management and shareholders should try to engage with an advisor team that has been through the process many times and who share the benefit of their experiences. Early exposure to misleading and self-serving advice can cause untold delay, and in some cases derail a transaction permanently.

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Relatively few companies will stay the course to achieve an IPO as part of part of their life cycle. However, for those that do join a stock market the access to capital and increased profile can have a substantial positive effect on growth and future value. These planning points are important elements of the journey to the market entry, but they are just the beginning. Ongoing engagement and communication with the market is required to ensure that the expected benefits are achieved. Invest time in the market and the market should invest time in you.

Crowe’s Capital Markets team can provide specialist support to take you to your listing, through your listing, and beyond, to find out more get in touch with Paul Blythe or your usual Crowe contact.

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