IPOhhhh no! – The dangers of going public too early

Tom Matthews

For many Australian founders, listing a company on the Australian Stock Exchange (ASX) is a life-long ambition and looked upon as the ultimate business goal and mark of achievement. However, going from private to public is not for the faint-hearted; it can change a business significantly and will certainly change the nature of work for its key executives.

Long after the thrill of ringing the opening bell has subsided, a new routine of paperwork, governance, regulatory compliance and constant communication with stakeholders settles in. And, for some companies, there is the very real possibility that listing too soon can have a damaging effect.

Why list a company?

There are many reasons to list on the ASX, including:

1. Access to capital for growth – A listing gives you the opportunity to raise capital at the IPO stage, and throughout your listing, to fund future growth
2. Currency for external growth – A listing can facilitate acquisitions by providing a ‘currency’ in the form of a more diversified and liquid share capital base
3. Increased company profile – An IPO can heighten your company’s profile with the media, analysts, potential customers and the industry at large
4. Attracting and retaining talent – An ASX listing provides you with the option of remunerating your employees with shares, thereby aligning their interests with organisational goals
5. Reassurance / customer perception – Listing on the ASX can improve the perception of your business strength due to the rigorous due diligence of the listing process and ongoing compliance procedures.

Cost considerations of an ASX listing

IPOs can be hugely advantageous if conducted correctly. However, IPOs can be very costly for companies that attempt to go public too early. There are significant upfront and on-going costs associated with an ASX listing, as well as indirect costs such as management distraction.

• Upfront costs – Achieving an ASX listing requires a significant amount of spend on specialist advisers (Joint Lead Managers, lawyers, investigating accountants, auditors, tax advisers, commercial / market consultants, Public Relations, Investor Relations, etc.), as well as prospectus insurance and other upfront costs
• On-going costs – In addition to the upfront costs associated with achieving an ASX listing, there can be significant on-going costs associated with being a listed company, such as directors’ fees, on-going Investor Relations, Directors’ & Officers’ insurance, annual reporting, ASX fees, registry costs, etc. It is not uncommon to see listed companies spend in excess of $1m per annum on these on-going costs associated with being a public company
• Management distraction – Beside the significant upfront and on-going costs, achieving an ASX listing can a significant distraction for management. During the listing process, a huge amount of management’s time is required on tasks such as prospectus preparation, verification, Due Diligence Committees, etc. Even after a listing has been achieved, many management teams find themselves having to spend more time on governance, investor relations, etc., which can take them away from the day-to-day operations of the business. It’s important to also understand that the skills required to be an ASX listed chief executive are very different from those required to get a company to the point of listing. If nothing else, ASX-listed chief executives need to handle all the governance, reporting and public scrutiny their roles entail. Not every founder or early-stage executive is comfortable, or equipped, for that
• Time to IPO and susceptibility to market conditions – IPOs take a lot of preparation – for example, the ASX usually requires a minimum of 2 years of audited accounts, you will also need a credible and well-credentialed board of directors (with a majority of independent NEDs), to prepare and lodge a prospectus, including financial forecasts that need to be robust and signed off by an investigating accountant and the directors. Even when the preparation has been done, you can be subject to the whims of the listed markets, and the “IPO window” can close in an instant.

The dangers of IPO’ing too early

An ASX listing before a company has sufficient scale will reduce the stock’s overall free-float and trading volume, placing a drag on valuation and liquidity.

• ‘Zombie stocks’ are those that suffer from limited liquidity and become stuck in the vicious cycle of being unable to attract a high quality share register. Zombie stocks make up a high proportion of the number of companies listed on the ASX
• Lack of liquidity – stocks with market capitalisations of less than $100 million have significantly less liquidity than stocks with market capitalisations of up to $1 billion. This lack of liquidity can place a significant drag on valuation

• Lack of analyst coverage – small stocks with a market capitalisation of less than $500 million tend to suffer from limited analyst coverage, which can reduce liquidity and valuation. Analyst coverage tends to decrease as market capitalisation falls, reducing the ability to attract institutional investors to the company’s share register

• Lack of index coverage – small stocks with a market capitalisation of less than $500 million tend to suffer from limited fund index coverage. Index funds, which provide significant trading volumes for securities, are concentrated towards stocks with market capitalisations of over $1 billion

• De-listings – an ASX listing before a company has sufficient scale can reduce the stock’s overall free-float and trading volume, placing a drag on valuation and liquidity. Ultimately, the risk of a de-listing needs to be contemplated. The number of ASX de-listings has increased over the last 12 years

How Pemba can help?

Pemba has significant experience in helping Australian founders achieve successful IPOs.

• IPO expertise – We have a team of over 20 experienced investors with significant domain expertise. Our team at Pemba have helped founders achieve successful ASX listings
• Board structuring – Pemba has significant capabilities in providing support at a Board level, whilst recruiting NEDs in anticipation of the future IPO event
• Capital – Pemba can provide the capital required to help scale up the company prior to IPO
• Institutional investor – Pemba’s institutional investor profile will increase confidence in the future IPO, attracting high-quality equity investors to the register, improving liquidity
• Broker relationships – Relationships with key brokers will provide efficiency and greater support during the IPO process.

Next steps…

If you are an Australian founder with the ambition of seeing your company achieve a successful ASX listing, then please email me at tomm@pemba.com.au and I would be happy to share my thoughts on how Pemba might be able to help, and ensure you avoid the potential pitfalls set out above.