By Cristín McCoy
A dual-track IPO/M&A roundtable hosted by Hamilton Locke and Deloitte was recently held in Sydney on 23 August 2018.
The roundtable was facilitated by Nick Humphrey (Managing Partner, Hamilton Locke) and provided a general overview of the dual track process and discussed:
the benefits and disadvantages
the main challenges in pursuing a dual track process
the key factors to consider
Key topics for discussion included:
Aaron Black (Partner, Deloitte) said it is important at the outset of any process for the target company and sellers to consider what their objectives are in a sale process. In general, a financial investor is more likely to be primarily focused on the sale price achieved whereas founder-sellers can have more wide-ranging objectives (access to capital, achievement of personal goals, employee equity incentive realisation, etc).
The key factors to consider before embarking on a dual-track process are time (including management time) and cost. The impact on management time (in particular the CFO’s time) was discussed and the group noted that any exit process is demanding on the management team and it is challenging to run both processes without the company taking on extra recourses to assist the team.
Target companies will need to select appropriate advisors at an early stage who are suitably experienced to advise on both processes and map out for sellers the likely time and costs involved. The corporate advisor will often test the market at an early stage to assess the viability of running a dual process.
The roundtable agreed that the key advantage of running a dual-track process is to build competitive tension. Market windows for IPOs can open and close, and target companies can sometimes be disadvantaged due to periods of market volatility or lack of investor demand. An alternate M&A process can be a valuable alternative for emerging growth companies seeking to exit.
Running a dual-track can afford the target company an opportunity to compare valuations and seek to leverage its position and increase competition between bidders.
Founders and management who want to participate in the future growth and profits of the target company can maintain ownership in an IPO.
One of the key challenges is the pressure it puts on the management team and the CFO, in particular. With a dual-track, this pressure is increased. Hal Lloyd (Partner, Hamilton Locke) noted that there are ways to alleviate this pressure including establishing separate IPO and M&A teams and bringing in external consultants to support the business. He noted that the preparation for an IPO is significantly more involved than for an M&A process. With an IPO, the company must change its compliance and reporting functions which adds a real cost to the business. The company must be committed to the IPO process in order to implement these changes.
Another factor to consider is the board composition. This is a key part of the IPO process and incoming directors will want to ensure they have sufficient time to get up the curve on the business and are actively involved in the IPO diligence process. It can take time to get the right mix of skills and experience on a board and it is important to factor board selection into the planning process.
IPO Structure and Escrow
Some discussion was given to IPO structuring options including a sale-co structure which is typically used to facilitate the sale of shares by existing shareholders in the IPO by ensuring that they are shielded from prospectus liability by not selling shares directly to the public under the IPO.
Escrow periods will often run for the forecast period in the prospectus. There is some prevalence for financial investors to have a ‘trigger-price’ for escrow restrictions to be released (i.e. the company issues a profits upgrade or a certain share price is achieved). Many financial investors have become more comfortable with holding their shares beyond the escrow period in any event.
For management and founders, the market generally looks unfavourably on early release from escrow and it is not unusual for underwriters to seek up to a 2 year escrow period for these classes of shareholder.
Aaron Black said he recommends to management that if they have an intention to sell then they should sell into the IPO rather than thinking they can sell as soon as escrow ends. Selling at the IPO is transparent and the market has the opportunity to consider its investment with the understanding of management’s intentions. If management look to sell-down when a company is relatively new to the market, it can be viewed negatively.
Vendor Due Diligence
Vendor due diligence can be a useful tool to maximise competitive tension and speed up the process. It can also alleviate stress on management during the often onerous buyer due diligence process as they are more prepared and the buyer will already have been provided with key information. Hal Lloyd noted that in an IPO process, the due diligence process is more integrated, with the financial, tax and legal due diligence key advisors also being members of the due diligence committee. The same cannot be said of the M&A vendor due diligence process.
The group noted that in the last number of years in Australia there have been very few ‘true’ dual-tracks; that is the date of the book build in the IPO is the same date as the final bids are due in the M&A sale process. This may be because of:
potential perception issues: if the transaction is ‘shopped’ to strategic buyers and not taken up, will the IPO market be receptive to it?
scale: not all companies will be of the requisite scale to be attractive to both the IPO market and the M&A market; under $150m is more attractive for the PE market. The IPO market is generally bigger.
appetite: some PE firms will not want to spend the time and resources in a dual-track scenario. One way to keep bidders in a dual-track is to offer break fees to bidders.
time: many companies do not have the bandwidth to run both an IPO and trade sale in parallel whilst at the same time ensuring that the business continues to perform.
The group noted that for quality companies, market windows are less of an issue. The market is becoming de-sensitised to geopolitical risks and that the market recovered quickly following Brexit, notwithstanding that it was not necessarily an expected result.
Nick Humphrey (Hamilton Locke) observed that banks have tightened up in recent times in Australia but that there is plenty of alternative credit available.
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The information contained in this article is for information purposes only and does not constitute legal advice.
About the Author
Cristín McCoy is a senior associate at Hamilton Locke and specialises in mergers and acquisitions and corporate transactions and has experience advising across a broad range of industries including retail, mining services, technology, manufacturing and financial services. Cristín works on a range of matters including acquisition and disposal of shares and assets, private equity transactions, venture capital investments and general corporate advisory work.