IPO: What is an Initial Public Offering and is it right for your company?

‘Going public’ can be the crowning achievement for founders and employees who’ve grown a company from an idea into a thriving business worth billions. But while successful IPOs make news headlines, some IPOs make the headlines for the wrong reasons, with the share price plummeting or controversy about how, where and when the company went public.

At SeedLegals, we encourage founders to think about their exit strategy – and IPO is just one of several ways to exit. In this post, we explain how an IPO works, what you need to consider, and alternative ways to sell or exit your business.

Contents

• What is an Initial Public Offering?
• Is IPO normal in the UK?
• Why do companies go public?
  What are the advantages of an IPO?
• What are the disadvantages of an IPO?
• What happens in an Initial Public Offering?
  Step 1: Prepare for IPO
  Step 2: Carry out due diligence and regulatory obligations
  Step 3: Prepare the shares
  Step 4: Step up your marketing and comms
  Step 5: List and start trading
  Step 6: Stay compliant after IPO
• Which country is best for an IPO?
• How long does an IPO take?
• How much does an IPO cost?
• When is the right time to IPO?
• What are some alternatives to an IPO?
  Go public a different way
  – List directly
  – Use a SPAC
  Stay private
  – Form strategic partnerships or joint ventures
  – Raise more with venture capital or private equity
  – Exit with a private share sale
• What happens if I have shares or share options in a company that will make an IPO?
• Talk to the experts

What is an Initial Public Offering?

An Initial Public Offering (IPO) is when a private company makes shares available for the public to buy. The process raises money for the company and after the IPO, shares in the company can be traded publicly.

At IPO, the company can issue new shares, and investors, founders and other shareholders also have the opportunity to sell their existing shares.

The exact rules and process for an IPO depend on the market where you choose to go public. In the UK, many companies choose to list on the main London Stock Exchange or the Alternative Investment Market (AIM). But whichever market you choose (and you can choose to ‘float’ in countries other than where you’re based, see below), IPO involves expensive and time-consuming processes and paperwork. IPO transforms your private limited company into a public enterprise and, like all public companies, it will be under much more scrutiny and outside control.

Is IPO normal in the UK?

IPO is not a common way for startups to exit. In fact, a merger or acquisition (M&A) is far more likely.

Total number of IPOs in the UK

From 2000 to 2009, the average number of IPOs per year in the UK was 150. From 2010 to 2019, the average was 82 per year.

Fast forward to 2022: 45 companies made their IPO in the UK, 61% less than in 2021 when 119 companies made an IPO. Of these 45 companies, only 22 went public on the main London Stock Exchange and AIM. The new listings in 2022 raised £1.6B, just 10% of the £16.3B raised in 2021. This downward trend for IPOs reflects increased caution from both companies and investors. (sources: University of Oxford, EY, PwC)

Total number of M&As in the UK

In 2022, 4,232 companies in the UK went through an M&A process. In 2021, this figure was 5,033 (source: PwC)

In summary, a UK company is 100x more likely to merge or be acquired than to make an initial public offering.

Why do companies go public?
What are the advantages of an IPO?

Every company making an initial public offering has its own reasons but usually these boil down to:

• Raise money 💰
  Sell more shares to raise money from the public to power your next stage of growth. When you sell shares to the public, this can come with far fewer strings attached than when you onboard private investors (angels or VCs).
• Reorganise company finances 🏦
  Use the proceeds from an IPO to pay off debts, improve the financial stability of the company, and enhance its creditworthiness.
• Reward your early investors 🫴
  Your existing investors can sell their shares at the IPO, to make the return they’ve been hoping for.
• Boost public awareness 🌟
  Going public puts your company firmly in the public eye. Boost perception of your company as a mature, stable business. Build trust to help you gain more customers and establish new strategic partnerships.
• Exit ⏏️
  While some founders stay on at a company after IPO, for others, IPO is an exit strategy. Founders can sell their shares in the IPO to end their shareholding and if they wish, hand over the business to new leaders.

What are the disadvantages of an IPO?

As we saw above, IPO isn’t a common event for companies in the UK, partly because many companies never reach the stage where an IPO is possible, but also because there are various disadvantages:

• More restrictions and regulations 🗃️
  There are strict regulations and requirements for the governance of public companies, which require more time and expense for the company to comply with the obligations.
• Loss of privacy 🕵️
  As an organisation listed on a stock exchange, the company has to disclose more details to the public and is under more scrutiny from the government, the media and the public.
• Change of control 🕹️
  Like any equity investment, at an IPO you issue more shares which means more people own the company. This inevitably shifts control in the organisation and adds more stress to your team to perform even better.
• Risk to your share price and reputation 🎰
  No matter what you raise at an IPO, if the markets and media perceive it as a flop, it can damage your company reputation for years to come.
• Expensive 💸
  Preparing and completing the IPO are costly. And then there’s the added expense of complying with the extra regulation and reporting requirements.

What happens in an Initial Public Offering?

When you take your private limited company through the process of an Initial Public Offering in the UK, here’s what typically happens, step by step:

Step 1: Prepare for IPO

• Evaluate readiness
  Assess your company’s finances, growth, forecasts and overall readiness for going public.
• Appoint advisors
  Get your dream team in place. Bring in expert advisors for the legal, financial and accounting aspects of the IPO, to help guide the company through the process.
• Appoint an investment bank
  Usually companies appoint one or more investment banks as underwriters. They manage the IPO process, set the IPO share price and help you comply with regulations.

Step 2: Carry out due diligence and regulatory obligations

• Carry out a full financial audit
  Be ready with accurate and transparent financial reporting.
• Create your IPO prospectus
  A prospectus is the equivalent of a pitch deck. Your prospectus should entice investors with detailed information about your company’s finances, operations, risks and forecasts.
  For the main LSE and AIM, a prospectus must be approved by the FCA (Financial Conduct Authority) because it’s promoting an investment (ie: buying shares in your company). For the AIM, in some cases companies can submit an ‘admission document’ instead and it must still be approved by an official advisor.
• Submit documents
  Prepare and send the required documents with the relevant regulatory authority (usually the FCA). In the UK, these documents include the registration statement and your prospectus.
• Comply with disclosure requirements
  Give accurate information promptly to investors and regulatory bodies.

Step 3: Prepare the shares

• Set the IPO share price
  Your underwriters help set the price per share for your IPO. ‘Book building’ is the process where the company and underwriters try to gauge investor interest to achieve the best possible price for your shares. The price is affected by many factors including market conditions, investor demand and company valuation.
• Allocate shares
  Decide how you’ll make the new shares available to institutional investors, retail investors and potentially to your employees.

Step 4: Step up your marketing and comms

• Present to potential investors
  Devise and run exciting roadshows and investor presentations to create a buzz and raise awareness about your IPO.
• Build your investor comms team
  Start establishing strong relationships with your investors to engage shareholders after the IPO.

Step 5: List and start trading

• Apply for listing on a stock exchange
  For example, in the UK, the main London Stock Exchange (LSE) or the Alternative Investment Market (AIM). To secure the listing, you’ll need to meet the specific requirements of the exchange.
• Register as a public company
  Your company will already be registered as a private company so you need to re-register as a public company with Companies House to be able to offer shares for public trading.
• Start trading
  When your company is listed, the company’s shares become available for public trading on the stock exchange. Trading starts when the exchange opens for the day.

Step 6: Stay compliant after IPO

• Comply with ongoing regulatory requirements
  Carry out your post-IPO reporting and disclosure obligations. These include financial reporting, corporate governance and shareholder communication.
• Comply with market regulations
  As well as the UK’s regulatory requirements, your company must comply with the rules of the specific stock exchange where your company is listed.

The process is similar for companies making an Initial Public Offering in the USA or on any other stock exchange, but the rules and regulations are different.

Don’t go it alone. Any company considering an IPO should seek professional legal and financial advice to make a fully informed decision.

Which country is best for an IPO?

When you’ve decided to go public, how do you decide where? Governments try to persuade companies to list in their country – a healthy stock market is a strong indicator of the state of a country’s business ecosystem. And stock markets are businesses in themselves so they compete for companies to list on their market.

Here’s what to consider when thinking about in which country and on which stock market to go public:

• Industry relevance
  Is the market suitable for a company of your size, and in your sector? On which markets are your peer companies?
• Size and liquidity of the market
  A larger and more liquid market can mean better access to capital and a wide range of investors, which can drive up your share price and make it easier to buy and sell your company’s shares. If you’re aiming to raise millions (or billions…) and boost your profile globally, then list on well-established, international exchanges such as the London Stock Exchange (LSE) or the New York Stock Exchange (NYSE) or Nasdaq in the United States.

• Investor demand
  Is there higher investor demand in a particular country or region for shares in companies like yours? If so, the greater demand for shares in your company could lead to a higher share price at IPO and increased liquidity and trading after the IPO. The level of demand varies based on factors such as market conditions, the regional economy and investor appetite in your sector.
• Political and economic stability
  Clearly, your chosen market and region must be safe and stable.
• Regulations and listing requirements
  The rules vary in each country and/or state, and each market has its own rules too. The requirements will affect your company’s operations, transparency, reporting and, for your investors, how their investment is protected. Consider what changes you’ll need to make to comply, and how much the ongoing compliance and governance will cost.
• Tax implications
  Every jurisdiction has its own tax laws and regulations which affect a company going public. And some countries have tax incentives or exemptions to help encourage IPOs or attract foreign companies. Take expert advice about how the IPO will affect your corporation tax, dividends and capital gains, and how the overall tax situation could affect your company’s profits, financial planning and, for your investors, the returns they get.
• Geographical proximity
  During and after an IPO, you’ll collaborate closely with regulatory bodies, underwriters, investors, media outlets and more. It can be much easier to meet, communicate and build relationships when you’re in the same country, nearby, or at least in a similar time zone.

To decide where to make your IPO, seek advice from legal, financial, and regulatory professionals with expertise in international listings.

How long does an IPO take?

It can take many years before a company is ready to IPO. To list on the London Stock Exchange, companies usually have to have been trading for at least three years. (source: FCA, p29, 3.3)

When you’ve decided to kick off the process, in the UK it can take six to eight months, from initiating the IPO with the regulators and market, to the first day of trading. On some markets, such as London’s AIM (Alternative Investment Market), an IPO can take place more rapidly.

How much does an IPO cost?

PwC looked at the public records for 1,175 companies which had completed an IPO in the US and found that the cost is roughly 4% to 7% of the gross IPO proceeds. (source: PwC)

The costs are likely to be similar in the UK. According to PwC’s costs calculator, the biggest expenses for an IPO are:

• underwriting
• legal
• accounting

When is the right time to IPO?

Like any decision to give away equity, it can be tricky to judge when the time is right. It depends on your company’s finances and strategic objectives, and the market conditions. To help you weigh up whether IPO might be right for your company, here are six questions to consider:

1. Are the company’s finances healthy?
   Your revenue, profitability and cash flow must be strong enough to attract investor interest.
2. Is the market favourable for IPOs?
   Assess what’s going on in stock markets generally and trends in your industry. Is there strong interest from investors in your sector? External factors that could affect the success of an IPO include macroeconomics, regulatory changes and market volatility.
3. Do you need more investment?
   If you need more money to continue growing the business, an IPO might not be the best way to raise the cash. Instead, you could raise a funding round.
4. Do you have strong prospects for growth?
   Just like your earlier funding rounds, to attract investors you must have a compelling backstory and forecasts. Re-evaluate your business model, market opportunities, competition, and plans for scaling.
5. Can you meet corporate governance requirements?
   With increased regulatory and reporting requirements after IPO, your existing processes, reporting and governance might need an upgrade. Assess what changes you’ll need to make.
6. Are your management team ready?
   You’ll need a strong top team to take your company public. Evaluate your leaders’ qualifications and experience. You might need to hire more help.

What are some alternatives to an IPO?

IPO isn’t the only way to ‘go public’ – and there are ways to drive your company forward while staying private:

Go public a different way

List directly

Instead of issuing new shares for sale publicly, and involving an investment bank to help with the IPO process, private companies can float on a stock exchange directly. This happens very rarely and means shares that already exist are offered for sale publicly. Music platform Spotify (in 2018) and collaboration platform Slack (in 2019) went public via direct listing on the New York Stock Exchange.

While this approach is no good if you want to raise money for the company, it’s a way to allow existing shareholders to cash in their shares and, if they decide to keep hold of the shares, they avoid being diluted.

There’s still plenty to do to comply with the regulations of going public, but it costs less to IPO this way and without underwriters involved, you keep more control over the process. And as with any IPO, private companies taking a direct route should bring in specialist legal and accounting experts.

Use a SPAC

Another way to take a company public is to use a Special Purpose Acquisition Company (SPAC). Compared to the US, this is relatively rare in the UK.

Going public via a SPAC involves forming a publicly listed shell company (the SPAC), raising money through an IPO of the SPAC, then merging the SPAC with your private company – which effectively takes your private company public.

This process comes with its own pros and cons. Private companies taking this route rely on expert legal and accounting guidance.

Stay private

Form strategic partnerships or joint ventures

Join forces with another company to gain access to new markets, technologies or customers that perhaps you couldn’t reach before. Yes, it’s time-consuming to research and secure partnerships – but it’s a tried-and-tested way to accelerate growth, and considerably less of a drain on your money and time compared to going public.

Like any partnership, be ready to negotiate and compromise. Be clear about what you want, how long the partnership will last and check your cultures are aligned. And if a partnership is no longer working, be ready to move on.

Raise more with venture capital or private equity

If your primary aim for an IPO is to raise money, then you might decide that private funding from angel investors or VCs is a better idea. The company gets a big cash injection and access to the networks and expertise of your investors, and you can stay focused on building the business without the pressure and scrutiny involved in being a publicly traded company.

However, when you onboard more investors, you dilute ownership of the company and reduce your decision-making power. Your investors might have their sights firmly fixed on a future sale or IPO, and add pressure for your team to meet milestones and financial targets. And you’ll need to spend time creating reports and updates, and building your relationship with investors.

Exit with a private share sale

If your aim is to exit your business, a private share sale can be far quicker and more discreet than an IPO, and you’ll have much more control over the process. You’ll have more flexibility to negotiate the terms of the sale, including the share price, payment structure and any agreements you want to include. A private sale is confidential, the details of your transaction stay private, and you avoid the public scrutiny of an IPO.

Compared to an IPO, you’ll have a smaller pool of potential buyers. Private buyers are usually other companies, private equity firms or individual investors – and this smaller pool can mean a lower valuation than if the company goes through an IPO.

Your existing investors will have an opinion on a share sale versus IPO, depending on whether they want to keep or sell their shares after you exit. The possible restrictions on selling shares in a private company could make it challenging for them to exit in the future – it’s much easier to sell shares if a company is public.

What happens if I have shares or share options in a company that will make an IPO?

Exciting times! Maybe you’re a founder, director or employee with shares or you have vested options from your company’s share option scheme.

Firstly, check what conditions there are on when and how you can sell your shares or when you can exercise your options (and sell the shares you get). You might be able to sell your shares at the IPO, or there might be conditions preventing you from selling for a while after the IPO.

At and after the IPO, the value of all shares in the company – including your shares – is influenced by what the market is doing. This can make it difficult to know whether to sell up and pocket the cash (and pay the tax you’ll owe) or to sit tight and hope the share price rises.

If you’re in this situation, talk to an independent, qualified adviser to fully understand the impact on your finances.

Talk to the experts

For many companies, an IPO simply isn’t an option. But if it is or might be, you’ll need to weigh up the pros and cons, and take professional advice to make a fully informed decision.

At SeedLegals, we help startups and small businesses create and organise the legal documents you need, and take investments from angel investors and VCs. To find out how we can help you get your company in great shape to be ready for IPO in the future, book a free call with one of our friendly experts.