Should I list? Notes from an IPO masterclass

The NZX and Xero, along with Cameron Partners and Bell Gully, held a “Masterclass” on IPOing in NZ on Wednesday.

Xero CEO Rod Drury wears two hats, as he is also a director of the NZX, but they were also represented by Tim Bennett, the new CEO and Andrew Harmos the chair. Ross Christie from Cameron Partners and Dean Oppenhuis from Bell Gully put their side of the story.

Here are my notes from the event, but you can also simply read the slides Rod et al. used.

Should I list?
Advantages of listing that Andrew highlighted were providing capital and liquidity for investors/founders, transparency, ability for punters to invest.

Later on Rod put up a slide with: providing capital for growth, giving objective market value and market for shares, employee commitment, raising corporate profile, enhancing credibility with customers and suppliers and creating ability to make future acquisitions.

The negative issues with IPOing and plublic markets were not really covered, but to me are profound. While it may create liquidity for employees and investors, the constant tracking of the daily movements of the stock price can be distracting for the team. How did we think the mood was inside Facebook as we met, after 10% then 7% daily price drops from the IPO? Stock markets tend towards driving the perverse incentive of short term numbers, making them seem more important than long term ability to conquer a global niche, or doing every thing for customers. Great companies can rise above that, but I do feel that Xero, for example, is underinvesting because of pointless bleats from some shareholders who want short term profits.

Overall I see that IPOing on the NZX is a much better option now than it was 5 years ago, but it is for certain companies only. It’s great if you are already a success story, and need more capital to keep feeding a growing machine. It’s lousy if investors here are not sophisticated enough to understand your industry or business model. Xero has come a long way with investors, but it still amazes me that many local investors do not see the method behind their model.

Another downside is that continuous disclosure can be painful for companies. There are rules about what they can and cannot talk about, and the channels for releasing information. Not many companies can be as disciplined as Apple when it comes to talking to markets, but we are ‘lucky’ here in that we only require 6 monthly disclosure. The legals and logistics can be painful, but the worst thing is that you end up taking about yourselves and results too often, rather than focusing on the customer and products. All material releases need to be through the NZX rather than through other channels, and this can be a pain, although Rod also sees this as saving on PR.

Xero has been public for 5 years now delivering an impressive 33% annualised return to shareholders since 2007. Their market cap is now over $400m, but still small compared to the froth of Square at billions in valuation.

From NZX perspective Trade Me and Summerset raised about $500m between them last year, with both going on to deliver raised share prices. Both were sell-downs by a parent who still holds a majority stake.

Rod’s History
Rod and his partners sold Aftermail for $15m plus earn out which they never saw, and thought he was doing well. However shortly afterwards the Trade Me sale hit, setting a new benchmark set of what great looks like. He saw that as a challenge, and saw also that the next company would need to address a global market.

With Xero Rod wanted to ramp up from day one, with 50 staff working from the start. While with SAAS the money would come in from customers on time, the payments were always going to be in smaller chunks, customer by customer, month by month. With 50 staff the burn rate would be about $500,000 per month, so Rod saw he needed to raise $15m to raise. The VC industry here was too small and immature (my words) to deliver that, while VCs from the US West Coast were not considered for a couple of reasons. The IPO raised $15m for 27% of the company, selling on the growth potential and selling that all portfolios need a higher risk/return propositions. (Rod says you couldn’t buy risk at the time on NZX, but he was probably not thinking of finance companies in that way – plenty of risk there).

Rod went all-in with Xero – put $1m of his own money in up front, and being the persona with the most at risk. Xero had to have 100 customers before listing, stock exchange rules, and so there were a lot of cousins, family and so forth using Xero. The IPO process involved a lot of hustling, a lot of go/no go milestones, a lot of debates about the speed, with Rod as the most bullish.

Getting ready
An IPO is a big event, and life after an IPO is forever changed. The company needs to prepare for greater disclosure, and put a lot of time into preparation and IPO process. They need a highly probable growth plan, decent corporate structure with good people, a good story and the ability to convince an iBank or broker to help prepare for and promote the IPO.

Rod was very demanding in speed and expectations. He also worked his existing media connections, meeting journalists and investment brokers who write articles seeking advice and involving them in the story. They needed more profile building, and so Rod wrote a whitepaper on broadband (on Xero formated letterhead) in particular. That particular paper went a long way. Being public is a necessary evil, but in NZ you can get in the public eye very quickly.

Key Rules
Generally there is no minimum amount to raise for an IPO, but guidance is to get 24 months of capital. On the other hand be careful in setting a minimum as you have to return the checks if you don’t make it. There is no requirement to state a maximum, though state it if you have one. State how you will deal with over subscriptions.

At least 25% of the shares after the IPO need to be with minority shareholders who have <10% of the shares (“the public”). NZX will waive this and other rules sometimes.

Prospectus and disclosure requirements will be replaced early next year after new regulation, though the feeling was that not a lot would change here. Companies need latest accounts that are audited and a summary of previous 5 years information. For those contemplating an IPO it is best to get into auditing accounts each year. A risk section boilerplate and specific risk section are required in the prospectus, as well as a forecast for end of next period plus one more period also required.

That prospectus is signed off by directors, who assume some pretty heavy liabilities if it is hogwash. The board itself needs to have at least 2 independent, defined as <5% and non-executive, directors for boards of 8 or less, and 3 for larger boards. Rod sought people who were well known and could help, with Sam Morgan in particular on the board before the IPO.

The directors and shreholders are typically prevented from selling shares for a lock up period after an IPO.

An NZX approved sponsor/organising participant is required, with sponsor investment banks working with brokers to sell through.

Xero shopped around, ended up choosing First NZ Capital and kept presenting to them, nagging them into it. There was not much money in it for NZFC to do small IPOs. Then Rod and co. presented to Rob Cameron from Cameron partners, and he just got it. Xero engaged Cameron Partners to work on Xero side, do the work for FNZC to take on. Rod sees that smaller companies need investment bank to guide the process. Cameron Partners did Ecoya as well, and got FNZC and Craigs NZ to push shares to the market.

Pre-IPO planning
Ensure a high quality management team is in place and any outstanding issues like shareholder loans, litigation are dealt with. Get a PR strategy prepared, remembering that the IPO process requires a quiet period. You can say “we have an IPO” and separately you can “raise the profile of the company”, and journalists have to connect the dots. It’s a bit asinine, and Mighty River Power has just been granted an exception on this one, and forthcoming rules will be a lot easier. The new rules will just make sure you cannot say anything misleading or deceptive, and are consistent with prospectus.

Ross says it took 3-4 months to get to market, with a lot of investor meetings along the way, and the prospectus delivered at the end.

Due Diligence is a necessary part of the process, as you are making claims that need to be backed up. Form a Due Diligence committee, basically a a board sub committee with investment bank representative and lawyers in it. The due diligence lawyers need to have reasonable grounds to believe statements in documents are true. Dean Oppenhuis broke the DD process into initial due diligence on the company, writing the IPO documents/risk report and financial forecast verification. Lawyers will look at all legal documents, such as contracts, in the first phase, so make sure they are clean. They will also interview management, using a detailed and customised questionnaire. They will ask management to verify statements made in financial forecast – so back key claims up by independent evidence. They will issue verification certificates, certifying that there is nothing false or misleading in the documents.

The verified document goes to NZX for approval, with a good degree of supporting documents, and once approved the IPO is good to go.

Well not quite. You still need to do the rounds of investors, and despite the existence of advisors, the lions share of the work will fall on the CEO and team. It is important to have very good advisors in general though, and you will need a lot of them. My own take is always that a deal happens when everyone in the room, including advisors, is smiling.

To get investors you need to knock off some key issues, including offer structure, financial information, capital structure and dividend policy, valuation and equity story and pre marketing.

Offer Structure
There is always a tension between the raise amount and price, and you need to get a balance. I increasingly believe that it is smart to always make sure that investors see a bargain, and to value the cash being invested highly. Being greedy and having a price that is to high might make it harder to raise money in subsequent rounds.

Building a book, where you get investors to name a price, is for later stage companies only, such as Trade Me. The were apparently very happy with the price set by investors, and were oversubscribed. However start-up companies like Xero are better off with a fixed price approach, asking investors simply are you in or out.

Regardless of all the marketing efforts, Rod did say that it all comes together in the last 2 days.

Staff and management
Trade Me gave a lot of thought to executive and employee components of the IPO to make sure they were personally aligned to deliver forecasts.

Xero meanwhile had some directors who could invest directly, and gave loans to others so that they were invested as well. They sold as much as they could to staff at pre-IPO rates.

Financial information
Make sure forecast period is appropriate as a long one increases prospectus risk for directors. Some of the detail about how the numbers work might be commercially sensitive.

Capital structure and dividend policy
Investors like conservative structures rather than optimal structure. Investors like dividends, but the market is beginning to understand, with Xero’s burn money to increase revenue approach becoming obviously good for them.

Valuation and equity story. The key is to have a strong IPO story. Develop an IPO story and investor presentation, and show momentum building through the process. Get analysts to cover the company, now that we have one or two. However you basically need to build your own investment book and brag about that.

Market considerations
Trade Me cross listed into the ASX, which avoid the small size of NZ market. The NZX guys think, naturally, that this is not really necessary, but it is still hard for people in Australia to physically buy NZ shares.

Over the last 5 years things have changed in international funding, with VCs and Angels taking up a lot of the early stage funding requirements. That means the larger and smarter players are looking offshore (from the US), and Xero is one company in the target range. Rod is now more comfortable to stay on NZX for a while longer, 3-5 years, but Nasdaq an option later. NZX market more accepting of an early stage listing.

One comment Rod made stood out – launch the IPO knowing it will work.

Costs
Costs are non trivial for an IPO, but you can back load them so they come out of the capital raised. The costs are higher as a percentage for smaller IPOs, say 6-7% of funds raised for them versus 3% for larger raises. (Facebook was ~1%). Rod says you need to budget a $50-100,000 retainer per month for advisors as you go through, and pay the rest when you deliver. The second raise once you are listed is fairly cheap, say 2-3%.

For their retainer the investment bank gives credibility, but also writes the offer documents and so on.

After Listing
After listing you become a “real company” and it’s easier to build a global business. Xero management tend to be older than peer companies and investors in Silicon Valley, and see they are doing well versus them.

Xero’s IPO was at $1, but the second was $0.90 which is when Craig Winkler (MYOB founder) invested heavily. That was almost 2 years later, with a GFC in between and the share price had not exceeded $1 for most of that time. After the Winkler raise the Xero share price stayed at about $1.50, until Peter Theil invested another 2 years later. They raised more again this year at $2.75 per share, and the share price has risen nicely subsequently. Xero has used shares and cash to purchase 2 companies.

Key rules once you have listed
Companies can raise up to 20% of equity without shareholder approval in any one year. Shareholder disclosure is required for ownership over 5%, while you can issue employee share schemes of up to 3% of issued capital each 12 month period. NZX has a share purchase plan (rights issue) which cuts down on documents and allows up to $15000 per shareholder. These are usually taken with larger investor coming in and are typically done in 21 days. (I have an issue with these as the larger placement can dilute existing shareholders with more than $15000 pro rata share.)

Investor relations. Get out there and talk to people, have a thick skin, but continually thank shareholders. AGMs are a good opportunity to sell the message to investors so make them high quality. Regardless of the PR efforts there will still be millions who have never heard of you – something we can forget in the online community. Keep marketing announcements factual and blog posts more

Rod talked about, and it is clear, that Xero is on a different curve now, and has a professional team to deal with the public company compliance, employees with ESOP and so on. They bounced through the awkward start-up phase into the professional phase courtesy of the IPO. I wouldn’t think that many others could manage the IPO trick so early, but it is certainly a much better opton than I had thought in the past.

Well done to NZX, Xero, Cameron Partners and Bell Gully, not only for the IPO but also for an excellent session.

Lance Wiggs is an independent consultant providing management, strategy, growth and valuation consulting to industrial, media and internet based businesses. He blogs at Lancewiggs.com.