*Image from Pitchbook

“The new big-money status symbol of 2020 is running your own blank check company. Hedge fund billionaire Bill Ackman has a new one. Oakland A’s executive Billy Beane, who was played by Brad Pitt in the film Moneyball, got into the game with an initial public offering in August. Even former U.S. Speaker of the House Paul Ryan is getting one going.” – Crystal Tse, Bloomberg Businessweek (Aug. 27, 2020)

 

“Unlike conventional private equity investors, SPACs are not reliant on high yield debt to do their deals (although they may make use of leverage or offer shares as well as cash by way of consideration for an acquisition). In the absence of significant inflationary pressure, they are relatively immune from falls in share prices generally, as the value of their cash trust fund does not diminish in a falling market (which may enable them to get more for their money).” – Westlaw

SPACs as a Third Way to Go Public

Often, SPACs and Special Purpose Vehicle (SPVs) hold funds for investment or distribution. To start, here are a few mechanics behind SPACs and SPVs. When an SPV is treated like a SPAC, and is not utilized for the purpose of holding sequestered or reserved funds, SPACs pay up to 5% on the money it raises to the book running the bank.

At this moment in economic history – long-term interest rates and the COVID pandemic – SPACs are being seen as a third way to go public. As of late, Silicon Valley luminaries Peter Thiel and Reid Hoffman have joined in the SPAC boom.

“When a SPAC completes its IPO, usually 100%, but in no event less than 90%, of the funds raised are held in escrow to be released either upon completion of a business combination transaction, or back to shareholders in the event a transaction is not completed within a set period of time. A SPAC business combination must have a market value of at least 80% of the value of the amount held in escrow at the time of the agreement to enter into the transaction. Shareholders that object to the business combination have the right to convert their shares into a pro rata share of the funds held in escrow. A SPAC generally has 24 months to complete a business combination; however, it can get up to one extra year with shareholder approval. If a business combination is not completed within the set period of time, all money held in escrow goes back to the shareholders and the sponsors will lose their investment.” – Laura Anthony, Esq.

What does this mean for the market?

Apart from SPACs and SPVs reverse merging with private companies, we are likely to see a plethora of cross-border M&A activity for a variety of reasons.

SPACs are almost always utilized to pool money together for an acquisition company or blank check company. In most aspects, particular 2020 funds are utilized to acquire a concern and then list the company through the SPAC as an asset and or entirely change the name and structure of the SPAC into the target company. Recent examples include DraftKings, Nikola and Virgin Galactic.

Going public is an exciting time for many business owners and investors, but the IPO market is cyclical, and at times can ground to a halt.  On the other side, a SPAC is relatively quick, requires much less interaction with the banks and investors, and has a certain element of price certainty.

Transaction Readiness

In our many years of deal work, we found that there are some clients who are keen to engage in a trade sale or capital raise but are simply not ready or clients are keen to understand what they would need to do to be ready for a transaction in a year or two.

This work commonly involves reviewing the history, business model, management and financial accounts, board practices and records, staffing, corporate structure, any existing transaction marketing materials, forecast financial models and other items and areas that may come up in discussions:

• Evaluating potential buyer positions and developing tax and financial scenarios to help maximize after-tax proceeds;
• Preparing a strategic and competitive industry-based market assessment Identifying, assessing, and supporting potential revenue and cost synergies Preparing, populating, and managing data rooms and buyer information requests;
• The degree of transaction readiness we find in the business, including discussion and recommendations on gaps and issues that may be uncovered;
• Summary of the Owners’ available options (fundraising, listing, sale) and our view on the appropriateness of each;
• A discussion of the existing transaction marketing materials and any recommendations for improvement.

If you would like to discuss your corporate and capital market options, please contact us at Eaton Square for a confidential discussion. You may book a call here.

“I used to encourage companies to list on the ASX. Now, the case for smaller companies listing is slim for all but the most suitable candidates”

Current market dislocation is driving growth for certain businesses and bringing alternate corporate pathways into focus. In my a 30-year capital markets experience, I’ve identified four key observations for directors, management and shareholders considering a listing, private equity or trade sale.

4 Key Insights when considering a public listing

1. ASX is no longer the natural home of small cap growth stocks

Historically, the absence of venture funds in Australia and the speculative history of the resource sector, morphed the ASX into a growth exchange, providing capital and liquidity for companies at an earlier stage than any other exchange in the world.

This distinguishing feature is now diminished, through higher regulatory standards, policy changes, and higher expectations by investors, based on previous market failures. Investors’ appetite for profit remains strong, but the tolerance of failure is low, by both the market and regulators.

2. Access to capital at what price?

Public markets are excellent vehicles for raising capital and providing liquidity for larger companies and higher growth firms with predictable businesses. However, through a perceived lack of other options or exuberant advisors, small companies still list on the ASX, earlier than most other bourses in the world.

A listing is the ‘starting line’ for scrutiny and judgement and should not be the ‘finish line’ for smaller companies seeking funding. When corporate results in the transparent world of continuous disclosure vary from expectations, investors reactions are exaggerated. If companies outperform, valuations are often overshoot fundamentals, but when results fail to meet expectations, investors will punish the share price and companies can sink into the illiquid mire of ASX oblivion.

For companies without a track record of profit, escrow conditions will restrict founders’ ability to sell-down and crystalise a capital gain.

3. What astute public market investors look for?

No CEO has finished an IPO process and said that was fun! It is uncertain, expensive, time-consuming, distracting and stressful. Organisational maturity, a strong operating outlook and reason to leverage public markets are essential.
The assessment criteria (other than for resource companies) is consistent across astute investors. It includes positive and growing cash flows, or an innovation pathway, understandable business models in attractive markets, and faith in the honesty and capability of management.

Smaller companies that may not quite meet these standards are sometimes offered a reverse listing on the ASX. Having advised on many listings, including the first RTO of the dot-com period, it is clear that RTOs are not often an attractive pathway. Changes to listing rules mean that unless the ‘shell’ is in the same business and a similar scale (with strategic, synergistic or funding advantages), the listing requirements and challenges are the same as for an IPO.

4. Preparation must examine private equity and trade sale

Advice for companies looking for a value event is that long-term preparation should deliver the best result. There is an adage amongst Venture Funds that an exit plan should be in place at the point of investment.

My experience in both venture capital and corporate advisory underlines the importance of objective analysis of alternative liquidity or funding points, work to a preferred plan, but maintain flexibility for competing corporate transactions.

An evaluation of a listing path should go beyond the ASX, including the London Stock Exchange and its AIM market, Singapore (and Catalist), Nasdaq, Toronto and Hong Kong bourses.

Private companies continue to hold their relevance and value to Trade and Private Equity acquirers. While some bidders have temporarily taken a step back to interpret the implications of COVID-19 across business sectors, the market dislocation is creating significant opportunities for private companies to attract the attention of strategic partners, trade buyers and private equity investment.

It is important for private companies to create competition between strategic and PE buyers as this impacts valuation and deal structure, and gives sellers the choice of ‘culture’ that they think will be best for their business and staff. Appoint an advisor with a global perspective, and not tied to a particular market strategy.

If you would like to discuss your corporate and capital market options, please contact Jonathan Buckley at Eaton Square for a confidential discussion. You may book a call here.

Whilst Directors may aspire to a future on NASDAQ, NYSE or LSE, most find the TSX and ASX more willing to support a listing at an early stage in their corporate development.

Leaving aside for another post, the discussion of the merits or otherwise of listing an early-stage business, we observe that once IPO champagne and party balloons have gone flat, life can get pretty tough.

What is considered an early-stage company?

Growth Strategies for Early-stage Companies

So what are the options for listed early-stage technology companies needing to change their stars?

1. Buy growth

   There is no shortage of small listed companies keen to buy earnings accretive businesses (preferring to pay in shares).  Ideally, these acquisitions are synergistic to the existing business but finding sellers willing to accept payment in illiquid stocks make life difficult for dealmakers.

2. PIPE (Private Investment in Public Entities)

   There are some institutional funds that specialise in PIPE deals in listed growth stage technology businesses.    These firms typically take a medium-term bet on a company’s strategy and execution capabilities of the management team.   The bet being that in a roughly 24 to 36-month period the company will be able to use the funds raised from the PIPE investment to make a significantly large transition that the broader public markets will warm to the company’s growth story lifting the share price whilst providing sufficient liquidity for the PIPE investor to offload their position and realise their profits.

3. Public to Private ownership*
   

   As the reach of international Private Equity (PE) companies grow, PE firms are finding that some of the best investments for their fund are currently listed. This makes P2P transactions more common and executable. As many smaller listed companies have tightly held shareholdings, the ability to make a P2P transaction work is improved.

   * Noting that most PE firms will only invest in profitable businesses with the ability to sustain some level of debt leverage.  Hence, this option is rarely available to most listed early-stage technology companies as they are typically single-business, pre-profit companies.

Stay tuned for our next blog in this series in which we will look at the two main variants of PIPE deals that we are currently seeing in the market.

If you would like to discuss your funding options, please contact us at Eaton Square for a confidential discussion.

Reece Adnams
Global Managing Principal

Reece is the Managing Principal of Eaton Square and is focused on M&A and capital services. His industry expertise incorporates IT Services, Engineering, Management Consultancies, Software and Technology and HR Services. With over 20 years of corporate strategy and mergers and acquisitions experience working in both global corporations and small and medium-sized services businesses, Reece’s depth of knowledge is invaluable in assisting clients to navigate the complexities of M&A transactions.

reece.adnams@eatonsq.com
Ph: +61 03 8199 7911

In these instances, Australian Super partnered with a private equity firm in offers to take the companies private. Senior portfolio manager Shaun Manuell, in conversation with the AFR, stated that he expected to see institutional investors showing increased interest in such transactions. “We’ve built up a very strong track record of how we see ourselves partnering with private equity.”

However, not all transactions conclude as expected. In the case of the bid for Healthscope the successful transaction went with the US based Brookfield. The bid for Navitas was ultimately successful for Australian Super and BGH. Nevertheless, the process was complex and long-winded, which suggests three points to consider for companies contemplating such a path.

Is the business suited to a private equity transaction?

It’s worth remembering that the goal of investment managers is simple – to ensure the best possible return on capital. While this is not far removed from the obligation on management, the timescales on strategy and outcomes may be quite different.

• PE investors like strong cash-flow businesses – it supports the load that comes from adding debt to leverage the equity invested.
• Businesses which have credible short-term growth opportunities have more appeal. Private equity investors usually seek to realise their investment within 3-5 years.

Ensuring that there is alignment between the business and investor goals is an important prerequisite to a successful engagement.

Do the investors bring suitable capabilities to the ongoing business?

Not all sectors are well suited to private equity investment. Some are inherently more challenging, requiring successful delivery on a wider range of factors. A case in point is the retail sector where historically the performance of acquired businesses has not met expectations. In the USA 25% of the 20 largest retail PE deals since 2005 have resulted in Chapter 11. This is visible not only in the USA but in Australia and other markets.

Retail requires an intense focus on a broad range of measures and despite strong cash flow generally lacks the margins to support costly initiatives such as store footprint expansion.

The level of understanding by the buyer of what it takes to survive, let alone succeed, in such industries should be considered seriously.

How well placed are the Board and management to secure a competitive process?

It’s quite common for a company to receive an unsolicited approach. Sometimes that can be a welcome signal, but in the context of securing the optimal outcome, it is important to be in a position to create a competitive bidding situation, not an easy task as private equity firms seek to secure exclusive opportunities.

Ensuring that the business can effectively respond to and initiate a competitive process is something that needs to be planned for ahead of time. Doing so may require a different skillset from what is presently within the company’s capabilities.

Early planning is key to this approach

Across our global network, we have worked with companies to ensure that such considerations are addressed ahead of time. If you would like to discuss these issues we would be pleased to have a no-obligation conversation.

Many such firms find that as they do not reach key threshold measures for larger market investors and analysts, their stock can be undervalued and left in the doldrums.

Going private enables businesses to pursue growth

In recent years Zenitas Healthcare and Pepper Group have shown that there is a great opportunity for publicly listed companies to be acquired in friendly transactions, much like a trade sale. In the case of Zenitas, despite an impressive performance by management which saw EBITDA nearly triple, the company was unable to excite market interest, resulting in a share price that languished prior to the offer to take it private. The company is now moving forward without the management distraction inherent to a listed entity. Pepper Group, an alternative lender, had a brief spike in its market value when it listed in 2015, but subsequently, despite continuing growth, it failed to attract the interest of investors. The offer to delist from a private equity group has freed the company to pursue opportunities with the backing of an entity having large capital resources.

The record flow of money into private capital funds in recent years, coupled with the continuing interest by global organisations in expanding operations by acquisition, makes the present time attractive for businesses looking to pursue their growth opportunities outside of the public markets.

Adopting a cross-border approach can unlock value

Central to this strategy is identifying and connecting with the right buyers internationally. We have worked with and are working with clients contemplating either the divestiture of non-core businesses or the undertaking of a public to private transaction. Our multinational capabilities assist in unlocking shareholder value by expanding the reach out to international parties interested in such an acquisition.

If these capabilities are of interest please contact us for a confidential, no obligation discussion.