by Radu Magdin
Many family businesses do very well as private entities. While, statistically, only about 10% of family businesses make it to the third generation, the ones that do are often global success stories, be it White Castle, which started with little more than a fry cook who looked beyond his station in life, or Goldman Sachs, which started with a Jewish immigrant and his son-in-law engaging in what at that time were the lower rungs of finance, IPOs. In other words, if one is looking for private company success stories, one does not have to look far. There are reasons for this. A private company, particularly a family-owned business, has the ability to take the long-term view and adapt to market trends faster than public competitors who may only have a few quarters to show a strategy is successful. Capital structures may also allow the company to weather difficult times in a manner which would leave a public company open to takeovers.
However, there are cases where the limitations of remaining private begin outweighing the costs. Debt capital is no longer as attractive with interest rates rising and the corporate bond market showing signs of weakness. As more and more industries become dominated by capital-intensive models, investment becomes more important than control. Simultaneously, network effects often create a winner-takes-all, highly polarised market structures, where competing as a private company can be a losing battle, particularly when up against global companies with deep pools of equity finance.
Consequently, more and more of the great family business success stories are looking at the prospect of going public. It’s not a decision to be taken lightly but many may find themselves needing to grow larger simply to defend current market positions. When that decision is made, the road ahead is well trodden and can be usually planned for carefully. Each company’s experience will include unique elements and unique risks, but the steps involved are fairly straightforward, even if difficult. The entire process is likely to take upwards of three years and it should not be underestimated. Not only will it take significant management involvement but likely involve restructuring parts of the business.
The road map in 10 steps
First of all, management needs to be fully cognisant of implications. That management may be family or professional managers but, either way, consensus from the outset is important. Not for naught, as management structures may need to be changed, either to better reflect informal decision-making processes or for regulatory purposes. That in turn can lead to friction, loss of power for key individuals and even family upsets but it is best that this stage is handled as soon as possible.
Not least, many family businesses are highly dependent on informal leadership. This is often critical in their success but in the glare of public oversight may be seen as either poor compliance or even a potential source of instability. Setting clearer roles and delimiting executive functions may involve difficult decisions that are best in the rear-view window before beginning the process.
Secondly, the business often needs to be reorganised. Many businesses often evolve in their particular ways. Many times, a family business may be involved in multiple industries, or be vertically integrated with informal agreements in what to an investor might seem unwieldy byzantine. What is thus created over many years may work quite effectively but may not meet the level of transparency and openness that are required of a public company. Sometimes that means restructuring the entire business to streamline activities and delimit profit centres. Again, that is something which needs to be done before the formal IPO process begins and may take a significant amount of time.
Third, the business needs to understand that it is selling itself as never before. Quite simply, market sentiment matters. As a business, the company may base its marketing on certain qualities, image or competitive advantages. However, as a public limited company, it will have to sell every aspect of itself: its compliance department, its accounting staff, its management’s habits, its worker turnover, its exposure to a changing legal and economic environment. Each of these will be seen as a potentially useful metric by which to judge a company, from the orthodox, such as valuation ratios, to the heterodox, such as employees reviews online.
Consequently, it is highly advisable that well before any IPO actually takes place, each of these aspects are minutely identified and given the same consideration that a risk-averse investor might. Most can be mitigated and a particular story advanced, just as when selling to a general retail market. But now the reactions of all of the above will be immediate and potentially tremendously costly.
Fourth, the underwriting bank needs to be selected. Most likely, the family business already has a long-standing relationship with a bank which offers this. The paperwork is long and can be labyrinthine but is otherwise quite run-of-the-mill for many investment banks. In situations such as these, trust tends to trump fees, which can otherwise be quite significant, but a company may need to manage its timing and re-tailor its IPO to a degree to which long standing relationships matter. Compliance and legal team departments are key to optimisation of this process from inside the company.
Fifth comes compliance with public company regulations. This can be fiendishly complicated, particularly for a fast-growing company that may need to completely overhaul its accounting department and compliance. Quite a few new people may need to be hired just in the initial stages and they have their work cut out for them for what can easily take upwards of a year. This will depend on each business and the legal framework in which the IPO is carried out, but if a listing in New York or London is being considered, one may notice it in the bottom line just from the number of financial and regulatory experts that may need to be hired, on top of the auditing firm.
Sixth, comes actually being approved for the process by the financial authority. This usually entails two aspects, one formally pushed forward by the underwriting bank and one by the company itself. The underwriters need to file several forms which will depend on the specific legislation but can be expected to include an official letter of intent, the underwriter’s formal guarantees and registration forms. On the company side, a prospectus needs to be filled which will contain a formal submission of the company’s financial history. Needless to say, this will entail a formal investigation by the relevant financial authority, and it will err on the side of caution.
Seventh, the company must get financial backing and establish a target market for the pool of shares to be issued. Simply put, many of the shares issued will not go to retail investors. They will be purchased by large investment funds and pension funds of various investment profiles and strategies. As a new stock with no back-data, it will have to be marketed.
The importance of this would be difficult to overemphasise as it informs the pricing strategy, as well as the stabilisation strategy. If only retail investors are targeted with a general market approach, there is a high risk of a failed IPO.
Eight, a date must be set. To a degree, this is a matter of market timing – not something one should assume can be calibrated too well. Instead, a middle of the road approach whereby one simply tries to catch a general bull market and coordinates the company’s public relations for that particular date is more advisable. Unforeseen events will inevitably affect whether the timing proved correct or not, and sheer chance will play an uncomfortably large role, but the do’s and don’ts are fairly clear.
Ninth, the offering itself must be managed. This is mostly a matter of avoiding a poor IPO and managing market expectations. The difficulty comes not from the procedure itself but the high emotional impact it will inevitably have on all those involved. Often fortunes are being decided and it would be unwise to think of oneself too above the turmoil that brings.
Tenth, the price must be stabilised. Volumes tend to surge at the beginning of the IPO but the lack of pools of shares with large funds and market-makers will mean that in the initial stages some market intervention might be necessary. This is traditionally handled by the underwriting bank itself but there are always tail risks involved. As trading volumes stabilise and the holders diversified, prices tend to move in a range, at which point stabilisation ends and the IPO is complete.
Cognisant of the above, it is clear an IPO is a difficult, potentially winding, process that should be given deep thought. The rewards can be tremendous – an unrivalled pool of equity capital that can set the company apart in its own league when compared to competitors. Quite simply, few can compete with the deep pockets of the world’s large-cap companies. That said, every structural weakness will also be magnified and only a limited number of companies can actually sustain that level of scrutiny. It is, essentially, the decision of a lifetime.