What You Need to Know for a Successful IPO

So you’re wondering whether it’s the right time for your business to get publicly listed. Before you get into the how’s, think about whether an IPO is even the right direction for you. Here are a few elements you should consider.

First, are you looking to raise capital? Are you looking to provide a liquid platform for your shareholders to buy and sell shares? Are you also looking to take some capital off the table? If your answer is a yes, then an IPO may be for you.

Second, is your management prepared to provide more predictability and visibility on a quarterly basis as opposed to on a three year cycle basis that’s typical in a private company? If you’re unable to commit to that level of predictability and visibility in the shorter horizon, you shouldn’t be going for an IPO.

Third, is your business using stock as a way to attract and retain talent? For instance, building stock option plans that you’ll then distribute within the business. Does being listed provide incentive for people to be a part of your business and want to work with you?

Lastly, think about the level of transparency that you’ll need to have as a business when you go public. Be it credit rating agencies, banks, financial institutions, or even government regulators, all eyes will be on you, but this doesn’t have to be a bad thing. You just need to be prepared to be closely scrutinised by the larger financial community.

If you can look at each of the above questions and your answer to them is a clear yes, you’re ready to take your company public.

Is an IPO For You?

If your business needs to raise capital every few years, you should look into IPOs. Once you’ve gone public, the timelines are much shorter. You could raise fresh capital in three months, if you’ve got your professional augments such as QIB (Qualified Institutional Buyer) in order. As a listed company, people have a better understanding of what you do, the education and verification process is therefore much shorter.

The financial services business is a great example. Their raw material is capital, so every few years they need to raise capital to grow their businesses. Similarly, infrastructure businesses’ raw material is also capital and the availability of infrastructure projects.

Obviously, the market is evolving and getting more sophisticated. There are ways to raise capital beyond just an IPO. There is certainly a cost associated with IPOs. However, the benefits include market reach, access, and liquidity.

There’s an ongoing debate that a lot of tech companies that aren’t profitable continue to raise capital from private markets. Private markets in turn raise money from pension funds and private investors to invest in private companies. The size of the pie is getting much larger. The imperative for such companies to IPO is not as great as compared to earlier, where VC companies provided small amounts of capital but the public market was where you went to raise large capital.

The world is divided in terms of whether or not you should IPO companies. Having said that, if you look at the US today, the ratio of private funding to public funding continues to be in favor of public funding. So there continues to be a great vibrancy in public markets.

Going forward, as well, IPOs will continue to play a significant part in how businesses raise capital.

The Right Capital

There are various forms of capital that you can access as a business. However, an IPO provides you with an equity that is the most expensive, but also the most long-term form of capital.

So in terms of long-term investment, as you're looking to build businesses you need capital which matches the investment horizon of your business. Not all of that can be met with debt capital alone. Debt capital will need to be serviced in terms of interest payments and repaid in principal repayments.

In both cases, you should be able to underwrite with high degree of accuracy. Only then does debt become a preferred source – a lower cost of capital as compared to equity. However, debt doesn’t provide you with flexibility. If your business strategy needs to pivot or you make a mistake, debt doesn’t allow you the latitude to make changes. Let me elaborate on that a little further.

There are several formal debt agreements, also known as covenants, that most lenders or providers of debt have. In addition to the capital you borrow and the interest you pay, you need to meet certain business and financial thresholds for the loan to continue to be a “good loan” in the lender’s perspective. Due to all of these covenants, your business will have to work within very measured parameters. So unless you have a clear view on how your business is going to build out, I would highly recommend thinking twice about raising debt.

The moment that the lenders notice any stress on the business, they would look to seek an acceleration of repayment. This would only add further stress on the business. In a way, debt forces you to be very disciplined about how you deploy the capital in your business.

On the other hand, I would advocate a combination of debt and equity overall, as it would give you the best of both worlds. Debt would give you the guardrails and discipline in terms of how you utilise capital, but you’d also have enough latitude to make crucial investments such as building markets, customers, brands, or products, or even doing R&D. Equity gives you the cushion you need to build your business.

The Right Timing

In the long term, you need to be raising capital when you don’t need it. That’s the odd way in which markets work. When a business is doing well and doesn’t need capital, I’ve seen investors flock to buy shares of that company and provide it with even more capital. There’s the perception that the business is a well-oiled machine, running smoothly.

And at that point in time, create a war chest – a cushion of sorts – for your business. Raise capital. Get your business evaluated at this time. Taking on the capital when your business doesn’t necessarily need it will eventually play out in your favour.

Bear in mind that it takes quite a long time to raise capital. If you’re a private business, you’ll first need to educate people about what you do. The “trust but verify” aspect will follow, where people want to trust you but need to do their due diligence to verify what you’ve said.

This process of raising awareness and building trust can take several months, sometimes even two or three quarters, before you can actually raise capital. When you go to market in India, you will need at least six months from planning to an IPO. A more realistic figure is nine to 18 months that you’ll need to factor in. So if you’re planning to raise capital, you’re better off starting the process earlier than you think you need to.

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Let’s shift now to the supply side of things. Markets also have windows – there are periods during which the market will open up for raising capital, and periods when the market will close down. These windows are largely driven by macroeconomics, for instance if a certain industry or economy is doing well. As cycles of growth and slowdown affect economies, the availability of capital will grow and decrease concurrently.

So if your business is doing well, you have started early, and if the market is primed for capital availability, you’re in a great position to raise capital.

It boils down to understanding your business, the market, and your strategy. Do you need the money or not? There are some businesses that do so well that they never require capital. But for most businesses, you’ll find that you will require capital through cycles.

The capital you raise doesn’t even need to go to your business per se. Sometimes, you can take advantage of a down cycle. Why not raise capital when the market is uncertain and use it as a war chest to go and acquire other businesses that might be even more adversely affected? With other companies facing their share of headwinds and challenges, an uncertain market can get you good businesses at very reasonable evaluations.

Telling Your Story

An IPO is an important milestone for a company. You’re going from caterpillar to butterfly, and with a lot of eyes on you. If you’re planning an IPO, you should start planning your media strategy at least a year before it happens. A successful IPO actual has a lot to do with the kind of image and perception that your business carries in the public eye. Actually, an IPO is like a product you’re launching for the company. And as with any launch, cleverly managing communications is a key strategy for success.

Whether you’re talking about social media, digital media, print, or even TV, each of these mediums requires a slightly different approach. Figure out your own rules of engagement for each channel.

Let’s look at Twitter. It’s a space where current affairs and topical content fits right in. Is there a particular environmental situation you want to share your company’s view on? Hop on Twitter to share your position or react to it.

Now if you’re writing a longer piece for a business journal, you’ll have to go into the granular details. Explain your business proposition, and anything else your reader needs to understand as clearly and descriptively as possible.

As you can see, these two mediums require very different messaging. From your business’s perspective, how do you leverage on these different platforms available to generate what I like to call “free advertising”?

Ultimately, your goal is to communicate your story to the marketplace without having to pump in a large budget to do so. The sooner you start developing and adapting your communication strategies for each medium, the more seamlessly you’ll be able to take your audience from curiosity to interest to conversion. That’s what business is all about! A lot of this will take trial-and-error as you learn the tools.

Let’s Talk Regulations

Market regulators believe that an IPO is a window for various types of investors, both sophisticated and less sophisticated, to participate in a business by buying stock. Their focus is to make sure that the business is being transparent and disseminating information in a holistic way, such that nobody has an undue advantage. As a business, you have to make sure to comply with the regulations: make price sensitive information, for example, available at the same time to everyone.

Your business will come under great scrutiny, from how your management behaves, to management or board actions. Are you communicating with the market, and at the right time? You need to be prepared to provide information on corporate filings, statutory and independent audit processes, governance structures on the board, and so on. Independent directors are essentially fiduciaries on behalf of public shareholders. Regulations help maintain a healthy system of checks and balances.

On your end, focus on producing reports and business information on a regular basis – this could be monthly or quarterly, depending on the filing cycles. This is something many businesses aren’t initially geared up to do, and therefore end up faltering when they need to produce this information. This is going to cause a lot of problems as a public company.

Over the last three to five years, large pools of private capital have been raised, which can fund 1-2 billion dollar rounds of private fund raising. These pools provide a realistic alternative to raising large amounts of capital in public markets.

However, private capital raising isn’t as liquid or as transparent, especially in terms of the valuations at which capital is being raised. IPOs offer a much more public test of what a business’s actual clearing price is.

As it goes, private market valuations aren’t necessarily fundamental, robust benchmarks of valuation. There are a few players who simply cannot drive private valuations against broader market-based outreach, which happens in a public valuation. I would say public valuations provide a more robust assessment in terms of valuations of businesses.

In the case of Softbank, we saw 20, 50, even 100 billion dollars in private fundraising, which wasn’t an option five years ago. Between them, Sequoia, Andreessen Horowitz, Tiger, Tencent, Naspers, and other large VCs, we’re seeing a new trend. They’re investing in private markets and providing a level of liquidity that we’ve never seen before!

It remains to be seen, however, whether these are sustainable trends. Only when we see funds go through their cycles and perform consistently through the entire fund investment can we make a clear call on how effective they are.

The Digital Disruption

The digital economy allows companies to build markets for their businesses in different ways. If we look at pre-digital companies, the business was built in a linear way. Digital businesses, on the other hand, tend to be non-linear in their growth. They grow by creating the right platforms or products. In terms of scalability, the strategy usually is to look for market domination.

A digital business would need to be number one or number two player in that market. This would allow them to aggregate market share between very few businesses. It is essentially an oligopoly, where a handful of companies cover the entire market. Because these trades are private, and the fact that they’re not required to provide public information and have it audited, there’s a lack of transparency. This makes it difficult to have a clear valuation of these companies.

Of course, we are still in the early days of digital businesses. I believe that in the long term, things will come back to the norm: transparency in business valuation.

With the digital economy, a lot of business models out there have never been tested. When they’re thrown in the line of fire – as with the case of Uber – that’s when the tough questions get asked. In Uber’s case, when they went public, they had to take a risk and claim that they may never be profitable.

If this is a marathon race, we haven’t even covered a tenth of the journey. There’s a lot more work to be done to understand how the private markets and private investors will behave in the long term.

Transparency

Why the lack of transparency in private markets, you may wonder. It boils down to scarcity. There’s a lot of scarcity value in these assets, which in turn drives a lot of the valuations. This scarcity is both in the availability of alternative businesses to invest in, as well as the availability of capital that you can deploy or shares you can buy. In the history of humankind, the moment you create a scarcity of any asset, you will see the price of that asset inflate quite rapidly.

Let’s look at Uber. You couldn’t get into Uber because there were a certain number of investors who owned it. These investors were not willing to trade because they believed that the price of stocks would continue to rise, which created scarcity value in that stock. The moment stock became available, there were a lot of buyers lined up, which in turn drove up the prices. This trend has been playing out in recent times, especially in segments where very few players have been able to demonstrate scalability and growth.

With emerging technology, companies are able to explore business models that are quite non-linear. Where previously you had to go about building your business in a linear way – assets, infrastructure, people – technology has opened up new ways of doing business. Ride-share businesses are a great example of such non-linear business models.

So while there’s massive growth, there’s a lot of volatility for businesses that have raised money in private markets. Only time will tell who they true winners and losers are.

The Way Forward

When you go public, you can potentially get much better valuations than you would as a private business. However, thanks to the digital revolution, private companies are seeing much better valuations than public companies. But this defies fundamental economics.

I sense that this trend will change. A publicly listed company - a liquid asset – should be traded at a higher valuation than a private company – an illiquid asset – which comes with a cost of illiquidity and therefore should be priced at a discount.

Asset valuation models fundamentally tell us that illiquid assets should be priced at a lower valuation than liquid assets. The liquidity of an asset essentially determines the returns that you’re able to generate. If an asset is illiquid, you can’t sell it. You can’t pay the same price for an illiquid asset and an asset that you can sell when you want to. This is called an impact cost, which is higher in private assets as compared to public assets.

In the tech world, this balance is slightly lopsided. But as more tech companies enter public markets, either the private market will start to adjust lower valuations of companies to reflect the illiquidity discount. On the other hand, public valuations might go up to reflect the premium over private companies.

1. Strengthen Your Internal Governance

With an IPO, your company will be scrutinised by the public in various ways. Make sure you’ve prepared your organisation to withstand being in the public glare 24/7.

2. Make a 3-Year Plan

Most investors will want to have an idea of how your business will grow in the next 18 months. In order to provide that, you should plan how your business will build out in the next three to five years.

3. Scope Out Your Alternatives

If going public is going to put your business under undue duress or risk, look at private fund raising. At the end of the day, you should go with the option that better serves your purposes.