It may seem counter-intuitive, but here’s why you need to start preparing for the end of the IPO drought in the next nine to twelve months, and some steps on how to do it...
As surely as the markets move in cycles, the current IPO drought will make way for a return of capital, and companies looking to list publicly need to be ready, in order to take full advantage of the bullish market conditions that will come.
The current drought was preceded by a time when interest rates were near-zero and central banks generously exercised quantitative easing, thereby helping companies – even loss makers – to list at lofty valuations. Then inflation reared, prompting central banks to reverse their stance at the start of 2022, which triggered sharp falls in stocks. That made investors cautious on new listings, which led to a sharp fall in IPO activity. This year began with that backdrop.
The good news is that this drought is likely to end in the next nine to 12 months, and it will begin with the public markets. The US interest cycle is close to peaking and private companies also are adjusting their business models to start generating profits again – an important milestone to elicit investor interest in the current market environment.
Nine to 12 months may seem like some time away, but a public listing requires detailed preparation, including planning out the investor communications strategy. Early preparation is key. Here are six milestones to start working on:
- Start early – It is important for companies to start building their narrative early, even if their listing plans are some time away. The Securities and Exchange Board of India’s (SEBI) disclosure requirements for a company preparing to list come into force from the day of the kick-off meeting. That is the first meeting with all external parties, including banks, law firms and auditors involved in the listing. These disclosure requirements remain until share allotment and apply to companies’ public communications, publicity materials and advertisements, among other items. While the requirements do not restrict regular business communications, they apply to anything beyond the ordinary course of business.
- Increase communication for visibility and transparency – It Private companies tend to undertake lesser external communications in comparison to their listed peers. There is, therefore, a need to increase frequency of this to enhance their visibility, especially in front of investors, helping improve their comfort with and confidence in the company at the time of IPO. Besides, companies that are perceived to be transparent tend to perform better from a stock price perspective over longer periods of time.
- Train and increase visibility of top management – The company should identify a few of their top management personnel and start building their public profiles. This would give investors’ confidence in the management’s depth and is important to ensure the company doesn’t come across as a single-person business – an issue experienced by companies in the technology sector that listed in India over the past two years. Interaction with the investor community is generally handled by the Chief Financial Officer with support from the investor relations team, but for new listings, the Chief Executive Officer is important too, as investors are trying to gauge the management team’s ability as much as the business model itself.
- Simplify business structure – It is important that investors easily understand the business model and its key value drivers – such as industry size and opportunity, revenue build-up, fixed and variable costs, and unit economics. Note that public market investors can only rely on the information provided in the prospectus. Therefore, there is a risk of investors undervaluing a great but complicated business if they aren’t able to properly understand its key drivers.
- Path to profitability – Investor perception on how to value businesses has now changed due to central banks tightening liquidity conditions. This has led to investors no longer willing to just pay for top-line growth or market opportunity. Instead, they are keen to understand the path to profitability. Should the company choose to go beyond qualitative factors and provide some time frame to achieve this profitability or growth target, care should be taken to ensure the guidance remains consistent in future communications and that the claims made are delivered on. This cannot be emphasized enough: companies shouldn’t come under pressure to provide any guidance they won’t be able to fulfil later.
- Build an ESG profile – Environmental, Social and Governance (ESG) standards have become an essential element for socially conscious investors, who seek out funds that align with their values. Globally, multiple studies have shown the benefits of ESG for a company’s financial performance and valuation multiple. This is due to active funds increasingly having an ESG variable in their investing thesis, the advent of ESG-focused funds, and companies such as MSCI having multiple indices focused on ESG, where a company’s inclusion would lead to an automatic purchase of its stock by passive funds who track these indices. Therefore, building up your ESG profile is important in order to be considered and actively selected by investors who are searching for these opportunities.
While these six considerations may risk making the listing process appear cumbersome, they actually form the foundational work that streamlines the internal processes, builds discipline and sharpens the focus on key business drivers, ultimately building stronger investor confidence and therefore, IPO performance. This arduous process has a huge pay-off: at the end of the day, it unlocks the much-needed capital for growth for companies that list publicly. Therefore, if you are looking to go public in the next nine to 12 months, begin the process now.
Gaurav Malhotra, EVP, Asia Pacific at Edelman Smithfield