Contrary to common perceptions, listing a company on an exchange doesn’t always involve an IPO.
There are alternative types of listing processes that facilitate a company’s shares trading on an official stock exchange.
As you can imagine, each method has its own advantages and disadvantages along with its distinct differences.
No matter what the method of listing is, the underlying transaction remains consistent; you are buying shares from a company privately, and in return you receive a certificate that indicates you have ownership through shareholder equity. You have bought shares in the primary market.
Once the company is public and listed, you are now able to sell your shares or even buy more shares from other shareholders in the form of trading activity on an exchange. This is the secondary market.
Before a company lists on an exchange there are many requirements that need to be met.
Audits, legal fees, company share structure, prospectus, applications…the list goes on.
This process is cumbersome, with constant disclosure that needs to be met in respect to financial reports, news releases, major changes, and more. Not to mention you need to be able to withstand the sentiment of the market itself, which can be unpredictable and impact the valuation of your company. This is often due to investor emotion rather than the intrinsic value of your company itself.
With this in mind, what are some of the different ways a company can list on an exchange, and why should you know about them?
Initial Public Offering (IPO)
The IPO is the most well-known process of going public.
It refers to the process of offering shares of a private company to the general public in a new share issuance. Many private investors see this as a significant early milestone, as this is a liquidity event for those who were early to the opportunity. Due to the riskier, more speculative nature of private early-stage companies, venture investors typically invest in the company at a cheaper valuation. By the time the company is public, there is a greater opportunity to have significant realized capital gains.
However, growth doesn’t stop. Many public investors have the option to invest in private companies just before they debut on an exchange. Private placements often happen at the IPO level, with valuations typically at a slight discount to the market and warrants often included.
The IPO process consists of two parts. The first is the pre-marketing phase, to gauge market demand and underwriter interest. The second is the initial public offering process itself.
Underwriters (often investment banks or merchant banks) lead the process and are chosen by the company. It is common to have more than one underwriter to collaborate. Underwriters take on every aspect of the IPO process, from due diligence, document preparation, filing, marketing, to issuance.
An important part of the IPO is the prospectus. A prospectus is a formal document that is required by exchanges and securities regulators which provides details about a share offering to the public. The prospectus includes a risk assessment, share structure, business model, and other crucial details used to evaluate an offering as an investment decision.
Here is the standard process of an IPO:
- Proposals – Underwriters present proposals, valuations, and share structures to the private company. They suggest the best types of securities to issue (common stock, convertible debentures, etc.), offering price, number of shares to issue, and the anticipated time frame for the offering.
- Underwriter – The company chooses which underwriter’s proposal to go with, and agrees to the terms of the underwriting. Underwriters normally charge fees for raising capital, as well as some form of share distribution.
- Team Assembly – Underwriters, lawyers, certified public accountants (CPA), and capital advisors all band together to form the team to take on the task of bringing the company public.
- Documentation – Companies compile their IPO documentation, comprising of the prospectus and privately held filing information. Info included in this document consists of expected filing date, share structure, business model, management team, and more. The revision process for IPO documentation can be lengthy, with lots of changes and additions.
- Marketing, Marketing, Marketing – Pre-marketing the share issuance to gauge demand and establish a final offering price is key. The company also takes the necessary steps to meet the exchange’s requirements, as well as the securities regulator’s requirements.
- Board of Directors – Companies form an official board of directors and ensure that the processes for reporting audit-ready financial and accounting information is executed quarterly.
- Final Share Issuance – Capital from the primary market issuance is received as cash and indicated on the balance sheet as shareholder’s equity. IPO shareholders receive share certificates that can be deposited into brokerage accounts as shares of the company.
- Post-IPO – Strategies to continue propelling the company don’t stop on the listing date. Underwriters may have a specific time frame to buy shares on the open market. Some shareholders are subject to lock-up periods to trade their shares as well.
IPO Pros & Cons
- Acquisitions become easier if there are any existing share conversions (such as convertible debentures). It is also easier for the company to become an acquisition target, as establishing the value of a public company is a lot more visible and universally accepted.
- Credit borrowing terms become favorable due to the increased transparency that comes with the required quarterly reporting.
- Secondary offerings are relatively easier than initial offerings and can be an efficient way to raise additional capital.
- Stock option plans are a great way to compensate management, executives, and skilled employees, as they are better for all parties. This often allows public companies to retain qualified team members better than private companies.
- IPOs can increase the company’s exposure, public image, and prestige. This often leads to enhanced sales and business awareness.
- IPOs are expensive to facilitate and the ongoing costs, especially those unrelated to the typical costs of doing business, can be substantial.
- Financial, accounting, tax, among other types of information, are required to be disclosed. This may reveal secrets and strategic methods that could be used by competitors.
- There is an inherent risk that required funding will not be raised if the market doesn’t accept the IPO price.
- New shareholders could gain voting rights and control decisions if enough shares are bought and consolidated in the open market. This may chip away at the control that the board of directors has.
- The risk of legal and/or regulatory issues, such as private securities class action lawsuits, and shareholder actions is increased.
- For management that are compensated and evaluated based on stock performance rather than financial results, the unpredictable nature of the market’s ability to alter a company’s share price poses a distraction risk.
Reverse Take Over (RTO)
Not to be confused with a hostile takeover. There is nothing hostile about an RTO.
An RTO, in essence, is simpler and more cost-effective than a traditional IPO. It can also be referred to as a reverse merger or a reverse IPO.
The RTO method involves a private company seeking to go public. A private company merges with an existing company that is listed but does not have active business. This publicly listed company is referred to as the shell company.
Shells can be created in various ways, including Capital Pool Companies, which are facilitated by a TSX Venture Exchange program.
Did you know? Capital Pool Companies (CPC) provide an alternative method for private companies to raise capital and go public. The process involves pooling capital among three or more qualified individuals and incorporating under a shell company prior to completing a qualifying transaction to list on an exchange.
In an RTO, the private company and the shell combine their companies either by a share exchange, amalgamation (when the two parties fully combine assets and liabilities into one new entity, rather than one company “swallowing” another), or a plan of arrangements to form one company, which is referred to as the resulting issuer.
Once the RTO process is finished, the former private shareholders own a majority of the shares in the resulting issuer, which becomes listed on an exchange under the shell’s previous listing. The business of the private company now becomes the business of the resulting issuer.
Here are the standard sequences of process for an RTO:
- Shell – Identify the shell and the target company (the private company), as well as agree on the valuations for each. In addition to helping the private company list, the shell company can bring financing abilities, management expertise, and other benefits. This all comes into play when evaluating a shell.
- Transaction Type – Determine the most desirable legal form of transaction, whether it be a share exchange or an amalgamation, etc. (Sometimes, tax and securities laws will influence this decision.
- Audits – Prepare audited financial statements for the private company.
- Disclosure – Prepare a prospectus-level disclosure, or filing statements for the private, company, public shell, and resulting issuer.
- Application – Apply to the stock exchange for the listing of the resulting issuer. In this part of the process, the exchange reviews the listing statement, as well as the suitability of the proposed board of directors and other insiders to manage a public company. Personal information of all involved will be reviewed.
- Congress – Hold a shareholder meeting to approve the transaction. This step is not always necessary.
- Fundraising – Complete all financings. This may involve financing for the shell, the private company, or both.
- Review – Appease any changes or additions required by the exchange.
- List – Close the transaction and begin trading. The ticker and name are often initially that of the formerly private company.
RTO Pros & Cons
- The transaction is predominantly regulated by an exchange rather than the securities commission (or provincial regulators if you are in Canada).
- The shareholder base that existed prior to the transaction can help with liquidity.
- The resulting issuer is free of the liabilities of representations made in a standard prospectus.
- The shell company’s public markets team can greatly benefit the resulting issuer with future financings, investor relations, continuous disclosure requirements, and expertise on stock exchange policies.
- There can be concerns with the shareholders of the shell company, especially with “rogue” shareholders who may own large blocks of free trading shares.
- The shareholders of the private company may undergo further dilution than with an alternative listing method, depending on the structure of the shell.
- Finding a shell company with a desirable structure can be time-consuming.
Direct Listing by Means of a Non-Offering Prospectus (NOP)
A direct listing is a common process of going public in Canada. It involves a private company listing on an exchange and skipping the underwriting process in which they sell their shares through an underwriter or an agent.
A company proceeding with a NOP still needs to have all the info that would be required in a prospectus readily available. However, no securities are being sold in connection to this “go public” transaction, which is why it is called a “non-offering prospectus.”
The approval for this transaction requires the securities regulators and the applicable exchange to sign off. The securities regulators tend to be the most scrutinous within this application.
An NOP can be a great option when the company already has enough funds to carry out its business plan within the first few years of listing. Companies undergoing a NOP are typically built to do so from the beginning, which means the share structure, number of shareholders, and the minimum public float among other factors, are set up with the intention of making this a seamless process.
The absence of the requirement for sufficient funds and re-structuring are two key aspects to executing a smooth direct listing.
Here are the standard sequences of process for a direct listing via NOP:
- Incorporate – Incorporate the company.
- Capitalization – This step involves planning the capital structure, issuing founders’ shares, vending in the asset/business, and obtaining distribution (ensuring there a sufficient number of shareholders to meet listing requirements.)
- Board – Create a board and management team with capital market experience.
- Audits – Obtain clean, audited statements for the company, and prepare the NOP with “full, true, and plain disclosure.”
- Apply – Prepare the listing application documentation to submit to the exchange. This includes personal information forms for insiders. (No criminal records!)
- Regulatory Review – This stage tends to involve lots of back and forth between the exchange and securities regulators. Once this is cleared, the hard parts are over.
- Receipt – The NOP receives a final receipt, and the company officially becomes a reporting issuer.
- Criteria – The chosen exchange will provide listing criteria based on the type of issuer. The final step is to satisfy this.
NOP Pros & Cons
- The overall cost of a NOP may be less than an RTO, as the NOP process does not require the acquisition of a shell company.
- Due to the absence of acquiring a new shell, time is saved by not having to perform the thorough due diligence required when taking over a shell company.
- This process does not dilute the existing shareholder base.
- Due to the absence of a required shareholder meeting, this timeline and process can be quicker than an RTO most of the time.
- The securities regulators are doing the bulk of the reviewing, and they are rather scrutinous.
- A company undergoing a NOP still carries liabilities for representations made in a standard prospectus.
- The company must raise the funds necessary for the company’s operations as well as achieve the required amount of distribution, all through private placements.
Although fundraising and regulatory review can be time-consuming, the NOP process is often completed within the span of 6-months if everyone involved has their ducks in a row.
Knowing which process that a private placement is undergoing can help with your understanding and expectations as you’re waiting for your investment to reach the markets. A company listing on the public exchange is a wonderful event… in theory. However, there are plenty of ins and outs that occur throughout the entire process. The more you know, the better you feel as you anxiously await to see your shares trade on a public exchange.