Up until recently, the initial public offering (IPO) market has been dormant, which has hindered companies like Crowdcube, Lufax, Uber, Airbnb and Lyft from going public until market conditions improve. Analysts continue to call attention to the fact that 2016 has been the slowest for IPOs since the recession of 2009, which has soured IPO investor sentiment and dried up capital raising streams through traditional funding sources such as private equity firms.
There's not all bad news in the IPO market. In late May, six companies started trading on U.S. exchanges, making it the busiest month on record for IPO activity since October 2015, breathing a little life into the otherwise flat public offering market. This flurry of activity aside, the IPO market's tepid start to the year has been so widely publicized that investors remain spooked about funding start-up companies that lack a strong balance sheet and a lengthy history of steady revenue and profits.
So what are companies that are still looking to raise funds in order to list on a U.S. exchange to do? Not to worry, there are three alternative options that CEOs can consider if they are looking to raise capital in the current turbulent economic landscape: private investment in public equity (PIPE), reverse merger and partnering with a major corporation or merging with a well-known entity. By utilizing one of these three alternatives, companies can increase their valuation and prepare for a corporate listing.
Overview of IPO Market Activity in 2016. Before diving deeper into alternative capital raising sources, let's take a closer look at the IPO activity to date this year in order to get a clear picture of what might be ahead as we enter into the second half of 2016.
Market fundamentals have been volatile in 2016, but signs of improvement have recently begun to appear, with the Nasdaq up more than 5 percent over the past three months. Additionally, May has woken up the sleepy IPO market, with six companies going public, bringing the total number of companies that have hit the public market in the second quarter of 2016 to 25. Among these companies to recently list on U.S. exchanges include US Foods (USFD), Gypsum Management and Supply (GMS) and Cotiviti Holdings (COTV). The US Foods IPO is the largest company by revenue to go public since October 2013, indicating an increase in investor optimism, a trend that is expected to continue into June.
Although the increase in IPO activity points to a resurgence in overall performance down the line, the lackluster deal flow to date is weak compared to that recorded in previous years. For example, there have been 41 companies to go public this year, as compared to 82 that were completed during the same timeframe in 2015. Still, experts believe that June will be the month that breaks open the IPO space, as approximately a dozen companies are waiting until then to IPO as market fundamentals continue to swing upward.
Financing Options in Weak IPO Market. While conditions are improving, many investors remain hesitant to invest in an IPO because 77 percent of those companies that went public in 2015 have stock prices that are currently lower than their IPO price, with the average return on IPO stocks in 2015 ringing in at only 2 percent. For those CEOs who remain interested in sourcing capital to list on a U.S. exchange, there are the following three options to consider:
- Private investment in public equity (PIPE). The use of PIPE deals slowed during the financial crisis, but have recently gained some steam as an alternative method of raising capital quickly and efficiently. PIPEs, which is a private placement into a newly public company, are available to retail or institutional investors and they help the company make the listing standards required by an exchange. As an example, Plains All American Pipeline LP, a midstream energy infrastructure company, raised $1.5 billion through a private placement of preferred stock that pays an 8 percent annual yield. These units are convertible into common stock after two years, which provides liquidity for investors, but shares are usually offered at a deep discount and at times harsh terms can be imposed by purchasers. These over-the-counter public offerings are great tools to help finance public companies.
- Reverse Mergers. In this alternative option to a traditional IPO, a company takes over another company whose business is already listed on a U.S. exchange. The benefits of this option are significant cost savings, as the IPO process requires upfront costs totaling approximately $1 million. And, it is much quicker than the traditional IPO process, taking as little as 30 days to complete versus a year or more that is involved when a company IPOs. One famous example of this method is Warren Buffet's Berkshire Hathaway company, which began as a textile business and eventually merged with Buffet's private insurance corporation. While the benefits of this option are clear, there are some challenges to be aware of if this is something your company is considering. First, given that you are merging with another company, you will be assuming all of that business's liability and debt, so do your due diligence in vetting the prospective company with which you intend to merge. Next, merging too quickly might sound appealing but you need to be sure that your company will meet all of the requirements imposed upon public companies, which can incur significant costs. Finally, the SEC imposed more stringent regulations for companies looking to pursue this option, which now requires a company to go through a one-year "seasoning period" in which they must trade over the counter while filing audited financial statements unless the deal includes an underwritten offering of at least $40 million.
- Partnering with a large company or considering M&A. If your company is looking for immediate access to cash, there is always the option of partnering with a larger corporation or merging with an existing company in order to raise capital quickly. Life sciences companies use the partnership method frequently, selling potential revenue streams from early-stage pharmaceutical drugs to seasoned companies in exchange for upfront money to bring the drug to market. With the M&A option, companies can pursue this option alongside filing for an IPO in order to see which yields more cash. This method ensures that you will get some form of capital raise, and given the due diligence required for a merger or acquisition, you will know exactly what you are getting.
Of course when making any investment decision, it is important to understand what your options are and to ensure that each and every opportunity is vetted thoroughly. While the above alternatives might work for some companies, they are complex investment vehicles and seeking the guidance of an attorney and financial advisor is recommended.