London listings: Time to revisit the traditional IPO?
Locations
After the temporary paralysis caused by the Covid-19 lockdown, new issues and IPO activity on the UK's public equity markets began to show signs of recovery entering the final quarter of 2020.
According to London Stock Exchange figures, excluding secondary listings, sixteen companies completed IPOs in London in the first nine months of this year (nine on the Main Market and seven on AIM), down from 26 in the same period in 2019 (which was hardly a bumper year).
However, a clutch of intention to float announcements in September – from businesses ranging from fintechs, to e-sports to mining companies – suggested there would be a late dash for public markets before the end of 2020.
A further seven companies completed IPOs in October (four on the Main Market and three on AIM).
But while London's capital markets cautiously congratulate themselves for being more or less back to "business as usual", some recent floats in the US and the UK have reignited the debate about the merits and missteps of taking the "traditional" IPO route.
Direct listings
In the US, Palantir, a data analytics company, made its debut on the New York Stock Exchange in September 2020 via a direct listing in which no new shares in the company were created or sold, and is the latest mascot for the "direct" IPO.
One of the main criticisms of traditional IPOs is that the process is designed to benefit the interests of underwriters and investors who buy shares prior to the IPO ahead of those of the company going public.
Other complaints about traditional floats focus on cost, cumbersome processes and alleged under-pricing by sponsoring banks – most of which can be sidestepped by listing directly and not selling shares to raise capital.
As previously observed, direct listings work well for companies that do not need to raise money at the time of their IPOs. However, for small and growth companies, accessing new equity capital tends to be a key motive for seeking a public listing in the first place.
Direct listings are also appealing if a business is well known to, or easily understood by, retail investors, meaning there is less need to spend time and money on investor roadshows – as shown by Spotify's direct NYSE listing in 2018.
For companies in new or specialist sectors, there is still a need for brokers and investment banks, whose contacts with fund managers and institutional investors are often essential for securing opportunities to explain the business model and raising the funding they need.
Although much talked about, to date, direct listings have not taken hold – in the US or the UK.
However, pressure is mounting on the London Stock Exchange and banks to take heed from this model and make the traditional IPO more attractive.
On 19 November 2020, HM Treasury published a call for evidence in relation to a review of the UK listing regime.
Jonathan Hill, Baron Hill of Oareford, who is leading the review, said stakeholders' views will be used to propose reforms to the UK listing regime that will attract firms and help companies to access finance.
HM Treasury said it intends to use the opportunity created by Brexit "to tailor requirements more precisely to the needs of companies, investors and markets." The call for evidence closes on 5 January 2021.
Alternative share structures
The suspicious approach UK regulators currently take towards share structures that give company founders a say in key decisions post-IPO, without requiring them to hold a majority stake, is perceived to be a drag on the competitiveness of the London markets, compared to the US.
The London IPO in September 2020 of Manchester-based e-commerce company, The Hut Group, created a stir because the company retained a "founder share" (also known as "golden share") structure, giving its founder, Matt Moulding, the ability to veto a hostile takeover outright.
The Hut Group also had an unusual incentive scheme that will raise Moulding's stake in the company from 20% at IPO to 25.1% — enough to block a takeover and delisting — if its market value increases by 40% in the two years post-IPO.
In addition, by holding the roles of both chief executive and executive chairman – a position common in the US but frowned on by the UK Corporate Governance Code – Moulding retains sweeping powers over the business.
Moulding said he opted for a UK listing, even though the US market was more accommodating of capital structures that give founders enhanced voting power at the expense of other shareholders – and intimated he had negotiated these protections in return for not taking The Hut Group across the Atlantic.
The price The Hut Group paid for these concessions was a “standard” rather than “premium” UK listing, meaning the (as of mid-November 2020) £6.4 billion company cannot be included in FTSE indices and its shares will not be bought by tracker funds.
Moulding's founder share will also expire after three years – less time that protections afforded to this class of stock in the US.
While there is solid regulatory justification for treating companies with such structures in this way, it remains the case that founders of promising companies who want to retain sway over their businesses post-IPO, have reasons to consider a US listing, ahead of London.
SPACs
Special purpose acquisition vehicles (SPACs) where founders raise money through a listing and then find a business to buy within a set period, have been popular alternatives to traditional UK IPOs in the past, and are currently booming in the US.
The "benefits" of SPACs are that they do not have to comply with the tougher listing rules that apply to traditional floats and the founders get to keep a greater share of the rewards, rather than paying significant shares of the IPO proceeds to banks.
Anecdotal evidence suggests that many privately held companies that explored traditional IPOs were put off by the strict requirements of the Financial Conduct Authority (FCA) and adviser fees, and either opted to stay as they were or looked to private equity or SPACs.
SPACs have fallen from favour in the UK in recent years. There are a combination of reasons for this, not least the tightening of the IPO market as a result of uncertain economic conditions due to Brexit and Covid-19.
Another contributing factor may have been the FCA's decision to exclude cash shells and SPACs from its position of removing, as of July 2018, the presumption of suspension where there is a reverse takeover.
The reason for this decision, according to an FCA technical note published in January 2018 entitled Cash shells and special purpose acquisition companies (UKLA/TN/420.2), was that the FCA had observed "a significant increase in the number of SPACs with very small market capitalisations joining the standard segment and (…) a lot of volatility and price spikes in those companies around the time of a proposed transaction".
It distinguished this trend from earlier incarnations of SPACs, where these vehicles were usually led or backed by high-profile entrepreneurs or promoters and raised significant amounts of capital.
As things stand, when a UK SPAC buys a company, the transaction is classed as a reverse takeover and the SPAC’s shares are suspended and trading cannot resume until a deal prospectus is published, for which there is no deadline.
Several UK SPACs that listed in 2017 remain suspended, locking investors' money up indefinitely.
The US, meanwhile has maintained a relatively relaxed approached to SPACs – a position some feel should be emulated in the UK.
However, in September 2020, the Securities and Exchange Commission (SEC) indicated that it plans to enhance disclosure and transparency requirements for SPACs, following regulatory concerns over recent fundraisings.
What next for UK IPOs?
At a time of considerable uncertainty for UK equity markets, alternative routes to market that make it easier for companies to list and for investors to invest, without compromising regulatory scrutiny and public trust, are welcome.
But while alternatives are appealing, the possibility of a new approach to traditional IPOs should not be discounted – especially pending the outcome of HM Treasury's UK Listings Review.
The Covid-19 pandemic has shown early signs of delivering a new crop of promising British businesses looking for ways to grow. Meanwhile, the depth, quality and sophistication of the UK capital markets continue to compel quality companies to seek London listings.
So while there is room for improvement, traditional IPOs still have a role to play in bringing good businesses to market in the UK.
Brad Isaac is a partner in the equity capital markets team at Fieldfisher. He advises on a range of corporate finance transactions including pre-IPO and secondary fundraisings, flotations and public company takeovers, with particular experience in the natural resources sector.
