9 minute read | November.30.2023
Orrick's Founder Series offers monthly top tips for UK startups on key considerations at each stage of their lifecycle, from incorporating a company through to possible exit strategies. The Series is written by members of our market-leading London Technology Companies Group (TCG), with contributions from other practice members. Our Band 1 ranked London TCG team closed over 320 growth financings and tech M&A deals totalling U.S. $9.76bn in 2022 and has dominated the European venture capital tech market for 31 consecutive quarters (PitchBook, Q3 2023). View previous series instalments here.
Taking your company public can be exciting and rewarding for a founder. An IPO is not for everyone and can be fraught with risk, including from market conditions. It’s also not unusual to run an IPO process in parallel with a sale process. Preparation is everything and there are a number of key issues to decide upon early. An IPO process usually takes 6 – 12 months, but preparing for it can take a number of years. A clear strategy and careful planning with advisers can lead to a better, more profitable and tax-efficient outcome. In the seventeenth instalment of Orrick’s Founder Series, we offer top tips to help UK startups build to an exit and manage an IPO process. You can read part one on managing an M&A process here.
1. Establish a roadmap. Key to any decision to pursue an IPO should be the liquidity objectives of company shareholders and market conditions. As with an M&A exit, you should be attuned to the dynamics of the company’s cap table (in terms of the “waterfall” and the motivations of your early and later-stage investors) and track IPO activity in your sub-sector. Consider which markets might be most receptive to your company’s sector and potential. For example, consider whether you are likely to be best suited to the U.S. markets, particularly NASDAQ, or whether one of the UK markets might be a better choice, even as a stepping-stone to the U.S. at a later date. Also, carefully consider the objectives of your key shareholders. For example, investment reliefs such as EIS and VCT relief are preserved for companies which choose to list on designated growth markets such as AIM; they may be lost if you choose to go to NASDAQ or the Main Market of the LSE (because these are known as “regulated markets”). Would having listed equity be a key driver to hiring and retaining the management team and employees that you need to drive growth?
2. Assemble an advisory team. Hiring good advisers well before embarking on an IPO process is critical. Engaging with them early will help you secure maximum value and a smooth and less disruptive process. Don’t underestimate the time management will need to invest in the process and the number of meetings that may be required over concentrated time frames. You will need dedicated support internally and externally. How much of your stake do you want to release at IPO? The goal posts often move and you may therefore want to engage an adviser to deal with this issue separately.
3. Focus on the financials. To list on almost any market, you will need financial statements audited to UK IFRS. If you elect to follow the path for a U.S. listing, you will need to produce financial statements to IFRS or U.S. GAAP and have those statements audited to the standards of United States Public Company Accounting Oversight Board (PCAOB), which is a private-sector, non-profit corporation created by the Sarbanes-Oxley Act of 2002. The board oversees the auditors of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, fair, financial disclosure. The key difference between GAAP and IFRS is that GAAP is based on legal authority, while IFRS is based on a principles-based approach. GAAP is more detailed and prescriptive while IFRS is more high-level and flexible. GAAP requires more disclosures, while IFRS requires fewer disclosures. Re-auditing to IFRS and restating to PCAOB (if needed) can take substantial time and resources and is frequently a gating time item in an IPO process. It is therefore never too early to start this process.
4. Get your ducks in a row (intellectual property). As with an M&A exit, expect every aspect of your business to be subject to detailed diligence. Identify gaps and weaknesses as early as possible. The bankers will appoint counsel to conduct diligence and will often appoint specialist counsel to review the intellectual property (IP) of any IP-rich business. Any uncertainty around IP ownership or deficiencies in the protection of IP rights can delay or derail a transaction or result in a much lower valuation. Undertake a review to identify areas of concern. Have employees and contractors properly assigned IP rights to the company? Do you have contracts for material IP used by third parties? Depending on your sector, a “freedom to operate” study may be prudent. For more on this, please see our fourth instalment on Protecting Your Ideas.
5. Get your ducks in a row (commercial contracts and compliance). Again, as with an M&A exit, your key commercial relationships will also be central to your value proposition, and you should expect bankers to undertake “customer referencing” as part of their due diligence. Whilst an IPO is not an outright sale, the process may involve introducing a new ultimate holding company (if, for instance, you decide to “flip” into a Delaware entity for a U.S. IPO), so check all of your key contracts for any “change of control” provisions that might allow counterparties to terminate their relationship with you, which might be triggered by a pre-IPO reorganisation. Any public company is expected to conduct its business to the highest ethical standards; if you do not do so already, you will be expected to have a significant number of compliance policies governing the business and covering everything from data protection and privacy to anti-bribery and corruption, gifts and hospitality.
6. Get your ducks in a row (group operations and structure). You may need to uncouple certain operations or assets from the core business to ensure a potential buyer receives a “clean” operation following the closing or, as explained above, you may decide to “flip” into a Delaware entity for a U.S. IPO or perform some other form of corporate reorganisation. This is always best planned well in advance as it may have knock-on effects for the preparation of financial statements and you may need to seek specific tax advice.
7. Prepare a data room. As soon as an IPO opportunity becomes realistic, or even before, begin compiling a “data room” of financial, commercial and legal information for potential bankers. Ask advisers to carry out a ‘health check’ to identify gaps and shore up weaknesses. For UK startups, our UK Startup Health Check can help identify some of these vulnerabilities and offer solutions as early as possible in the process. When the time comes, your lawyers will also advise you on making information available to a prospective buyer.
8. Consider your board structure. It is never too early to start considering the optimal make-up of your board. You will need some independent non-executive directors. What classifies directors as independent varies from market to market. In the U.S. it is not unusual for non-executive directors to be the recipients of share incentives; in the UK this completely compromises “independence.” Whichever market you are looking at it is essential to have a non-executive director with appropriate accounting qualifications to chair the audit committee. Are any of your key investors minded to take or retain board representation or observer rights? This has implications not only for the size of the board but also for classification of their status as “independent”. Will the market wish to see your chief financial officer on the board or will it be satisfied with a CFO reporting to the board?
9. Do you want to retain control? The concept of “weighted” voting rights for certain shareholders in public companies, usually founders wishing to retain ultimate control over the strategic direction of the company, has had a colourful history. It started in the U.S. and the concept has been imported into the UK. Carefully consider the way it might be received by the market; will it damage potential valuation? Also consider how long it should enure (known as the “sunset” provisions): Will it have other regulatory or tax implications?
10. Take advantage of “lite” reporting in the U.S. Non-U.S. companies listing in the U.S. are known as “foreign private issuers” or “FPIs”. FPIs can take advantage of several dispensations from full Sarbanes-Oxley reporting, in favour of local governance and reporting regimes. These exemptions can lower the regulatory burden. For example, having a twice yearly financial reporting regime as opposed to quarterly reporting. However, exercise caution when considering availing yourself of the exemptions as investors often compare companies to a peer group and being out of line with your peers can therefore have negative consequences on your share price or even prevent certain investors from investing (where they consider your taking of exemptions to be a material impediment to full disclosure and transparency, hence worsening your risk profile).
Our London Capital Markets team understand the listing requirements for the key UK markets and how to list on a U.S. market. As a result of being involved in a large number listings of UK companies on NASDAQ and the NYSE they are ideally placed to help you navigate the process. If you would like to discuss your options or plans, please contact Ed Lukins or Ed Dyson.