Georges van Erck is Managing Director at JPMorgan, London. He has more than 30 years of investment banking experience, most of which have been spent providing corporate finance services to family-owned companies.
At a time when banks are increasingly cautious about lending money, the stock market can be an attractive alternative source of capital for a family business – and, explains Georges van Erck, an IPO need not mean the family loses control of the business
Why would anyone want to give up owning and managing a family business to become the hired hand of fickle and volatile financial markets? This has long been a legitimate question, but one that has particular resonance in 2003.
To IPO or not IPO? That is the question
Companies that have only recently been criticised for failing to adapt business models to new technologies are today being punished for having invested in areas that do not deliver an immediate cash return. Three years ago, payment of a dividend was seen as a failure of management creativity; now it is the sine qua non of a successful enterprise. To that can be added the sheer quantity of time and resources required for investor and analyst meetings, corporate public relations and maintaining compliance with forever-changing regulatory requirements. Taken together, these factors must give family business owners pause and may well make them "rather bear those ills [they] have than fly to others [they] know not of". But would you really have to be madder than the Danish prince to want to bring your company to market?
An attractive source of finance
Any business that requires capital beyond its current cash-generating ability will need to access external finance or risk destroying value. Banks are increasingly cautious about lending money in situations where they perceive they are taking equity risk for low returns and often refuse to lend money for development or restructuring projects. Private equity and venture capital firms are currently flush with funds but are expensive, expecting a 20-25% per annum return on investment and often requiring board representation, a degree of control over important strategic decisions and the right to force an exit. By contrast, though it has risen steeply in the last few years, the cost of public equity remains relatively inexpensive at 10.1% (JPMorgan estimate, February 2003). In aggregate, the total capitalisation of the world's public equity markets is approximately US$13 trillion (Source: JPMorgan, Bloomberg), representing an unparalleled pool of investment capital.
An IPO adds value
An IPO, or initial public offering, can help protect – and even increase – the value of a family's investment. By nature, public companies have higher profiles than their private counterparts, which helps to build brands and strengthen market positions. Taken together with the incentives of share schemes and stock option programmes, this can help to attract and retain better managers. Indeed the whole process of an IPO – the rigorous due diligence process, the preparation and execution of an attractive investment thesis or 'equity story' – can often add value.
Helps diversify exposure
An important issue for all family business owners is the risk that arises from their concentrated exposure to a single company, normally operating in a single industry and often in a single geographic market. In most cases, the long-term objective for a family should be to diversify that risk. If, after analysis of the company's situation and market position, the family's interests are best served by selling out of the company altogether, then an outright sale to a strategic or private equity buyer is likely to be the best route to maximising value. If the family wishes to remain involved in the business, however, or if the value of the business could be enhanced by an injection of capital, or if there is no suitable buyer, then an IPO offers a number of attractions over the alternatives.
Smoothes the path to future liquidity
Following an IPO, the public holding (free float) provides a transparent valuation of the company as a whole, which can be used as the basis for future fundraising or for negotiation of a subsequent sale. By contrast, selling a minority stake to a strategic buyer may make subsequent conversations with other players more difficult. Furthermore, at any particular time, potential strategic buyers may have issues of financing or of their own strategy that might prevent a bid at a fair price. For many businesses, there may not even be a suitable strategic buyer. An IPO, on the other hand, provides access to liquidity at times which, subject to market conditions, are at the discretion of the owner.
No loss of control
Perhaps the key attraction of an IPO is that it does not require the family to lose control. A party with about 40% of the voting rights can, de facto, control a public company. (If the issue goes well, then the public portion will most often be widely held and unlikely to vote as a block.) Family owners may, however, feel more comfortable with the de jure control provided by a majority of the voting rights. In many jurisdictions, structures such as multiple boards, tiered classes of shares, company bylaws and multiple voting rights can be used to maintain voting control with a minority holding. Whilst care is required to maintain the confidence of institutional shareholders, market professionals tend to understand that this is an area of sensitivity for families and may be a condition of bringing the company to market. As a result, many families continue to play a leading and successful role in the management of their companies (eg, Daily Mail and General Trust in the UK; Bouygues, Peugeot, and Michelin in France; Fiat in Italy).
The IPO process
The cornerstone of a successful IPO is a strong business, characterised by leading market positions, intrinsic profitability, a strategy for continued growth and quality management committed to executing that strategy. But market success is also very much dependent on a set of extraneous factors such as good timing (finding the right market window) and meticulous execution both in the planning and in the marketing of the transaction.
It is the function of the investment banks (usually two) who are leading the transaction (the underwriting banks) to manage these extraneous factors and to use their experience and market intelligence to advise the shareholders on the key decisions required with regard to timing and pricing.
In the planning phase the business is groomed for the market. A business plan is established with targets for earnings and dividends; underperforming units are restructured, disposed of, or excluded from the IPO perimeter; and gaps or weaknesses in strategy are addressed by selective acquisitions or strengthening of management teams. At the same time, accountants prepare a track record of historic financial performance and lawyers draft and verify the Prospectus.
Marketing of the issue falls into three areas:
- Media: The company and its advisors endeavour to create a 'halo effect' before the IPO by carefully sequencing newsflow and interviews in various media. The goal is to elevate the company's profile, strengthen its brand and raise overall awareness.
- Equity research: Equity research analysts will meet with senior management and prepare reports based on their independent view of the business, its prospects and valuation. These reports will then be presented to investors who will form their own judgments on the company's equity story, its attractions and weaknesses, and its valuation relative to peers. Based on initial investor feedback and the current trading prices of comparable companies, the company will then agree with the underwriting banks a price range (width is usually 15%) at which the shares will be offered to investors. This marks the beginning of the public phase of the process; the price range is published and the 'books' are opened to receive investors' orders.
- Management roadshow: Key members of the company's management team will take to the road – or to the skies for an international offering – to meet with selected investors in person to explain the business, its prospects and their plans. Investors have an opportunity to ask questions and to evaluate the management team. This is an extremely demanding period for management, entailing between five and ten meetings per day, in a different city every day for at least two weeks. For example, during the IPO roadshow of Oberthur Card Systems (a family-owned 'smart card' business brought to market by JPMorgan in 2000), management met with around 150 investors in more than 10 different cities in two weeks.
During the roadshow, the underwriting banks accumulate orders from investors (mostly institutional investors such as large fund managers and, to a much lesser extent, retail investors) who wish to participate in the offering within the stated valuation range. At the end of the roadshow, the book of orders 'closes' and a price is set at which the offering is comfortably filled. Stock is allocated to those investors who have placed orders at or above that price. An announcement is made to the market and, within a few days, the company's shares begin to trade.
Timing and timeframe
The whole process usually takes about six months. In exceptional circumstances it can be achieved in half that time but more often it will stretch over a longer period. The overall timeframe of an IPO is often dictated by the level of preparation of the company, but the availability of a launch window is also a function of market conditions. Even the best companies need a favourable market in order to list!
Investors, concerned that the inherent volatility of the equity markets might cause them to face an immediate loss on their investment, will insist that the deal be priced at a discount to comparable trading companies. In difficult markets, such as those we have seen recently, that discount widens out beyond the level at which the owners are prepared to sell. Conversely, when stocks are rising, investors will compete to get hold of shares from exciting IPO candidates; in these circumstances the IPO discount narrows considerably.
Family-owned companies need to pick the right moment to come to market. Timing is optimal when investors are looking favourably on the sector in which the company operates and upon new issues more generally. Investors tend to overreact on the upside as well as the down and a patient family can take advantage of this behaviour.
For the company's management team, including any members of the founding family who remain in management, the story is just beginning. From the run-up to the IPO onwards, all their decisions will be exposed to public scrutiny and their successes and failures will be discussed in the press and in analyst reports. They will have to publish financial statements not just annually but at least twice a year and, in some countries (the US and Germany, for example), four times a year. Investors will expect access to the CEO, CFO and to the head of any major division. Satisfying their demands for information and access will require a full-time employee (head of investor relations).
Will it be worth all the trouble? Only time will tell, but when a stock-market listing enables the company to make a strategically vital acquisition or to raise new finance for a crucial investment programme, the question of whether to IPO or not to IPO will have been answered.
Outlook and conclusions
Due to increased market volatility, there have been fewer IPOs executed in recent years. Volumes in Europe have decreased from €94 billion in 2000 to €13 billion in 2002 (Source: JPMorgan). Activity is expected to resume, however, once market conditions stabilise. Investors are currently cash-rich, and the equity markets remain an extremely attractive source of financing.
In summary, an IPO is a long, demanding and complex process, and represents a substantial ongoing commitment. As such, it should not be undertaken lightly and, once commenced, needs to be seen through with creativity, flexibility and single-minded determination. In return, an IPO can provide access to the world's deepest market of liquidity for re-financing and diversification, a market which can be accessed without losing control over the business. For businesses where an IPO makes sense, now would be a good time to start planning ahead of a future market rally.