IPOs of VC-funded companies

At the end of an investment in a VC-financed company, the best-case scenario is a successful exit. In addition to a trade sale, an IPO is a common option. It is often said that an IPO is complex, expensive and time-consuming. Practice often shows that there are no significant differences here. In particular, there are possible alternative ways to make IPOs somewhat leaner. The traditional IPO is only one of several ways to go public. It should not be underestimated that the IPO can also have significant advantages.

Advantages of going public

1. Routes to the stock exchange 

Preparation of an IPO raises the question, which listing venue and which Going-Public-structure to use. Both questions are interlinked and relate in particular to timing. Time and again, there is a combination of several of the following options.

Traditionally, German companies use the Frankfurt Stock Exchange für an IPO. The options available there are the highly regulated Prime Standard and the less heavily regulated Scale segment (part of the unregulated market), which is also attractive for IPOs. The following table provides an overview of the main differences between the two options:

There is also the NASDAQ in the USA as an option. It can yield higher valuations and broader investor access compared to an IPO in Europe. On the other hand, this route is not open to every company. Typically, this is an option for tech companies or companies from other sectors that are currently very popular on the capital market and provided those companies are large enough to attract the attention of international investors. The downside is the complex and costly regulations of the US capital market and the permanent cost burden of two regimes (German law for the company and its operating business and US capital market law). Many large German companies have terminated their dual listing on the NASDAQ after some time, as it became apparent that international investors can also be attracted with a listing in Germany, or that the benefit-cost ratio does not pay off in the long term. It will always be a question of the individual case whether an IPO on NASDAQ is an interesting option for a German company in exceptional cases. 

Finally, there are also alternative stock exchanges that could be considered. One option could be the regional stock exchanges, particularly in Dusseldorf and Munich, with their offerings (more on those possibilities, which are exciting, below). Other European stock exchanges may also be an option. For some time now, Scandinavia has been attracting many German companies with so-called Nordic bonds on the debt capital side. The Scandinavian capital market is currently often considered by German companies, particularly by small and mid-caps, and the uniform EU capital market regime means that the cost of a listing abroad is significantly lower than in the USA. The Scandinavian IPO market is also being discussed as an option. This market is currently open to companies from Scandinavia and is also repeatedly discussed as a dual listing or primary market for German IPOs. However, there is as yet no reference experience beyond individual cases.

2. Routes to the stock exchange 

The classic route for an IPO is the traditional IPO. This means that a prospectus-based public offering of the company's shares is made, typically over a period of two weeks, followed by a listing on the selected stock exchange if the offering is sufficiently successful. 
However, there are also alternative routes to the stock exchange that may be of interest. 

a) Technical listing

The first alternative route to the stock exchange is the so-called technical listing. The traditional IPO consists of two elements, namely the placement of shares and then the listing. With a technical listing, the first step is omitted or the order is reversed. In this case, there is (only) a listing without a public offer of shares. This shows directly when this may come into consideration: Only if the company either raises capital in advance (for example by way of a private placement) or plans to do so subsequently, for example in the next twelve months, or currently has no financing requirements at all this can be an option.

There are several use cases for this purely technical listing, as practice shows. On the one hand, these can be companies that want to use the capital market or the capital market listing to open doors in their business operations with their profile as a listed company. If you are a young German company, in America or Asia, for example, the decisive first step can be made easier if potential business partners see that you are a listed company that can be found via the relevant websites and publications.

Another key point also applies to the alternative routes to the stock exchange described below, namely the volatility and receptiveness of the market. Since the financial crisis, the market for IPOs in Germany and Europe as a whole has proved to be very volatile and challenging. Windows, in which investors are prepared to accept the valuation expectations of companies and their shareholders often open briefly and then close again. In comparison, the classic IPO is cumbersome and requires long-term preparation. If, on the other hand, the company is already listed on the capital market, the options for action are much more flexible. Capital increases and secondary placements can be implemented overnight in accelerated bookbuilding once opportunities arise. The latest reform of prospectus law has also made larger placements possible with a significantly shorter preparation time than before. In addition, there are alternative structures that have become established, such as pre-placements, where the necessary prospectus is only prepared afterwards. This time advantage can be very significant. At the same time, in these cases, if things do not work out, a company does not attract as much negative attention as in the case of a failed IPO, the latter may or may not be due to the company itself, but to market circumstances. Announcement periods are much shorter once a company is listed on the capital market.

Another factor for a technical listing can be that the company initially establishes itself positively on the capital market and convinces investors of ist business and management team. With IPO candidates, investors are often faced with the uncertainty of whether the potential listed company will keep its promises. With a purely technical listing, companies can first prove that they are also ready for the capital market in practice and that they communicate in a high-quality manner and reliably fulfill their plans. This in turn leads to higher valuations.

The challenge with a technical listing is the low free float. Institutional investors will typically find it difficult to invest in a share where the vast majority of shares are still held by the founders and investors, which is why the trading volume is limited. Ways must be found to circumvent this problem, for example with several smaller capital measures before or after the listing. This route is therefore particularly attractive for companies that already have a broader shareholder base consisting of investors and employees.

b) SPAC

A SPAC is another way of avoiding the aforementioned problems of a traditional IPO (time-to-market). In a SPAC, a company (the SPAC) raises capital in advance and subsequently looks for a company that is not listed and is taken over by the SPAC, i.e. the VC-financed company. The investors then have the option of agreeing to the acquisition of this company and, subject to certain conditions, can also opt out of continuing their investment by returning the shares in return for repayment of their capital investment. Recently, there has also been a separate legal regulation for SPACs in Germany, the so-called shell company. The shell company raises capital by way of an IPO and must then make an investment in an unlisted company within 24 to 36, maximum 48 months. To date, there is no such SPAC in the form of a shell company under German law. However, there are other SPACs, i.e. listed companies that essentially only have capital. In a SPAC transaction, the question always arises as to whether the existing shareholders receive a cash-out or whether they receive shares in the listed company instead. The large number of SPAC transactions a few years ago have led to investors being rather critical towards an exit by the founders and VC investors; in any case, a complete exit will probably not be possible with a VC-financed company. Overall, however, SPACs are currently rather rare on the capital market in Europe and the willingness of investors to participate in the launch of new SPACs has so far been low.

c) Reverse merger

A third variant of the alternative IPO is the so-called reverse manager. A reverse merger mirrors a SPAC in form but uses an existing listed company without a strong cash position. It therefore simplifies the listing and is particularly attractive if it is a listed (shell) company that has a certain number of shareholders from the past (free float). This solves the problem of technical listing, according to which it can be difficult to get trading going without a sufficiently broad shareholder base, which in turn deters institutional investors from investing. In addition, such a reverse manager can run much faster than a classic IPO and you are no longer dependent on the small windows that a classic IPO has due to the requirements for the prospectus in terms of figures. In our practice, we accompany several such cases every year. There are also so-called synthetic shells, which have no previous history, but were only listed on the stock exchange in Düsseldorf for the purpose of bringing in an operating business. The advantage is that these shares are always completely clean, but the disadvantage is that they then lack the free float. There are also repeated use cases for this, for example when a private placement is carried out at the same time in order to generate the free float.

3. Preparation for the IPO

The preparation for an IPO, regardless of the structure, often requires structural and legal adjustments. The extent of the changes and how quickly they need to be made depends heavily on the stock market segment that is being targeted. If, for example, an IPO takes place in a segment with IFRS reporting, the accounting requirements are significantly greater than if the German Commercial Code is initially retained. Regardless of the transparency requirements in the segment, it is crucial for future success on the capital market that the company fulfills its transparency obligations in a qualitative and timely manner. There is no more negative publicity than when statutory deadlines are missed or corrections to content are necessary.

In order to meet the corresponding transparency requirements, in addition to a good accounting department, someone is also needed to take on the investor relations function. This can be a dedicated investor relations employee or an external agency, which then works internally with, for example, the assistant to the management board or similar departments. It is important here to allocate responsibilities and to create an internal understanding of the necessary measures and establish structures through early training. As banal as it may sound, not all companies take the required attention for checklists, processes, etc. The effort involved is not that great; many things can initially be outsourced to lawyers and auditors and later, after some time of practice, insourced to reduce costs. Typical process issues that are often underestimated include the procedures for the Annual General Meeting, the regular reporting obligations through to the preparation of the Supervisory Board meeting (including the various elements to be prepared upfront to this meeting, such as the dependency report, Supervisory Board report, etc.), establishing processes for ad hoc disclosures and other obligations under the Market Abuse Regulation, informing the executive bodies and major shareholders about their disclosure obligations when trading in the company's shares, etc.

Another important preparatory topic is the establishment of a governance structure that is suitable for the capital market. The first step here is for the management to set itself up appropriately. At this point at the latest, a CFO is required who "has his figures under control at the touch of a button". Capital market experience is desirable, but not always essential. What does not work is to place the topic of finance "on the side" in another department.

The structure of the supervisory board should also be examined. If the company enters the regulated market, an expert in finance and an expert in auditing are required. In addition, there must be an independent supervisory board member on the three-member supervisory board. The members of the supervisory board should also embody a certain "stature"; the chairperson of the supervisory board in particular also has an impact on the capital market. It is not uncommon for the European Company (SE) to be chosen for IPOs. This can also be staffed with the classic supervisory board structure as well as the Anglo-Saxon word structure with an administrative board and managing directors. The decision on this must be made at an early stage. Roughly speaking, administrative boards are also supervisory bodies, but are also responsible for fundamental strategic decisions, while the supervisory board can only monitor and exercise reservations of approval, but has no authority to make independent strategic decisions. The majority of the members of the Board of Directors must be independent members, i.e. only a minority may also be managing directors.
An essential part of the governance structure is also that the persons involved accept that transparency requirements apply and that the company is not owner-managed but has a responsibility towards outside investors. This is usually the case with VC-financed companies anyway, because financial investors have already been taken on before the IPO. Experience has shown that this transformation is therefore relatively easy. 

4. Team (experience, judgment, flexibility)

One of the key success factors for an IPO is the team - team quality drives success. There are three key factors to consider. Firstly, experience is necessary. Experience can take many different forms, but the decisive factor is that it fits the specific project. Knowledge of current and innovative structures, how to find them and the current practice of transactions on the capital market and BaFin as the responsible supervisory authority should not be underestimated.

Another important factor is a realistic assessment of the options and situation. On the one hand, over-optimism that chases unachievable goals can lead to the company racing ahead without realistically achieving its goal. On the other hand, however, formalism is also counterproductive.

This leads directly to the next point, namely flexibility. Flexibility and pragmatism are often necessary for all parties involved. Being pragmatic in solving legacy issues, navigating obstacles, and adopting innovative structures (e.g., prospectus shortcuts, alternative IPO routes) should be part of the team’s DNA.

Out-of-the-box thinking has already saved more than one transaction.

5. Timing

The timing of an IPO depends largely on the chosen structure and the circumstances at the company. In a classic IPO with prospectus preparation, the preparation of the necessary historical financial information (financial statements for the prospectus), including the associated audits, is also crucial for the overall timing. Here too, one size does not fit all. There are typical processes, but - especially but not only - for smaller and medium-sized companies, adaptation to the specific circumstances and a certain degree of flexibility are required to make transactions possible. The following is therefore a very rough outline to give you a feel for the timeline:

A key element on the timeline is the preparatory corporate restructuring. This may include the conversion to a marketable legal form (AG, SE or KGaA), the structuring of the appropriate transaction form (classic IPO, private placement with technical listing, reverse IPO, anchor investors, etc.) and the selection of the internal and external team. Depending on the circumstances, a total of three months should generally be taken into account for this workstream.

A second line of work is the aforementioned preparation of financial statements. The amount of work here varies greatly. Questions that determine the specific scope of work are, for example Have there been any recent restructurings, for example spin-offs, company acquisitions, etc.? Is IFRS conversion required? Are the historical financial statements already available or do they have to be prepared for the first time? Is the cooperation with the auditor well established or is this a first-time audit? How many years in the past need to be audited? All of this is a question of the individual case. In the case of alternative IPO routes, less time-critical work is generally required and this can be postponed to the future. Of course, marketing aspects are also very important in this context. Sometimes, for example, the data for the equity story cannot be obtained from the financial statements without further measures, which can then lead to additional work.

Another aspect - at least in the case of the classic IPO - is the preparation of the securities prospectus and the implementation of the so-called approval procedure with BaFin as the responsible supervisory authority. You should allow roughly four months for this. In individual cases, it may be quicker, but experience shows that you should not plan too tightly.

The other IPO readiness measures are an additional workstream and usually run in parallel, be it setting up future accounting structures or establishing IR work.

Finally, and this is of course a very decisive factor, the development of the equity story and the preparation and implementation of the placement are the focus of attention after all the technical preparations. Management attention is required here. An IPO also always means that a management team has to convince investors. For VC-financed companies in particular, the focus is on strategic development and future growth. Just as is the case with a VC financing round, from the capital market investor's point of view a great deal depends on the team that is to lead the company to the next step.

All the individual strands presented do not run sequentially one after the other, but at least partially in parallel. A total of roughly six months can be estimated for the corresponding measures.