The Australian demand for initial public offerings has shifted away from small caps to favour larger listings, forcing many smaller and mid-market companies to find other ways to raise capital.
The IPO Watch report from chartered accounting group HLB Mann Judd suggests a definite trend towards bigger floats.
In 2013, 19 of the 49 listings on the Australian Securities Exchange were for companies with a market capitalisation over $100 million. However, they accounted for 92 per cent of the funds raised.
Within the small cap sector (market capitalisation under $100 million), 53 per cent were from the $75 million to $100 million range. This was a big shift from 2012 when only 4 per cent of floats were for companies valued above $50 million and there were none at all above $75 million.
As a result of the bigger valuations, the average raised by small caps was $12 million, up from $5.3 million in 2012 and $6.8 million in 2011.
The smaller the company, the less likely they were to meet their subscription target. HLB Mann reports that 100 per cent of floats for companies with a market capitalisation over $100 million reached their target, while for small caps in the $25 million to $100 million range it hovered around 96 per cent to 98 per cent. The minnows in the $10 million to $25 million range struggled the most, with only 67 per cent reaching their subscription targets.
‘My personal opinion is you need to be of a decent size to consider a listing and if you go in too early, you just get lost among all the other small caps,’says Simon James, a HLB Mann Judd corporate advisory partner. ‘You want to get capital at the lowest cost and if you’re too small, the cost of capital is incredibly expensive, firstly in terms of the price of doing it and all the roadshows to actually raise the money, and secondly in terms of the discount you have to give to the market to ensure it gets away.
‘You see the spike in share prices of small businesses on listing and that’s primarily because it’s been priced too cheaply, which isn’t in many business owners’ interests.’
So what are the alternatives? Listed below are eight possible non-IPO options for capital raising, with analysis of the availability, advantages and disadvantages of each one.
1. Engineer a reverse takeover
Recently, a number of technology companies have done reverse takeovers of mining companies in order to secure a back-door listing on the ASX. Bulletproof Networks and Decimal are two recent examples.
But James says this accounts for less than 5 per cent of the deals on HLB Mann’s books and the reason is that it is often so time consuming and expensive that you would be better of doing an IPO.
‘Ultimately if you’re doing a back-door listing, the listed company has failed. You’re basically starting from square one, so you’re looking for potentially something the board has some interest or knowledge in, which may be totally different to what the company did before,’ James says.
Brett Boynton, the co-founder and managing director of gold company Signature Gold (an HLB Mann client), adds: ‘A reverse takeover or back-door listing isn’t going to give you access to capital unless your story is good and there’s a particular pool of capital that would invest in you except that you’re not listed.
‘It’s a very difficult thing to get right, not least because there’s a lot of lifestyle directors sitting on these boards who are very happy to just carry on taking five grand a month and they are not really interested in either being moved off the board or doing more work.’
2. Sell the company
The less risky model, particularly for technology entrepreneurs looking for an exit, is to sell to a cashed-up buyer like Microsoft, Google or Apple. Boynton points out that the falling Australian dollar is likely to make this option even more attractive because of the increased return from a sale in US dollars.
James says there is heat in the market for technology valuations and the prudent move would be to go for cash rather than scrip.
‘Do US investors know how to value a technology company? If you look at the price-earnings multiples of some of these businesses… Freelancer is actually making money so that’s better than some of the other technology businesses that are worth billions and aren’t making money,’ James says.
‘I cut my teeth in London in the dotcom boom days making people very rich on paper listing all sorts of weird and whacky ideas but whether anyone actually made any money and the valuation is correct, there’s a difference between a paper valuation and a cash valuation, and if you sell to one of the majors, especially the Googles or Apples that are cashed up, you can sell your technology and get paid cash, it’s a hell of a lot better than sitting on [scrip]. The founder of Freelancer is worth x hundred dollars in paper but actually being able to convert that into cash and diversify his personal portfolio of assets is easier said than done.’
Matt Barrie did actually have an offer from Japanese company Recruitco to buy Freelancer for $US400 million. At BRW we think he was right to float the business on the ASX instead – but that won’t be true for every business.
3. Debt, otherwise known as bet the house
This is the most expensive option and will often involve mortgaging the family home, which is a risky move.
HLB Mann’s James quips that the problem with debt is that banks will usually only lend to people who don’t really need it.
‘Usually the most expensive cost of capital is debt,’ James says. ‘The banks are starting to lend a little more, the cash rate is on a 55-year low, and Westpac is expecting it to drop to 2 per cent by the end of the year. But even if the actual cash rate is low, the rate for a mid-market company is ridiculously high, and if you haven’t got property security to put on the table, you’re effectively at credit card interest rates if you can actually get over the line at all.’
4. Hit up your rich mates
Start-ups often tap into angel investment networks and find high net-worth individuals to invest seed funding. For example, young Melbourne entrepreneurs Chad Stephens and Chris Koch tapped family connections to secure investment from the founders of CarSales for their start-up 1Form, now sold to REA Group.
However, even assuming you have the right connections, HLB Mann has noticed this market is tightening.
‘High net-worths were a popular source of money over the past couple of years in Australia,’ James says. ‘We’ve got lots of people with cash floating around looking for alternative investments. We’re starting to see that one dry up a bit.
‘I think people have been banging their heads on the walls in terms of accessing that cash. It’s very hard to get through the gatekeepers to actually get to the right person and then to be able to articulate your proposition in a way that gets it over the line. It’s very time consuming and costly way of doing it and unfortunately not much success around it.’
5. Get into bed with private equity
Fundraising from private equity investors can be a good option if you can pull it off. This was how Boost Juice founder Janine Allis grew her business, creating Retail Zoo as an owner of multiple franchise chains by selling a large stake to The Riverside Company several years ago. However, James says smaller and mid-market companies might find it a difficult market these days.
‘Private equity from an Australian point of view has been hit hard over the last few years,’ James says. ‘There are some funds that are doing well. But as fund sizes get bigger, the investment decisions seem to get bigger too.’
James cites figures from the Australian Private Equity and Venture Capital Association (AVCAL) that in 2013, private equity invested $5.5 billion in Australia and the average deal size was $109 million or new investments and $14 million for bolt-ons, which were also less common.
‘The problem is private equity can afford to be very, very choosy so if you’ve not got a very smart business plan, an excellent management team on board, and a growth story that you can articulate, then you’re just wasting your time, because the guys are seeing all the deals coming through and can cherry-pick,’ James says. ‘The advantage of private equity though, if you can get the right deal size and the right team behind you, is that it’s not just cash, unlike an IPO where it’s mums and dads and institutions, you’re getting an advisory board and network of people who can add value to the business.’
6. Get into bed with your competitor
Some companies might get a better result from creative solutions that don’t require cash. James suggests that mergers or partnerships can be a good idea.
‘It’s a cash-free way of plugging a hole in the business. Whether you’re looking to enter a new market, develop new products, bring in some know-how, if there’s another business out there that’s already got that, why not join forces either formally or informally?’ James says.
‘Mergers are a lot more popular [at the moment], they’re harder to do, and take more investment time, but the chances are the people you’re merging with are sharing some of the same pain and if you get together maybe one plus one can equal three.’
7. Beg from the public
Traditional crowdfunding where people back projects for either altruistic reasons or to acquire ‘rewards’ are a good option for businesses that need capital to develop a particular product. Listing a project on a site like Kickstarter or Pozible can work as a pre-order channel and lets the entrepreneur test the market before committing capital. The concept has been around a few years and there have been some great business success stories, making it an increasingly popular option.
But James is sceptical about the moves afoot to allow equity-based crowdfunding, arguing that it would be too onerous for entrepreneurs.
‘The biggest problem with any fundraising is managing a diverse shareholder base,’ James says. ‘If you get to the point where something has worked from a crowdfunding point of view … and you end up with a million mums and dads owning a share each and you have to go to a shareholder vote every time you want to do anything, it would be a huge drag on the company,’ he says.
8. Save for a rainy day
Do you actually need to raise finance at all? Perhaps you can achieve your goals the old-fashioned way, by growing revenue from customers and conserving cash within your business.
‘The only other way is to save your own cash, retain your profits within the business, don’t distribute them out, keep reinvesting in the business itself,’ says HLB Mann’s James.
Many successful companies have boot-strapped to get where they are today. A good example is software company PageUp People that became a multi-million dollar business through organic growth. It is only within the last two years that the founders Karen and Simon Cariss have taken on outside investment, to help fund expansion into Asia.
The upside is that it’s less risky, you don’t dilute your equity or take on costly interest repayments, and you can be confident you’re building your business on solid foundations rather than quicksand. The downside is that it is slower and your competitors may grab market share and entrench their position.