Pre-IPO finance...The route to success?
Article Date: Jul 01 2004Going public - via an IPO - is not the only way to attract investors and raise cash. Over the last year, there has been a significant increase in ‘pre-IPO’ fundraisings.
For most entrepreneurs, the conventional way to attract serious sums of money to develop their fledgling businesses has been to float on the London Stock Exchange, AIM or OFEX via an initial public offering (IPO) or placing.
However, in an intriguing development that throws up exciting possibilities for many British entrepreneurs, sophisticated investors with deep pockets and those institutions allowed to dabble in unlisted securities are increasingly taking a chance with pre-float fundraisings when the company is still private.
What is pre-float finance?
The concept of pre-float finance is very simple. Basically, non-risk-averse investors agree to invest a set amount in a business, at a pre-arranged price, prior to its flotation on the market within (usually) six to 12 months.
Those funding the deals tend to be high-rolling individuals, well versed in the markets and the more entrepreneurial institutional investors.
One group that successfully exploited the pre-IPO funding route is Adwalker, a hi-tech sandwich board venture brought to the market by former Ogilvy & Mather adman Simon Crisp. When it joined OFEX, its shares were priced at 8p (valuing the company at £8.5 million), but pre-IPO investors were able to buy their shares at a variety of prices ranging from 1.25p to 7p.
Another, rather more exotic venture currently engaged in the process is Van Diemen Mines. This group is run by Aussie investment duo Clive Trist and Ken Frey, who hope to tap the London market for funds to buy options on promising tin and sapphire-bearing properties in Tasmania.
To pull this off at a time when the mining market has gone off the boil, they have employed Richard Chase of Ambian, a young London Stock Exchange member, to help them raise £1.9 million through a private placing of a convertible loan note ahead of an AIM flotation later on. This loan will be convertible within a month of flotation at equivalent to half the AIM issue price.
Get a good return on your investment
As these examples show, the attractions of a pre-IPO funding for the actual investors are obvious. This select group are offered the possibility of doubling, tripling or even quadrupling their investment within less than a year should the company they back go public as planned.
One finance group active in the pre-IPO game is John East, whose corporate broking side is now spearheaded by City heavyweight and former Kleinwort Benson luminary Johnny Townsend. Says Townsend, ‘there is a tremendous interest in pre-IPO fundraisings at present. The attraction for all the players is that they know they can get exposure in a soon-to-be-listed venture at attractive prices. However, they get in at lower prices because they are essentially backing a private company, which, by its very nature, represents a greater risk than a publicly listed one.
Of course, as well as seeing a welcome profit when the company floats at a price far above what they paid, these early-stage investors are also insulated from any volatility in the immediate after-market. Those who backed Adwalker at between 1.25p and 7p for instance, were completely shielded from the share price swings that saw its price surge from 8p to 20p post flotation before resting back at 12.75p.
Bridge the funding gap
It’s arguable that the real benefits of pre-IPO fundraisings accrue to the entrepreneurs and the companies receiving the cash.
According to Bill Brown of ISIS, a respected City institution that runs a broad range of investment funds, pre-IPO deals ‘are blurring the lines between venture capital and public share markets’. Brown is helping to float two companies which have had prior financing and argues the key test is whether these deals are necessary to pay for the steps to be taken to make the companies involved floatable. ‘AIM requires companies to state that they have enough working capital for 12 months and pre-funding may be necessary for that.’
These sentiments are echoed by Townsend who suggests the deals actually help plug the funding gap entrepreneurs constantly encounter. ‘I have lost count of the number of times fund managers have said to me, “We like the company, we like what they do and we value the management, but it’s still too early for us.”’
According to Townsend, with pre-IPO funding, the company is able to get an injection of funds at a crucial period that enables it to enhance its internal organisations, grow its sales and profits and then return to institutions as a much more attractive investment proposition.
‘This necessary addition of working and expansion capital can seriously improve the investment public’s perception of a venture. In my experience, companies involved in pre-IPO fundraisings ultimately attract higher valuations when they float. Institutions don’t mind paying a premium because very often a lot of the risks they may have previously objected to have been eradicated. This is usually reflected in the higher values these businesses fetch when they float. And of course, it’s much better for the founding entrepreneur if his company is able to gain a significant upward lift in its value.’
Get ready for the flood
At present, there is a veritable queue of companies doing pre-IPO fundraising rounds prior to their public market entrance within the coming year.
John East is assisting Madwaves, a group that owns software enabling mobile phone users to change their ring tones ‘in real time’ until they find one they like. It is seeking ‘at least’ £2.5 million, which will value the group at around £20 million. Townsend says this will be followed by a public float later this year, valuing the company ‘at many times that’.
Another in the John East stable is Holiday FM, which is looking to raise a pre-float £1 million. This money will be invested in a project to provide holidaymakers in Europe and on cruises with London Capital Radio programmes. If Holiday FM gets its cash it will be valued at between £3 million and £4 million and, once again, East hopes to achieve ‘a multiple of that valuation’ with a public float a few months later. With ex-Warner Bros luminary Tim Foster as managing director and a team including Capital Radio founder Paul Robinson and presenter John Sachs, Holiday FM projects £1.25 million pre-tax profits in the year to October 2005.
Investors subscribing 50p a share to internet legal reporting specialist Law///Alert’s £1.5 million Enterprise Investment Scheme issue naturally hope its planned AIM float in 12 to 15 months’ time will command a significantly higher price. By then, with help from the EIS issue, the company hopes it will have achieved profitability.
There are risks involved
Unsurprisingly, raising money pre-IPO is an exercise not without its risks, both to your business and your reputation.
If you embark on this route, you have to make sure that the ‘seed investors’ you attract will be committed to your business long-term and not just involved because they can turn a quick tasty profit. Later investors may not take too kindly if they cash in their chips at the first opportunity.
You also need to be careful how close to flotation you raise pre-float funds. If it’s far too soon, the wider investment public once again may not take too kindly to paying substantially more for their stakes than a charmed circle of pre-float regulars. As Bill Brown says, ‘if I was faced with an IPO which had had money very recently put in, I would ask why, if at all, we should be asked to pay a significantly different price.’
Lastly, it’s worth remembering that if you get the balance, price and the timing wrong, pre-float funding can have a depressing affect on the market for a company’s shares after flotation, possibly inhibiting future corporate moves.
Early backers of Russian gold producer Highland Gold Mining, including the merchant banking Fleming family and entrepreneur Ivan Koulakov, bought 40 per cent of the company ahead of its late 2002 float at a mere fraction of what others paid for 20 per cent of the company in that float. Its shares have not thrived.
Another mining company with attractive Russian prospects, Trans-Siberian Gold, raised £16 million last November with an AIM float at 150p. However, it had previously raised £4.5 million in two pre-float fundings at 58p and 125p and profit-taking from these was blamed for the shares’ subsequent fall to 136p.