Anatomy of a deal: IPOs
26 October 2007
Were Number 1! cries the wooden cheerleader from the walls of tube stations, trains, buses and across the internet. Moneysupermarket.com, the price comparison site, has recently launched a visible and successful advertising campaign nationwide. But what is this company? Moneysupermarket.com offers a free online service to consumers to enable them to search for and compare a wide range of products across a substantial portion of the relevant market to assist them in finding the product best suited to their needs.
While price comparison websites are growing in popularity, stirring even that behemoth of UK capitalism Tesco into action, moneysupermarket.com is a pioneer in this field. Its main website (moneysupermarket.com) has been around since 1999 a veritable OAP in internet terms.
Have you ever wondered who owns a company such as this, and how they get the money to provide these services (not to mention pay their employees and advertise and invest in upgrades to their technology)? Since summer 2007 moneysupermarket.com has been owned by a mix of large institutional investors, its own management team and, most importantly, individual investors. How did this happen? Throughout the spring and summer of this year, moneysupermarket.com went through a process known as an initial public offering (IPO), or flotation.
What is an IPO?
An IPO is the first sale of a companys securities to investors on a public stock exchange. A security is an ownership interest in the company.
Types of investors
Investors in IPOs fall into two broad categories institutional investors and the general public.
Institutional investors are entities that have large numbers of assets and earn a living by investing. These can be pension funds, insurance companies, mutual funds, hedge funds and many other organisations that invest in different kinds of companies. If a member of the general public decides to invest in securities, they can either purchase shares in a fund, which will then act as an investor on their behalf, or they can invest directly on their own. Investing with a fund is generally less risky, as funds typically own shares in a diversified portfolio of companies. Investing on your own behalf in individual companies is more challenging, but potentially more lucrative.
The scope of regulation for an IPO depends in part on who the shares are offered to. The wider an offer, the more laws will apply. IPOs can range from private offerings made to institutional investors or high-net-worth individuals, to retail offerings, where members of the public can purchase shares. In the case of moneysupermarket.coms IPO, it chose to list its shares on the main board of the London Stock Exchange (LSE). The IPO included an online retail offering in the UK, where members of the public could purchase shares, as well as an institutional offer in the UK, the rest of Europe and the US.
Why do companies choose to float?
Engaging in an IPO has a number of potential advantages, including:
the ability to raise funds;
attracting high-calibre employees by being able to offer them stock in a publicly traded company;
greater access to future capital; and
There are, however, some disadvantages to being a public company, including:
no longer being a private company that is controlled by its existing shareholders;
disclosing information about the business that it may be reluctant to make public because, for example, it could benefit potential rivals;
increased liability exposure for the company and its board of directors; and
Companies will usually want to launch their IPOs during periods when markets have strong investor demands (known as bull markets) the higher the demand for a companys shares, the more the company itself will be worth.
If a company decides that the time is right to float, one of the first steps is to assemble a crack team of advisers. The IPO team will include both internal members, such as the companys senior management, and external members, such as the underwriters, the lawyers (for both the underwriters and the company), accountants and other specialists. The company is also known as the issuer.
A companys senior management team is the most important participant in the IPO process. An IPO will require a significant amount of senior managements time and energy. They will be involved with all aspects of an IPO, from initial meetings to the final selling by the underwriters.
The underwriters usually consist of one or more investment banks, which purchase the offered shares from the company at a fixed discounted price and sell these shares on to investors. In simple terms, the underwriters main role is marketing the IPO to potential investors. As a result they will assist in structuring the offering, coordinate the timetable of the deal, participate in the drafting of the prospectus, organise the IPO roadshow and advise on the pricing of the float.
On larger IPOs, the lead investment bank (known as the global coordinator) typically recommends an additional group of investment banks to help distribute the stock, which is referred to as the underwriting syndicate. In certain jurisdictions, such as the UK, a bank also performs the regulatory role of sponsor. The sponsor, among other things, assesses the suitability of the company for listing and typically makes certain declarations to the securities regulator. Underwriters receive a fee based on a percentage of the gross proceeds from the IPO. The role each bank receives affects its allocation of the underwriting fees, which vary depending on a number of factors, including the size of the IPO and where a company is being listed.
For moneysupermarket.coms IPO, the global coordinator and sponsor was Credit Suisse, while Lehman Brothers and UBS Investment Bank acted as co-lead managers.
Issuers legal counsel
The role of the issuers legal counsel involves:
taking the lead in drafting the prospectus, which is the document that describes in detail the company and the securities being offered, and which is distributed to potential investors for them to review as they consider whether to invest in the company;
conducting due diligence on a company to gather information to draft the prospectus and to help minimise potential liability for the company and its board of directors;
assisting in pre-IPO corporate housekeeping matters and preparations, including any corporate reorganisations, refinancings, corporate governance matters and employee incentive schemes;
delivering certain legal opinions to the underwriters to provide comfort that the IPO process was conducted properly; and
preparing a company for the legal environment it will operate in once it becomes a public company.
On moneysupermarket.coms IPO, Herbert Smith acted as the issuers counsel.
Underwriters legal counsel
The primary function of the underwriters legal counsel is to oversee the work of the issuers counsel and advise the investment banks on their underwriting role or on any other roles they may have in certain jurisdictions (eg as sponsor). Throughout the process, the underwriters counsel is focused on protecting the reputation of their investment banking clients by identifying and mitigating risk. Specifically, underwriters counsel:
conduct due diligence on the company to assist the underwriters in satisfying their due diligence obligations;
prepare research guidelines;
review and comment on the prospectus;
draft the underwriting agreement and related documentation; and
coordinate the closing documentation for the IPO.
Freshfields Bruckhaus Deringer acted as the underwriters counsel for the moneysupermarket.
A company usually engages one of the large international accountancy firms. The terms of its engagement and the scope and purpose of its work are typically set out in a detailed engagement letter. While the exact scope of the accountants work depends on the operating history of the company, market practice and applicable rules in each jurisdiction, their duties usually involve delivering:
a report on financial statements included in the prospectus;
comfort letters to the underwriters and the companys board of directors to the effect that the financial statements included in the prospectus comply with applicable accounting standards;
other financial information included in the prospectus that has been properly extracted from the accounting records of the company; and
the preparation of the financial statements to be included in the prospectus, which is usually an important factor in determining the IPO timetable.
KPMG Audit worked as the accountants for moneysupermarket.coms IPO.
The IPO process
An IPO takes a significant amount of time, effort and money. So what are the main steps in an IPO after the team is established?
The kick-off meeting. A meeting between senior management and external advisers occurs at a preliminary stage. Expectations and timetables are discussed and senior management is informed what it will need to provide throughout the IPO process.
Due diligence. Due diligence is a central part of any IPO. Essentially, due diligence involves a detailed investigation by the companys advisers into the company and its plans. This is done to check that the company is ready to go public, to inform the drafting of the prospectus and to minimise potential liability for the offering participants. There are usually three main streams to due diligence: legal due diligence, conducted by the lawyers, which mainly involves reviewing material contracts, board minutes and any outstanding litigation issues; business due diligence, conducted mainly by the underwriters, which involves interviewing the issuers management team at length about their business practices; and financial due diligence, led by the accountants, which analyses the issuers financial statements, working capital requirements and internal controls and financial reporting procedures.
Due diligence is an ongoing process that will occur from early on in the deal to the night before the deal closes. Junior lawyers in particular will take significant responsibility for the process itself, which can be both exhilarating and frightening. As part of the legal due diligence exercise, and to assist in preparing the prospectus, a company needs to assemble a data room where its material documents are placed for review by legal counsel. It is important for the advisers to start their due diligence early to allow sufficient time to address any issues that arise.
Drafting the prospectus. The companys legal counsel usually has primary responsibility for the drafting of the prospectus. The prospectus is not only a marketing document, but also a protection document. From a marketing perspective, the prospectus explains the companys competitive strengths, strategy and market opportunity (often referred to as the equity story). From the perspective of the issuers legal counsel, the preparation of this document will be the main aspect of the lawyers work on the deal. The prospectus must inform investors of the risks relating to the issuer to protect the company and its officers and directors from potential liability for material misstatements or omissions. The specific content requirements of the prospectus vary, depending on where a company lists, where the shares are sold and the nature of its business.
The roadshow. This is the pivotal stage of the selling effort and occurs after the prospectus is printed. The roadshow is the opportunity for senior management to meet with investors and tell the companys equity story. It typically involves a number of presentations in various cities over several weeks, as well as one-on-one meetings with key potential investors. During the roadshow, the lead underwriter builds a book of investor interest in the shares to be offered, noting how many shares investors would be prepared to acquire and at what price.
The pricing meeting. The pricing meeting occurs immediately after the roadshow. The underwriting banks and the company meet and review the
order book, set the final price for the securities
and determine allocations.
An IPO is a lengthy, demanding and exciting process that takes on average from three to six months to complete. After months of effort and much burning of the midnight oil, a typical IPO will culminate in a closing dinner, during which everyone can relax and celebrate a job well done.
Adam Wells is a partner and Ben Novick an associate at Herbert Smith