21 Sep Exiting Through IPO–Investor Deal Planning
While the IPO market slowly cools, we are still seeing many a private equity sponsor looking longingly at the public markets as a method for exiting portfolio company investments. Unfortunately for many private equity sponsors and limited partners, many of the nuances incident to becoming and maintaining a public company are overlooked. Expectations of a quick liquidity event and a successful exit through IPO can become over-shrouded in the issues inherent in the processes, regulations and hiccups inherent throughout the pre and post-IPO process. Keeping in mind some of the following nuances will be helpful before one considers investing as a sponsor or private equity limited partner.
The entity structure of a company with an IPO on the horizon is likely to look different than the initial structure of the original private investment. Converting from a flow-through entity through “up-C” to a C-corp is often best accomplished when the existing stockholders or operating agreement has flexible terms, allowing the owners to more easily restructure the investment to ensure greater tax efficiency. Covenants allowing investors and co-investors to both reasonably appeal for and implement new management structures, allow for a smoother transition to the public market if and when that becomes the determined vehicle for exit liquidity.
Public company governance issues can negatively plague the original private investors in the now public vehicle. Post-IPO the original private investors will likely hold enough of the voting block to hold the majority of the board seats. As the investors sell their equity into the public float their ability to maintain their hold of the majority control over the board is likely to dwindle. Planning for and implementing a tiered step-down in voting rights as investors exit their position. Stockholder agreements should include rights to nominate one or more board members, including proxies that plan for the liquidity over time.
Determining the who, when and how shares are sold by the original sponsors once the company becomes public can be a key deal component for registered underwritings. Shares can be sold through registration rights, block trades and Rule 144 trades. Strategic planning is required to ensure the coordination of share sales. In most of today’s public market sell-downs, seller coordination committees help plan for sponsors to communicate their selling efforts as original shareholders look to liquefy their stakes. Without proper coordination among shareholders, blocks of shares can hit the market at inefficient amounts and intervals. Coordination of the sell-down among original sponsors can help to maintain a steady flow and natural market in the public float.
The rights and relationship of shareholders can significantly change between the time of the original investment and after the company goes public. The relationship changes further as shareholders sell-down the majority of their shares. Pre-planning for things like anti-takeover provisions and other rights can ensure for good, long-term sustainable governance even after the original shareholders do not maintain control over the majority share block.
Being preemptive in how sponsors plan for and implement an Initial Public Offering, including negotiating pre-IPO structures will not only solidify how company owners can better prepare for their liquid exit (including potential tax issues), but such planning will also cement the company for long term sustainability post-IPO. Thinking carefully about existing stockholder agreements, including things like indemnities, D&O insurance, taxes and regulatory considerations is necessary to ensure the original shareholders get the best deal post-IPO. Re-trading can be nigh to impossible once the public offering is in place and the provisions are solidified.