When you are a successful company running a successful business, there is the big question over how you are going to cash out. Broadly, you have two options. You can look to an IPO to partially monetize your stake in the business. Alternatively, you can also look at a full-fledged merger with a much larger name. We have seen that happen in the case of Transelektra merging into Godrej or Air Sahara merging into Jet Airways or more recently the case of Linked In merging into Microsoft. At the same time, some iconic IPOs have created wealth for shareholders, and that includes examples like Facebook, Google, and Amazon in the US. Back home, it includes cases like Bharti, Infosys, D-Mart which have all created tremendous wealth through an IPO listing.
To merge or not to merge; or whether you are better off with an IPO?
Every entrepreneur looks to monetize holdings at some point in time. Going public via an IPO or being acquired by another entity are two approaches by which start-ups seek liquidity. When should you prefer the IPO route? Usually, a company chooses to go public when it has made significant progress in sustainable profitability, solid revenue growth, or other material milestones. That is the language that IPO investors understand; both retail and institutional. But one of the preconditions of an IPO is reasonable valuations. Otherwise, it will be challenging to market these ideas to IPO investors.
In cases where a company may require significant growth capital, and the company already has a high valuation potential acquirer with an in-depth understanding of the business may be a better partner. Also, many acquirers prefer the M&A route well before the actual IPO as they do tend to get valuable companies at attractive valuations. Let us also look at the pros and cons of both the approaches.
What are the pros and cons of going public through an IPO
Adopting the IPO route over the M&A route has some merits but has some downsides too. Let us look at both sides of the story.
- IPO offers the company the potential to raise money at a higher valuation than on the private market. This is more so in case of companies that are operating in sectors which are classified as emerging business ideas.
- If the company is looking at an eventual merger, then an IPO can be a good starting point. The company can effectively use its stock as currency to create more value ahead of an acquisition. Also listed stocks being liquid tend to generate better benchmarks for future valuation.
- The IPO route also offers easy access to liquidity for founders, investors, and employees; that is the ability to sell shares on the public market. Monetization becomes a lot easier too.
- But there are some downsides too! An IPO entails significant legal & disclosure obligations and information provided to shareholders. A very high degree of transparency is called for, and this becomes an issue for companies in the areas like biotechnology and genome research where public scrutiny may not be too proper.
- Remember, the IPO process is both expensive and time-consuming for the management team. Also, there are restrictions on stock sales. There is typically a lock-in period after the IPO to protect the stock against price volatility. Also, the company stock has to avoid too much volatility post IPO as it can belie the trust imposed by shareholders.
Pros and cons of adopting the M&A route
How exactly the M&A route differs from the IPO route regarding attractiveness? Let us look at the alternative scenario.
- An M&A deal is normally structured as an all-cash, in which case the company can get immediate liquidity instead of relying on the public markets. This is useful if the promoters are not keen to go through the elaborate IPO route.
- Compared to IPO, there is the relatively lower market risk and also reputational risk in an M&A transaction. Moreover, such transactions can be planned and executed with a high degree of confidentiality compared to an IPO where a lot of critical information is required to be in the public domain. In a way, the company is saved the regulatory and administrative hassles like quarterly results, in-built guidance, disclosures, forecasts, analyst calls, shareholders, etc.
- But there are downsides too! When you opt for the M&A route, you forsake on valuation arguments. Unlike the IPO where the company can command better valuations, an M&A works typically in favor of the acquirer.
- The existing promoters have little control over the stock price in the future. The promoter either receives cash or shares in the new company. Either way, there is little of the original company left when the promoters. In the IPO route, they control future upsides via control & management of the company going forward.
Finally, being acquired also means less control, affinity, and agency. Typically old brands are liquidated, or there is a sun-setting clause. We have seen that in the aviation industry in India and also in banking. That is something the original promoters have to be prepared for.