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Initial public offering (IPO) activity is on a high

The momentum from first half of FY2021 has continued with a healthy pipeline of listings on the Australian Securities Exchange (ASX) to see through the 30 June year-end, and with many more rumoured.

As the coverage of ASX activity is prolific, we instead redirect the spotlight to fundraising activity by private companies and highlight some of the themes around the equity investment conditions we saw during the height of the pandemic last calendar year and the contrasts we are already seeing as we approach this 30 June year-end.

Generally, we found that the implications of COVID-19 placed many businesses in a vulnerable position where their survival became dependant on obtaining immediate funding.

In particular, as founders conceded a reduced valuation of their business, this provided opportunity for investors to structure their equity investment and governance rights more favourably.

This article and the tables below set out a few examples.

Security class

We saw… We are seeing…
The preferred equity class was preference shares – mostly, with same voting rights as to ordinary shares, but ranking ahead of ordinary shares on a winding up and also in respect of distributions. We are seeing a preference for diversification of investment to more hybrid structuring. For example, a mixture of equity in the form of preference shares or ordinary shares but coupled with a convertible note(s) and/or warrant (each with triggers for conversion into the underlying security) – mostly to minimise some of the upfront equity risk.
This was unsurprising, as the risk of insolvency for many corporates was immediate during the pandemic and the equity raising was literally one of (or the last) option for survival.
The investment was often also conditional on the entity clearing as much debt as possible, so to shorten the list of creditors. With little-to-no ability to repay that debt, this often meant using most of the equity injection for that purpose and at the same time convincing existing creditors to convert some or all of that remaining debt into equity.
From a practical perspective, the material benefit to investors structuring their equity investment in the form of preference shares
(as opposed to ordinary shares) was marginal. This is because, the equity injection removes the immediacy of insolvency, and as in any equity investment into private operations, the possibilities for distribution of profits in the near future are low.

The immediacy of funding

We saw… We are seeing…
Funding that was secured by the relevant parties was paid in full on completion due to the urgency for funding requirements by the company. We are seeing a preference by investors for tranched funding, with follow-on tranched payments subject to certain conditions or milestones – another method to de-risk some of the upfront equity investment.
Resulting investor governance rights also cemented in full on completion of issue of shares. However, this has implications for the investor governance rights. For example: what does the investor receive upfront on completion of the first Tranche (some or all governance rights), and if some, then when do all governance rights become embedded? Further, if follow-on tranche payments do not complete then what governance rights (if any) remain with the investor (should they determine to keep their less-than-complete equity investment)?

Board seat vs board observer role

We saw… We are seeing…
Equity investment was mostly conditional on a Board appointment and to some degree, an alignment of the company’s governance arrangements with that of the relevant investors. Investors are keeping their options open with respect to Board appointments – the right to an appointment is still there, but they may not necessarily exercise that right. Instead, there is an increasing emphasis on Board observer appointments, and through that observer role, having full insight into Board discussions. Naturally, observers to the Board are not directors (and do not have director voting rights).
In this regard, we saw greater emphasis placed on the regularity of Board meetings and Board conduct. Investors are more keenly aware of the personal directors duties any nominee director will assume in that role, and as a result, are at times more comfortable with an observer role on the basis the investor (as shareholder) has the necessary reserved powers entrenched in the Shareholders’ Agreement.
  In this instance, the parties will be expected to agree upfront the appropriate information-sharing protocols of the company as well as a more comprehensive list of shareholders’ reserved matters (see also below).

Key decision maker

We saw… We are seeing…
We saw a preference for the majority of reserved matters to be decided at the Board level given the prevalence of the Board appointment condition. Where a Board appointment is optional (or even non-existent), the reserved matters are naturally with the Shareholders and are lengthy (and detailed).
In addition, where the company had numerous shareholders the Board was the more contained (and convenient) forum for the majority of the reserved matters. We are seeing rigorous discussions around business operations and the requisite thresholds (financial / non-financial) requiring shareholder approval.

Expectations for IPO

We saw… We are seeing…
Any IPO exit event was tied in to the usual broader “Exit” event. Consistently, there is an expectation for IPO, and IPO trigger events are much more defined (for example, in relation to valuation and revenue thresholds).
It was rare to see any particular trigger events, other than the parties being in mutual agreement.