Podcast transcript: How private equity-backed companies can prepare for IPO

17 min approx | 13 Jan 2020

Winna Brown   

Hi, and welcome to EY’s NextWave Private Equity Podcast.  In our series, we explore the impact that private equity can have on the economy and society, capturing insights from industry thought leaders and private equity practitioners from across the globe.  I’m Winna Brown from EY and I’m your host. 

I’m really delighted to have my friend, Jackie Kelley, join us today.  Jackie is EY’s Americas IPO leader, and I’m sure she’s no stranger to our audience with her regular appearances on programs such as Squawk Box, Bloomberg Tech and Yahoo Finance, where she shares her IPO market insights.  Jackie, thanks so much for joining me here in New York today.

Jackie Kelley     

Thanks, Winna.

Brown

So, Jackie, while many CEOs aspire to ringing the bell on the Stock Exchange floor, not all companies are cut out to be publicly listed.  So, when a private equity firm weighs up its various exit options, what are some of the key factors they should bear in mind that makes one investee more ideal for the public market than the other?

Kelley  

Well, an IPO is not for every company, Winna.  For the investors and management, an IPO is often not an exit right away.  So, today, IPOs are often done to start that liquidity path, also for growth capital, and even more so today -- especially for some of our tech companies -- to attract and retain talent. 

The profile of the ideal IPO company it really varies by sector.  So, most investors want to see strong growth trends, top line and bottom line, but in certain sectors, we’ve seen that’s not critical right now.  Today, what’s really great, I think, is that IPO markets really are open for everybody.  We’ve seen that IPOs today raise about 100 million on capital on average.  That’s been like that for a while.  So, the great news is if you do have a company that may be a candidate to be an IPO, the markets are right for you today.

Brown

Fantastic.  Now, you’ve mentioned that there are a few sectors that aren’t very critical to have those top line revenues and bottom lines.  Can you kind of share which ones those are?  Maybe some of our people in the audience are kind of interested to know if it applies to them.

Kelley  

Yes.    Who doesn’t have to have a top line?  Well, I think sometimes like, you know, like some of our biotech companies.

Brown

Yes.

Kelley  

Right?  The expectation is that, you know, this is a longer-term plane.

Brown

Yes.

Kelley  

Those investments.  Although biotechs are getting to market faster, which is why you see so many life sciences and biotech companies accessing the public markets over the last few years.  Also, as far as bottom line, some of our tech companies, some of our hot unicorn companies, are not expected to have instantly that profitability, but they do have to demonstrate to investors that there is a path to profitability, there is an expectation there.  So, you can come in without that bottom line.  However, there needs to be a path to get there quickly.

Brown

Yes, I know that makes complete sense.  And you touched on unicorns.  So, there’s a lot of buzz in the market about unicorns, and I know you are working with a lot of them.  So, what makes a company a unicorn?  And where do they come from?

Kelley  

The term “unicorn” is very fun, right?  It is a term that sort of bubbled up through the venture community, and it’s a privately-held company with evaluation greater than $1 billion.  So many of these companies are backed by financial sponsors.  Today, there’s approximately 500 unicorns around the world.  About 200 of those are in the U.S.  Of the unicorns, most of them have not exited yet.  Again, these are all privates, but the ones that have exited, most of those have done IPOs.

Brown

And why are they leaning towards IPOs?  That have to do with their size?

Kelley  

I think a lot with the valuation.  The valuations have gotten so high.  And then some of these companies really have gotten fairly large, growing in the private markets with the private funding, both, you know, the financial sponsors as well as getting money from institutional investors, as they get later stage.

Brown

Okay.  So, you’ve got these companies that are, you know, there’s a lot of pressure put on them because they’re valued so high and they’re looking at a big, public, splashy exit on the public markets.  What’s your advice to them?  You know, how do they get ready for the public market? 

I think you and I have spoken often about, you know, getting ready for an exit.  You know, the key to that is to get ready early.  And I had a similar conversation with our colleague, Charles Honnywill, around, you know, exits that are sale-side exits, so sales to other investors or to corporates.  Is this true as well for an IPO?  And, if so, just how early should a company prepare?

Kelley  

Right.  You know, specifically, as it relates to IPO, we like companies to start really thinking about the readiness process 18 to 24 months in advance of that anticipated transaction.  But I think to your point, and to Charles’ point, this applies whether the IPO’s, the ultimate destination or you’re going to do an exit through an M&A transaction, whatever it might be, that preparation process is absolutely critical.  And many of our companies today are exploring multiple options at the same time. 

One of the keys to success here in this preparation process is putting a robust plan together, so really getting tactical around what are the things I need to do over that next 18 to 24 months.  And you’ll want to leverage experienced advisors as you kind of look across the different functions and help those functional leads mature their organization and put a robust project plan behind that.

Brown

Well, you know, that makes sense.  Good planning and planning in advance and getting ready early is great advice, but, come on, I’m sure there’s lots of war stories of companies who ring you up and say, “Hey, I want to go public in a couple of months.”  What do you do when they call you up and say that?  And what are the dangers of listing before you’re truly ready if you haven’t had that 18 months to really get yourself prepared?

Kelley  

Right.  Exactly.  Well, going public too early definitely has its risks.  I had a CEO come up to me, of a very large company, and says, “My management team just, you know, giving me all these excuses why we can’t go public.”  He goes, “How come I can’t go public in six months?”  And I said, “You absolutely can go public in six months. 

The issue is once you’re public, can you perform?”  And he goes, “I got it.  Okay.”  So that’s the most important thing here is that you want to make sure you’re prepared to be that public company and practice doing that in advance. 

Now, of the companies that go public today, about 25 percent of them miss their first quarter earnings projections.  Now, whether that’s their own projection they gave to the market or the analysts’ projections, if they’re not doing quarterly guidance, either way, they’re missing those projections, and that’s a sign, right?  Those are the kind of things you want to avoid, if possible.  You don’t want to be in that 25 percent if you can.  And that means that you do have to do a lot of preparation to do that. 

If you are a company that is in that group -- whether that’s first quarter, second quarter, third quarter -- oftentimes, we see if that’s meaningful miss(?), you are in a two- to three-year recovery period.  That is a long time for management and its stockholders to be holding on.  It’s very stressful, and, oftentimes, folks are holding their stock a lot longer than they planned.

Brown

Yes, and certainly not an ideal situation for private equity who’s planning an exit.  So, what’s your advice if you’re a private-equity sponsor and you’re looking at a path of your investee that leads to the public markets?  How can you support the company and management through that process?

Kelley  

Many of the private-equity investors also sit on the board.  So, they do have influence and they are working closely with management.  We definitely like to see, and I think many of the private equity we work with encourage preparedness early.  So, they’re talking to their management teams about getting the right team in place, making sure that the processes are mature, making sure that the right technology is in place, supporting the function, not just the financials, but the operational processes within the organization.  You want to make sure all that’s in place before the IPO and it’s all being used and operated efficiently. 

And then one of the things that many of our private-equity sponsors ask for from their management teams these days is an enterprise-wide IPO-readiness assessment.  Assess the company.  Make sure, working with management, that assessment has been performed.  Leverage those experienced advisors I had talked about previously and have a report that you can use to really guide you as you move forward.

Brown

So, you know, clearly, getting ready for an IPO is a long process.  You know, it involves a lot of people, getting the right team, the process (Inaudible), a big investment of time.  From a private-equity perspective, what does having, you know, a flagship IPO in your portfolio do to your market perception and your fund profile?  I mean, is it worth all the hassle?

Kelley  

Well, most PE funds, still, the principal exit is an M&A transaction.  Although, if you talk to PE investors -- which I do frequently -- they’re looking at every single one of their investments or even evaluating at the time that they’re making the investment saying, “Hey, is this likely an M&A exit or an IPO exit?”  So those evaluations are happening very early.  But, obviously, as they continue to hold those investments, they’re continuing to challenge that. 

Some PE firms that we work with do a lot more IPOs than others, and that may also be a function of the types of investments they’re making or when they’re making those investments in those companies, you know, how late-stage that is.  But we have worked with some PEs that have done like their first IPO and have gone through that process in their portfolio, and they are very quick to say, “Wow, you know, this has been a great experience and this recent IPO really helps us for our fundraising on our next fund.”

Brown

Which is always really important, obviously.  So, you know, one of the key ingredients, though, to having a successful IPO is having a hot market, you know, and you can’t necessarily control that.  So, what happens if you’ve done all the right things, you’ve prepared, but the market and the window actually closes on you?  How easy is it to pivot from where you were in terms of preparation for a public listing to an alternate exit?

Kelley  

Today, the markets that we’ve been in really for the last few years, the markets close on our companies unexpectedly.  I mean, anything can trigger a closure.  It’s much easier to pivot if you are prepared for that.  So, if you’re going in with all your eggs in one basket -- “I’m only IPO bound” -- the market closes, that can feel like a bit of a setback. 

You know, most companies work through that and they hold through that, but if you’ve got … You know, if you go in knowing, “I’m preparing the company.  I’m not going to worry so much about the market.  I’m just going to make sure I’m the best prepared,” you have a lot more optionality, so you can move around with the timing of the markets. 

You can flex to an open window, even if that window is shorter, because you’re well prepared.  And it also allows you -- If capital is really, really important and it’s time sensitive, you should have that plan be running at the same time.

Brown

Yes.  Absolutely.  Absolutely.  So, let’s just say we go down the path and we get to an IPO, I mean, you know, it’s pretty sexy.  It’s that great, you know, great thing that everyone aspires to have, you know, under their belt in terms of experience, but what are some of the downsides to being a publicly listed company?

Kelley  

Well, you’re now in the spotlight.  And, frankly, some people love that.  So that also is one of the drivers for doing that.  But there’s also a lot of transparency. 

One of the things we talk with companies about, the transformation process from private to public, is you really need to think about how you communicate.  We find oftentimes that the companies are either very transparent communicators internally and they have to pull that back or they’re very close to the vest and now guess what’s going to be in that public document, a lot about you, owners, you, founders, you, executive team, your compensation programs, how things are structured.  All that’s available now in the public market. 

So, obviously, a lot of transparency is now out there, and it’s expected that you’ll continue to be transparent as a public company on what you do. 

Also, accountability.  So where before -- Not to say that, obviously, the management team isn’t accountable to their existing stockholders, but, now, sometimes that accountability becomes much more short term.  So, you know, not only what are those long-term goals, but what are the short-term goals and how are you going to hit those metrics?  So very, very important. 

But that said, you know, despite what are some of those new challenges, you know, so many opportunities present themselves, too, as well with the IPO.

Brown

Absolutely.  And, now, I know an IPO is actually quite a -- as we talked about -- a lengthy process in order to prepare for, it’s also pretty expensive as a process.  How does it compare to other types of access from a cost perspective and do the higher valuations that you potentially get on market actually make up for the costs?

Kelley  

You know, it definitely costs more to be a public company.  Those that do this -- and we do have serial entrepreneurs that do IPOs over and over -- they will say the valuations and that liquid currency is just, you know, they wouldn’t do anything different. 

But that said, you know, you are going to have to make investments if you’re going to be a public company, and if -- You know, we find with a lot of our fast-growing startups that the investments they’re having to make those 18 to 24 months, they feel pretty significant, they hadn’t made those along the way. 

You know, really, as the cash was coming in and the investments were being made, those are being made to sales, engineering, IT, critical parts of the business that are driving growth and very customer facing, but they haven’t made a lot of the investments to mature the back end, sort of infrastructure and processes. 

So, really, what happens is companies now have to make investments in talent and infrastructure to, one, run a very predictable business -- that’s absolutely critical -- to continue to scale, and then, thirdly, really to meet regulatory compliance requirements that come with being a public company as well. 

So, you are going to make more investments.  If you haven’t been making it along the way, you’re going to feel some of that as you’re getting closer to the IPO, and then things with stabilize.    

Brown

And then thinking about, you know, IPO through the lens of private equity, I mean, they’re looking to exit from the investee.  So, you know, you would think that the challenges of being public going forward, you know, it’s really management’s journey that they’re going to be on versus private equity.                   

But, I guess, if we actually unpack it, an IPO is not really a true exit in the first instance.  So, the private-equity sponsor, you know, can’t just sell down all its investment, unlike if it’s doing a true sale. 

So how long, you know, after an IPO can a sponsor expect to be able to actually divest of its shares?  And, you know, they really do need to be aware of how long they need to operate within a public-market environment if they still own an investment in that company.

Kelley  

You’re right.  You’re right, Winna.  Private equity generally does not exit at the time of the IPO.  Now, if, you know, getting some liquidity is important, there’s a lot of structuring that often takes place either pre- or, you know, through those follow-on processes to get that exit process going and get that liquidity happening. 

But, you’re right, it’s generally not happening at the IPO.  Investors don’t want to see like everybody exiting at the transaction date.  They expect the shareholders to continue to be in the game. 

So, there are things that -- structures and other strategies that do happen leading up to the transaction that can provide liquidity, but you’re right, you’re probably going to be in there.  And depending on the performance of the company, maybe it could be several years before you’re out.  Some private equity like to stay in. 

Their goal is, “We’re coming in and we’re not planning to go anywhere in the near term.”  And so that, obviously, is a strategy as well.  But it could take a while, and it’s going to -- often takes a series of follow-on transactions to get that liquidity process going.

Brown

Well, and then I guess circling back to what we were talking about earlier, you know, the more prepared a company is and the more its ready to act public and meet its projections post listing, the better the share price is going to be, the better up …

Kelley  

Yes.

Brown

… the more upside, if you will, there is for private equity as they hold onto those shares post listing. 

Kelley  

Right.

Brown

So, it is really critical for a number of reasons, you know, to really do prepare and be able to hit those marks post listing and act like a public company.

Kelley  

That’s right.

Brown

Fantastic.  So, Jackie, you know, you’ve been helping companies navigate through the IPO process for what?  Over 20 years now?

Kelley  

Yes.

Brown

If there were three or four things, you’d want our audience to take away from today to help them as they contemplate an IPO, what would they be?

Kelley  

I guess first and foremost, start early.  You know, don’t wait to start to think, “Okay.  That IPO is probably still two or three years out.”  It’s never too early to start talking to advisors around IPO readiness and start to gather insights and figure out what you can get started on. 

Secondly, make sure that you’ve teamed with advisors that have been there and done that before.  It really makes a difference.  They’ve seen the pitfalls.  They can advise you on how to avoid those.  They’re going to really be a strategic advisor for you leading up to the transaction.  And then, ultimately, that relationship often continues after, as you continue to grow and scale. 

Thirdly, I’d say don’t underinvest.  Sometimes, you know, as getting closer to the transaction and, you know, companies get very concerned about their spend, but,  ultimately, you will get the benefits back if you’re investing, and that’s investing in the right people, that’s investing in the processes and the infrastructure needed and, you know, making those investments to have a really strong equity story. 

And then the last thing I’ll say is really focus on creating a strong foundation, not only for the IPO, but also for the company’s growth.  Most companies, after the IPO, they’re going to double in size within three years.

Brown

Well, thanks, Jackie.  That’s really great advice for everyone to take away today.  You know, the IPO journey is not only about being ready for the IPO event itself, but for actually being ready for the years to come and the high growth trajectory. 

So, the more that you do to prepare in terms of bringing the right people in, creating the right processes and building the right infrastructure, it’s really going to help you to be prepared to ensure that you capture all the growth potential post IPO, just as you suggested. 

So, thank you so much, Jackie.  Really enjoyed having you on the show here today and for sharing your insights into the IPO market and really what it takes to prepare to be a public company.  I know that everyone in the audience has learned a lot today, as have I.  So, thanks so much.

Kelley  

Thanks so much, Winna.  Great to be here.

Brown

I hope you enjoyed this episode of the NextWave Private Equity Podcast.  Please subscribe, review and, of course, share it with your colleagues and friends.  To find out more about the topics we discussed, check out ey.com/private-equity.  I’ll see you all on the next episode.

Disclaimer: The views of third parties set out in this publication are not necessarily the views of the global EY organization or its member firms. Moreover, they should be seen in the context of the time they were made.