6 minute read 31 Aug 2023
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Back to basics for IPOs?

Authors
Rachel Gerring

EY Americas IPO Leader

IPO readiness and financial accounting advisor. Sounding board for CXOs and entrepreneurs. Transformation guide. Wife and mother of two remarkable daughters.

Mark Schwartz

IPO and SPAC Advisory Leader

Corporate finance advisor, experienced in IPOs, listings, carveouts and related public and private market equity transactions.

6 minute read 31 Aug 2023
Related topics IPO Start-ups Private equity
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More traditional approaches in the IPO market may become fashionable again when the US-based new issue window reopens.

As new issues start coming to market again, what will it take to return to initial public offering (IPO) volumes of years past? The IPO market had a banner year in 2021, and investors were eager to join the party as average 30-day returns topped 20%. That year, nearly 400 IPOs raised more than $150 billion, fueled by historically low interest rates, massive economic stimulus and record public company valuations. 

Strong investor interest enabled companies to modify IPO processes and terms to accommodate their interests and those of their key stakeholders. For example, many IPOs featured shorter and staggered lockup periods compared with the “standard” 180-day IPO lockup, facilitating earlier liquidity for shareholders but eviscerating share supply constraints for investors. As investor leverage waned in the hot IPO market, we also saw hybrid auctions gain popularity, forcing investors to bid for shares and driving IPO prices higher.

IPO activity slowed dramatically in 2022, with only 90 IPOs generating less than $10 billion in proceeds. Challenging market conditions emerged — by October, the S&P 500 had dropped more than 25% from 2021 highs, inflation surged to a 40-year record, the Federal Reserve increased rates from 0.25% to 4.5%, and stock market volatility spiked to levels that made investors wary of investing in new public companies. 

As we enter the second half of 2023, a thaw in the IPO market may be underway, with the pace and size of US IPOs beginning to recover over the past few months. Through midyear, 63 IPOs raised $10 billion, representing increases of 115% and 24%, respectively, compared with the prior year period.

While some of the improvement is attributable to larger strategic carve-out IPOs, the market backdrop for IPOs has improved considerably — equities have rebounded with the S&P 500 up more than 25% from October 2022 lows, inflation has been moderating, interest rate hikes may be nearing an end, and market volatility has returned to pre-pandemic levels.

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The combination of strong aftermarket performance of some of the recent higher-profile IPOs and the accommodative market backdrop presents hope for more robust IPO activity levels later this year and next year.

Will IPO processes look different when the market recovers?

When the IPO market returns in earnest, bankers will strive to de-risk transactions and investors will require more investor-friendly IPO structures and terms. Issuers are likely to encounter a market that requires greater planning and may not be as receptive to some of the accommodations we saw during headier times just two years ago. For example: 

  • More pre-marketing

    Prior to launch, companies should be prepared to undertake more extensive investor marketing efforts to develop longer-term relationships, gauge interest in their story and incorporate feedback into their messaging and proposed IPO structure and terms. We will also likely see a rise in anchor orders from brand-name investors disclosed at IPO launch, signaling interest in the deal and reducing the supply of shares for sale in the IPO to create pricing tension.

  • Larger IPO discounts

    Following the sharp declines in the performance of the 2021 IPO class, investors will seek more rational valuation approaches and greater IPO discounts as the IPO market reopens. Companies considering an IPO, particularly early in the next IPO cycle, will likely need to be less valuation sensitive at the time of IPO and have compelling longer-term reasons to be public.

  • Smaller deal sizes

    By downsizing the percentage of the company sold in an IPO, issuers can influence pricing and enhance aftermarket trading by restricting the supply of shares available for sale. This requires adequate private funding ahead of the IPO, but it can be an effective strategy to take pricing leverage away from the buy side in an IPO.

  • Transparent book building

    The use of hybrid auctions to drive pricing at IPO may be curtailed as the IPO market returns. Traditional book building generally provides investors with greater transparency into investor sentiment, potentially facilitating better longer-term stock performance for IPO investors.

  • Tighter lockups

    A return to greater control over the ability of existing shareholders to sell additional shares in the aftermarket could be required by IPO investors to provide comfort that aftermarket performance won’t be unduly affected by heavy selling pressure. Companies and banks may be inclined to reduce areas of potential pushback in IPO marketing by returning to more conventional IPO lockup structures, making the management of shareholder liquidity needs ahead of an IPO even more important.

Are you considering an IPO?

Considering this potential “return to basics” in the IPO market, companies that are contemplating an IPO as part of their strategic plans should consider:

  • Meeting with investors

    A primary goal in an IPO is establishing a natural long-term shareholder base. Ideally, this should begin well ahead of the IPO roadshow to “get on the radar,” develop relationships by “doing what you say you will do” and incorporating investor feedback into your strategy and messaging. Pre-IPO companies need to build investor relations muscle well in advance of their public debut. Proper preparation and support from an experienced investor relations team can help ensure that these meetings achieve their goals and bypass some of the common pitfalls companies often encounter.

  • Shoring up funding

    Companies frequently debate whether to pursue a final funding round ahead of an IPO or the optimal sizing of a pre-IPO financing, but there is no one-size-fits-all answer to these questions. However, ensuring adequate capitalization can be critical when IPO windows are particularly fleeting, growth capital can be challenging to come by, and IPO sizes may need to be managed to optimize pricing and liquidity dynamics.

  • Providing liquidity for shareholders

    In some cases, the pullback in the IPO market has kept companies private for longer than expected with their shareholders invested for longer than they may have intended. Some companies can provide private funding solutions to generate liquidity for these investors. When shareholders’ considerations can be addressed privately, companies can better manage their IPO timelines based on company-specific circumstances and prevailing market conditions rather than succumb to pressure to IPO before they are really ready.

  • Driving toward profitability

    The nature and extent of the IPO market pullback have illuminated the need for companies to demonstrate profitability or a path to profitability. In some cases, this requires a fundamental shift in strategy toward reducing experimental initiatives to execute against what a company does best and/or moving away from “growth-at-all-costs” or “market share-is-all-that-matters” mentalities.

  • Operating like a public company

    Making the move to the public markets requires a distinct set of skills and an operational rigor many entrepreneurial companies have not yet institutionalized. The best way to prepare for this monumental change is to begin operating today as you will be expected to operate as a listed company. From quarterly reporting, to identifying and managing key performance indicators (KPIs), to implementing appropriate internal controls, and beyond — the time to make these adjustments is well ahead of the days, weeks and months leading up to an IPO.

Sources: EY analysis, Dealogic, S&P Capital IQ

The views reflected in this article are the views of the authors and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.

Summary

Well-managed companies with strong growth prospects will always have an advantage as they work toward a public debut. But careful planning and the recognition that the market will likely demand more traditional investor-friendly IPO structures will be an important element in new issue success as we eagerly await a return to better days in the IPO market.

About this article

Authors
Rachel Gerring

EY Americas IPO Leader

IPO readiness and financial accounting advisor. Sounding board for CXOs and entrepreneurs. Transformation guide. Wife and mother of two remarkable daughters.

Mark Schwartz

IPO and SPAC Advisory Leader

Corporate finance advisor, experienced in IPOs, listings, carveouts and related public and private market equity transactions.

Related topics IPO Start-ups Private equity
Upvote