Video #3: When private equity goes public

Guy Berman (00:10): Hi everyone. Welcome to the Torys IPO series. Today we're going to focus on IPOs from a private equity perspective. My name's Guy Berman, I'm a Partner in the Private Equity Group here at Torys.

Janan Paskaran (00:21): Hi. I'm Janan Paskaran, and I'm a Partner in the Corporate Group of the Calgary Office of Torys with a focus on capital markets.

Guy Berman (00:29): Well why don't we jump into this, Janan? So our clients—our private equity clients—will have a private company, and if they're thinking about going public, I want them to think of what they should be thinking about from the get-go. Most of our clients will have ASPE-audited financial statements. Is that going to work from a public company perspective?

Janan Paskaran (00:49): No, that's a good question. I mean, the first thing I think obviously the accounting standards will be different. So as a company moves to consider a public listing, they're going to have to get full IFRS compliant financial statements. And so that's a relatively large undertaking for management of the portfolio company to start thinking about in terms of the differences between ASPE moving to IFRS and really depending on the industry that they're in, there could be a number of different accounting treatments that they'll have to work through. So I think that's a really key point for a portfolio company and a sponsor to be thinking about as they look to the public listing process. I think the other thing is as a company looks to a public listing is thinking about their governance, thinking about the board. You know, as you move from a private company to a public company, there are different skill sets often that are required not only from a listing and a stock exchange perspective, but what investors and public investors are looking to see. So I think another big thing for private equity sponsors to be thinking about is the constitution of the board, thinking about the skill sets that they want to have as the company transitions into a public company. And probably the last thing, depending on the industry, I think particularly for resource issuers, in the mining and oil and gas perspective, they of course would have to publish technical reports for their assets. And again, that can also be a large undertaking. So there's a lot of gating items that a company needs to be thinking about as they think about the public listing process.

Guy Berman (02:22): And so just focusing on the gating items for a second, how long does it take, for example, for the accountants to bring the financial statements up to public company standards?

Janan Paskaran (02:33): Yeah, I think it's issuer to issuer-dependent I think it'll depend on the nature of the existing financials. But I think as a rough guide, I mean it's usually probably three to four months of work that it'll take for a company to move from private company to public company standards. You're looking at three years of historical financials, so it's a relatively large undertaking. And then often, you know, most private companies don't publish interim financial statements typically. And so the public process will also require you to have interim financial statements for the most recent period. So, you know, we tend to budget three to four months, is what it will take. Some people might do it a little sooner, but a little bit later. But I think that's a pretty good estimate of what it's going to take.

Guy Berman (03:15): Well thanks for that. So when our private equity clients are investing in companies, they typically have complicated capital structures. They'll potentially have sub debt, different classes of pref shares, common shares. How is that going to work from a public markets perspective?

Janan Paskaran (03:35): Yeah, I think that the thing that the underwriters will often tell you is "simple is the best" and a simple capital structure that's easy for the public to understand is really what the desire is. So often as you move into a public process, you're looking at converting some of those complicated capital that you have in the private company context, whether they're convertible pref shares or convertible debt or other types of instruments. Typically you're looking to have all of those converted into effectively a common instrument. And so I think that's something as a PE sponsor, you need to be thinking about because you effectively will become a common shareholder. And, you know, a lot of the rights and preferences that you may have in a private company as you move to a public company go away. And so I think that is an important thing for people to understand when they think about an IPO and they think about monetizing an investment, a lot of the rights and the preferences they have will go away in the public context.

Guy Berman (04:38): And is there any shot for any of these private equity funds to have multiple voting securities? Or is that a tough ask?

Janan Paskaran (04:45): You know, I think it's a tough ask, but it's certainly out there. I mean, there are of course, in Canada in particular, there are a fair number of multiple voting security companies out there. You know, typically they've been historically ones with family founders and things like that. But it's certainly something that can exist. But ultimately, it'll depend on a particular issuer and the nature of that company. But it's a "never say never". Certainly, I think there's a preference that it wouldn't be there. But certainly multiple voting structures are something that are out there, available and, you know, probably more common here than in other jurisdictions.

Guy Berman (05:20): And now just focusing a little bit on the exit itself—

Janan Paskaran (05:23): Yeah.

Guy Berman (05:24): At the time of the IPO, are the underwriters going to want the private equity funds to have a retained interest or are they fine if they sell all or most of their securities?

Janan Paskaran (05:38): Yeah, I mean, it's always a good question. And I think obviously the sponsor is often keen to liquidate at least a large part of their investment. They've probably been holding it for a reasonable period of time, often. And they're looking for monetization. The underwriters will be guided sort of by what the market and what the size and the book looks like for the overall IPO. I think they'll be balancing the concept of, they don't want a big block, which could have a large overhang on the stock as they move past IPO and into a listed company. On the flip side, they want to ensure that there's enough demand and in enough shares to fulfill new investors coming in. So there's always a balancing act between the underwriters and the selling shareholder as to what the right amount of shares the secondary offering will look like. And there's a bit of a negotiation there, I think. I think all sides should be aligned to get the sizing right, because ultimately it should help the company on a go-forward basis to have the right capital structure, to have the right investors, and obviously to not have a significant amount of stock coming off post-IPO that could bring the share price down. But there's definitely competing interests, certainly from the PE sponsor side. Often they want to be completely out where the underwriters, you know, often may want to reduce the size of the secondary in order to ensure that demand from new investors is fulfilled.

Guy Berman (07:08): So Janan, maybe as a last question—and I'll make it a two-parter—we've now gone public. Our private equity sponsor client has a large, sizable stake in the public company, let's say 15, 20, 25%. What is their hold period going to be and how do they start selling down in the market? And presumably they'll want to sell in larger chunks and how do they effect that?

Janan Paskaran (07:31): Yeah, it's a good question. I think for sure the underwriters in an IPO are going to be looking for lockups from the major shareholders and directors and officers. You know, the lockup they should be expecting is anywhere from 90 to 180 days typically. Sometimes it can be a little bit longer. There also maybe avenues to negotiate a little bit of tiering, so that's a percentage of the shares may come off a little bit earlier. But from a practical perspective, for a sponsor, you're not going to be able to liquidate your holdings on day one, you're probably looking at, you know, up to six months to be able to actually start selling the stock. I think the other thing that a sponsor needs to look at is, as you say, when your holdings are going to be in the 10%+, 15%+ and sometimes even 20%, you have to think about how you can actually sell these stocks and the rights that you may want to negotiate as part of the IPO. Because, you know Guy, in the private company context, there's often a very large suite of investor rights that you will negotiate, whether in the shareholders agreement or otherwise. And of course that is a little bit less common in the public company context, but often for PE sponsors, the things that they will look are one board nomination rights. Nomination rights are a little bit different than appointment rights that you would see in a private company context. In that, of course, in a private company, you can often just have the directors appointment. You probably have all the shareholders together and you can simply appoint directors where in a public company context, you have the right to nominate directors for election, but ultimately the shareholders have to vote them in at a shareholder meeting. So they're slightly different, I think that's a right we often see the sponsors want. A big right, I think that's often negotiated especially, as you say, where your 15% shareholder is what's called "registration rights". And what that means is that you can ask the company to file a prospectus to allow the sponsor to sell its shares in the market. And you know what that does is allow you to do a full prospectus offering to be able to offer the shares to sort of a wider group of people and I think when you have larger blocks, it's an important right to really be thinking about because sometimes post-IPO, the liquidity in the shares is, is not always as big as you'd like to see and so where you're a sponsor with a large number of shares, it's not so easy to get off the share position. So registration rights are an important thing for a sponsor to be thinking about. You know, the other thing we often see is "preemptive rights", sometimes sponsors do want to stay in and they're looking to actually maintain their share ownership position and they want the ability to keep up their ownership position if the company issues new securities. And so preemptive rights are certainly something that a lot of sponsors will be thinking about as the company goes into an IPO.

Guy Berman (10:34): Thanks Janan. That was terrific. I'm sure our viewers have learned a lot today.

Janan Paskaran (10:38): Thanks Guy. And if you'd like to learn more about our IPO work, please go to www.torys.com and take a look.