All aboard for an IPO boom

The stock market is on track to attract a rush of listings in the second quarter of 2014. Tony Featherstone reviews the risks and challenges for directors embarking on the IPO route.

Good boards and executives often go into battle on behalf of stakeholders. For Indoor Skydive Australia Group (ISA) (Twitter @indoorskydiveau), one of last year’s most successful initial public offerings (IPO), the relationship extends far beyond the boardroom, to the battlefields of Afghanistan, Iraq and East Timor.

ISA non-executive chairman Ken Gillespie AC MAICD (Twitter @ken_gillespie), the former Chief of Army, met ISA CEO Wayne Jones MAICD and chief operations officer Danny Hogan MAICD while inspecting Australia’s military operations in war zones and peace-keeping operations.

Jones and Hogan were part of the Special Air Service (SAS) Regiment that provided protection for top military officials. Having served with the Australian Defence Force for 43 years, Gillespie is one of Australia’s most distinguished career soldiers. He retired from the military in 2011.

Although he did not know Jones or Hogan well, Gillespie was intrigued when they asked him to chair ISA, which will this year open an indoor simulated skydiving attraction in Penrith in Sydney’s west. “They wanted someone to chair ISA who they trusted and spoke their language. I looked at what they had done to date, how far they had come with no help, and their characters and knew it would be a good board to establish,” Gillespie says.

Like skydiving itself, Gillespie took a leap of faith. He had never worked in a listed company, let alone chaired one. Jones and Hogan, both military skydiving instructors, had never run a company and had no experience raising funds for an IPO. ISA originally wanted to raise up to $12 million to build the first skydiving entertainment and training facility of its kind in Australia. Asking investors to stump up millions of dollars to back an early-stage venture with no cash flow, and an unknown management team and board, was a huge ask. After extending its offer, ISA eventually raised $6.1 million and listed on ASX in January 2013. Its 20¢ issued shares have since rallied to 73¢ and this year, Gillespie recruited former Commonwealth Bank CEO David Murray FAICD as a non-executive director – a coup given ISA’s size and profile.

Gillespie’s path into governance was more unusual than most. But hundreds of directors this year will join boards through an IPO, taking on significant reputational, professional and legal risks as they put their name to an organisation yet to prove itself on the market.

Last year’s IPO market was the most dynamic in a decade. About $9.7 billion was raised from 60 IPOs in 2013, excluding compliance listings, debt IPOs and others that do not raise capital. That compares to $1.2 billion raised from 44 listings in 2012, as a volatile sharemarket all but shut the IPO window.

After years of low IPO volume and values, the float pipeline was flush in the second half of last year as a rising sharemarket encouraged vendors to sell assets, and rising risk appetites and high valuations encouraged institutional investors to buy them, albeit with the usual grumblings about IPO valuations. Some of these companies were formed for an IPO; others were speculative ventures that will live or die by their ability to get to the next capital raising. A smaller group was well-established companies that had long planned an IPO as the next step in their journeys.

Whatever the case, joining the board of a company undergoing an IPO has higher risk and requires higher due diligence. The transition from private to public brings extra layers of risk, and dealing with entrepreneurial founders of small ventures, or their backers, can challenge even the best boards.

Gillespie was well aware of these risks. “My reputation is everything to me,” he says. “I did all the usual due diligence one would do before joining a board, but ultimately it came down to my confidence in ISA’s management team and my shared belief that what it was planning would be very successful.”

He says a key board role during and after the IPO is developing governance structures to support a fast-growing company. “The board and management team had to very quickly get up to speed on what is required to run an ASX-listed company. As a senior leader in the military, you spend plenty of time thinking about the right structures and processes to minimise risk, and help the organisation get to where it wants to go, in the most efficient way. In many ways, it’s very similar to how boards operate.”

ISA has since hired a company secretary and general legal counsel and Murray’s appointment takes the board to six directors, which is high for its size. Small IPOs often have three-person boards to minimise fees and they sometimes lack independence. Murray’s connection with ISA also came via the military. Gillespie served with two of Murray’s brothers over a long period and knew him socially through golf days and other functions. “David knew we were building a strong board and that we are looking to the future when ISA has skydiving attractions in other states. It’s about getting the right governance foundations early.”

Gillespie says a challenge in IPOs is inspiring executives to think beyond the day-to-day. “When you are running a small company, with no cash flow and limited funds, you are obviously very focused on short-term performance. The board’s job has been to help management find that balance between short-term and long-term thinking in a collaborative way.”

Directors can easily underestimate the human side of IPOs when choosing to join a board. Large listed companies have more resources, more experienced management teams and are less volatile than emerging ventures, which at times can be a governance roller-coaster ride. Large companies can also have strong-willed CEOs, although their personalities and behaviour are often worlds away from the entrepreneurial founder who has staked his or her life’s work and savings on a speculative venture, and who may not appreciate critical thinking from the board – or any input at all.

John Martin MAICD, chairman of promising life sciences company Regeneus (Twitter @Regeneus), says choosing to govern a company undergoing an IPO comes down to “fit”. “Fast-moving companies that are not profitable can be scary for some. These companies often have to take big and calculated risks, they work in less predictable sectors and have entrepreneurs running them who are not always easy people for boards to work with.”

Regeneus raised $10.5 million through an IPO last year to develop cell-based technologies that will enhance the body’s natural ability to repair tissue damaged from injury and disease. It wants to be an early mover in the fast-growing field of regenerative medicine. Martin, a former corporate partner at law firm Allens, has deep experience in high-growth tech start-ups, having been a co-founder and director of two biotech spin-outs from Macquarie University in Sydney. He is also a non-executive director of Ai-Media and Eagle Eye Solutions (Asia Pacific).

Martin had previously worked with Regeneus CEO and co-founder Professor Graham Vesey and some of its non-executive directors. But he cautions against joining boards that are essentially a group of friends who have succeeded with other start-ups. “I get on very well with everyone, but we recognise it is a professional working relationship. If the chairman or other directors are best mates with the entrepreneurial CEO, it can make tough conversations much more difficult,” he says.

Martin says chairing a recently listed entrepreneurial venture is akin to coaching. “The founder is usually very good at what he or she does and knows far more about the company, the science and its product than anybody else. The board’s role, therefore, is to help shape and strengthen the entrepreneurs’ thinking and advise them on areas where they may have less expertise, such as dealing with investors, regulators and commercialisation. It is more about asking the right questions and making sure the right support is in place than giving the entrepreneur the answers.”

Martin says directors of emerging ventures need a high tolerance for risk. “People know it’s riskier than governing a big profitable company, but you never fully appreciate the risks of an emerging tech company going through an IPO until you are involved in one. You can’t be afraid of getting that call from the CEO at midnight about a pressing issue or that things are suddenly not going to plan.”

He says good collaboration and trust between board and management is crucial. “That’s true of any board, but things always move a lot faster in entrepreneurial ventures. If the founder has to wait around for slow-moving board decisions, or gets bogged in compliance, the company tends to get stuck and the board is viewed as baggage.”

Regeneus’ early efforts have paid off. After listing in September, its 25¢ issued shares have rallied to 49¢, making it one of the better-performing IPOs in the past 12 months. 

Although ISA and Regeneus have had early sharemarket success, the majority of small IPOs often trade below their issue price. Sharemarket communication is a constant challenge after listing. Poor secondary market support weighs on many small IPOs and the sharemarket has a knack of forgetting about recently listed companies if their share price tumbles below the issue price. In emerging ventures, the chairman often has to educate the market about the company, explain its technology and promote a stock not covered by stockbroking analysts. Right or wrong, the governance role can often come with a communication, promotion and sales role.

Algae.Tec (Twitter @AlgaeTec_) executive chairman Roger Stroud spends much of his time promoting the company to investors. Algae.Tec listed on ASX in January 2011 after seeking $5 million through an IPO. His company is among the more interesting and unusual to list in recent years. Its technology allows sequestration of carbon dioxide by producing micro-algae in modules resembling shipping containers. The modules can be stacked next to power plants, which provide unwanted carbon dioxide emission as an input to grow algae. Algae are nature’s fastest-growing plant organisms and an emerging source of balanced protein and natural nutrients for human consumption, and for vegetable oil which can be used for biodiesel and biomass for animal feed. Algae’s potential as a source of alternative fuel is well accepted overseas, but getting local investors to back a small clean-tech IPO, in a sector heavily out of favour, has been hard work. Stroud says: “As chairman, you have to tell the story at every opportunity, talk to everybody you can and keep building the shareholder base. It’s a process of constant communications from the ground up.”

He says boards of tech start-ups must always have an eye on the next capital raising. “The reality is that most of these companies have no or limited cash flow and must be in a position to get to the next capital raising with a reasonable share price, so that existing shareholdings are not heavily diluted. Your share price effectively becomes your currency to raise more capital, to get the company to its first cash flows, which we expect Algae.Tec will get to later in 2014.”

Capital-raising skills are paramount, given the volatility of technology start-ups. “Directors have to plan for start-up ventures often having over-runs,” says Stroud. “That is, things taking longer to complete than management expected, often because of factors beyond their control. The over-runs can mean the company goes back to market sooner than it would have liked, because it cannot raise debt capital. So boards must always be thinking about cash flow and the ability to raise capital quickly.”

Stroud says unpredictable markets can also force sudden strategic shifts. “Algae.Tec originally went to market with plans to build a strong position in biofuels. But the boom in shale oil and gas means the market for biofuels is tougher. So Algae.Tec is expanding into nutraceuticals.”

Algae.Tec announced in December that it is entering the $205 billion global nutraceuticals market and intends to grow chlorella, B-Carotene algae and other high-quality dietary supplements. It entered into a collaborative agreement with Nutrition Care Laboratories, a large manufacturer of these products. The announcement boosted Algae.Tec’s share price, but it has since drifted to 15¢ and now trades below the 20¢ issue price. But it did trade above 50¢ in the first year after listing.

“The share price becomes another challenge for the board, especially when the company is performing well operationally and meeting its main strategic goal,” says Stroud. “It isn’t fun when the share price is falling, but it makes you run faster, get the next announcement out and work harder to please existing shareholders and bring in new ones. It can feel like a battle every day to get people to understand the company’s potential. Still, chairing an IPO is a good experience if you can handle the highs and lows.”