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Burton, Helliar and Power, 2003

Executive summary

OVERVIEW

This report details the findings of an extensive investigation into how and why UK firms raise equity capital. The project was divided into two parts: first, an analysis of the decision to issue shares for the first time as part of the flotation process (i.e. initial public offerings, or IPOs) and second, an examination of the decision by listed firms to raise further equity capital (i.e. seasoned equity offerings, or SEOs).

For both IPOs and SEOs the findings are based on: (i) interviews with senior executives, accountants, fund managers and investment bankers, to enable a range of perspectives and viewpoints on the process to be compared and (ii) a detailed questionnaire survey of firms with recent experience of the equity-issuing process.

IPO RESEARCH METHOD

The study of IPOs involved a series of interviews with seven company managers and three advisers. Following on from these interviews, a questionnaire was posted to corporate treasurers of 450 companies that had undertaken an IPO in the previous six years to ascertain their views on the process; 102 replies were received.

REASONS FOR UNDERTAKING AN IPO

The findings of this study highlight a number of reasons why companies seek a listing on either the Official List or the Alternative Investment Market (AIM). These reasons include:

1. increasing the visibility of the firm and getting its name known to future investors, customers and suppliers
2. raising funds
3. allowing an exit route to existing shareholders
4. widening the shareholder base
5. facilitating a strategy whereby share options and bonus schemes can be offered to employees and
6. taking advantage of a `window of opportunity¿ where the stock market seems to have an appetite for shares of companies in a particular sector.

The timing of an issue was decided predominantly by the need for cash for investment and expansion purposes. The views of major investors and advisers were also important in deciding upon the timing of the IPO. For AIM companies, market trends were often crucial. The choice of market on which to list also depended on the views of advisers and major investors. Smaller companies tended to list on AIM because it was cheaper to do so. The geographical location of the customer base and the location of the company¿s operations, as well as the liquidity and regulatory regime of the stock exchange, all influenced the decision on where to list, especially for larger companies. Tax considerations also featured among the views of the questionnaire respondents, as AIM companies qualified for the Enterprise Investment scheme.

ALTERNATIVES TO IPOS

Most companies did not consider alternatives to the IPO, often because these alternatives had been exhausted. Thus private equity, trade sales or venture capital were not normally viewed as options. Also, most of the companies were too small to be able to raise the funds needed through debt financing. A listing was often seen as a last resort, therefore, by firms seeking to raise cash. The cost of an issue normally ranged from 10% to 20% of the proceeds and depended upon the company size as well as on the amount raised. The opportunity cost of management time was a major concern to all those who had obtained a listing; the scale of this cost had often not been factored into decisions made before the IPO. Legal fees were seen as exorbitant by AIM companies and many of those interviewed questioned whether the costs of some advisers outweighed their benefits. Advisers were often selected on the basis of a `beauty parade¿ where research ability and distribution channels for selling the equity were important considerations. Smaller companies, however, sometimes had difficulty in finding anyone to sponsor them.

CHANGES AS A RESULT OF THE IPO

The main changes that took place in a company both before and after the flotation tended to involve corporate governance issues. Audit and remuneration committees had to be established and non-executive directors appointed. Executive directors were also changed in the run up to an IPO if the existing management team was thought to need strengthening. Overall, those surveyed highlighted the difficulties of undertaking an IPO and the new `mind set¿ needed to manage relations with investors once a listing was obtained.

IMPLICATIONS OF THE IPO FINDINGS

In the light of recent declines in market capitalisations across the globe, governments and market regulators may need to address these concerns on an urgent basis, if a steady stream of new listed companies is to be found to replace those departing voluntarily or otherwise from the market. Many of the views reported in this study demonstrate that a negative interpretation of poor share price performance is seen as having the potential to harm a firm¿s business as well as its market prospects. The increased visibility offered by a market quotation no longer appears to be a one-way bet.

SEO RESEARCH METHOD

For the SEO part of the study, a series of 11 interviews were conducted with different stakeholders in the process. Eight of these were with firms that had had recent experience of issuing equity and were spread across a range of sectors, while two organisations were involved in an advising role (one of the `Big Four¿ global accounting firms and a major multinational investment bank) and one was a major UK fund management firm. Following the completion of the interviews, a questionnaire was sent to 452 firms that had undertaken an SEO in the years leading up to the study; 63 replies were received.

THE SEO FINDINGS

The results of the SEO part of the study indicated a number of important findings. First, the choice of issue method was contingent upon a number of factors, but primarily the ability to bear costs, the influence of advisers, the urgency with which the funds were needed and the extent to which a widening of the shareholder base is desired. Second, there was little evidence of what the behavioural finance literature might term `firm irrationality¿; firms appeared to take a great deal of care over the decision to issue equity, and their views generally concurred with those of the advisers and investors. Third, the findings of the current investigation indicated that it would be very difficult to use conventional large-scale analyses of firm behaviour to model accurately a firm¿s choice of equity issue method. Not only did the circumstances of each issue differ across time and sector, but the impact of some of the most important influences on SEO method choice, in particular the role of external advisers, would be near impossible to gauge and proxy for in practice. Fourth, firms continued to perceive the SEO process as costly and overly time-consuming, and some relaxation of the pre-emption guidelines would be welcomed.

POLICY IMPLICATIONS OF THE SEO FINDINGS

The SEO section of the report concludes with a renewed call for some relaxation (but not removal) of pre-emptive rights. In particular, a move to increase the maximum size of an external placing to 10% is recommended, in line with the UK listing rules governing minimum issue size possible without production of a detailed prospectus. Such moves have drawn resistance from shareholder groups in the past, but the findings presented in this part of the report suggest that, while firms continue to see real benefits in the flexibility provided by a relaxation of the guidelines, they have no desire to seek the gradual erosion of UK shareholders¿ long-standing right to first refusal on new equity issues.

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