What is an IPO? Why are law firms floating on the stock market?
The bull v the bear market
“If I had another life, I would keep my company private,” said Jack Ma, speaking before the Economic Club of New York in 2015.
A year before, Ma’s company, Alibaba, raised $25 billion from the New York Stock Exchange. It was the world’s largest IPO.
But, as Ma explains, running a company after an IPO comes with its own unique challenges: “Life was tough before the IPO. After IPO, much worse.”
In this guide, I’ll break down what IPOs are and why companies choose them.
I’ll cover the following:
What is an IPO?
Imagine you own a private company in the UK. It’s not a small company, but it’s not as large as you want it to be.
You want to open international offices, but you don’t have enough capital to finance an expansion. You’ve tried to approach banks, but they’re unwilling to lend you large sums of money.
Instead, you decide to raise equity finance.
But who do you raise equity finance from?
You could ask:
Early-stage companies will often raise capital by selling shares to family and friends.
An angel investor is a wealthy individual (or a group of wealthy individuals) who invests his or her own money in a start-up or early stage company.
Venture capital is available for both early-stage companies and more developed companies. Unlike angel investors, venture capitalists are usually firms or companies, and they invest other people’s money through a fund.
Unfortunately, these sources of investment aren’t enough. Your cash needs are larger, and these investors won’t be able to fund your international expansion.
Instead, you offer shares in your company to the general public for the first time. This is an initial public offering or “IPO”. It’s also known as “going public” or a “flotation”.
Now, you are lucky. IPOs aren’t feasible for most companies. In fact, few companies ever reach the size and scale to successfully float. But your company is large enough to attract investment and capable of complying with all the regulations that come with an IPO.
Private v Public Companies
Most companies are like yours – they’re privately owned. Private companies are easier to set up and subject to fewer regulations than public companies.
So, why would you ever want to become a public company?
Well, public companies – unlike private companies – are allowed to offer their shares to the public. And, importantly for an IPO, public companies can have their shares officially listed and traded on a stock exchange.
So, as you want to raise money through an IPO, you will have to re-register as a public company.
Listing on a Stock Exchange
To offer your shares to the public, your shares need to be listed on a stock exchange — a market place where shares, among other things, can be bought and sold.
If you have any existing investors, your listing will allow them to sell the shares they own in your company, which is useful if they want to exit or reduce their investment.
But first, you need to choose the stock exchange you want to list on. Let’s look at some options.
The largest stock exchanges in the world by market capitalisation are:
- New York Stock Exchange (United States)
- NASDAQ (United States)
- London Stock Exchange (United Kingdom)
- Tokyo Stock Exchange (Japan)
- Shanghai Stock Exchange (China)
Sometimes, companies will list on the stock exchange in a foreign market. For example, in 2017, nine of the ten largest IPOs on the London Stock Exchange by size came from outside the UK.
But, let’s suppose you decide to list on your domestic market.
The London Stock Exchange
As your company wants to list on the London Stock Exchange, you have to choose from two markets to list on, the Main Market or AIM.
AIM is more suitable for smaller, growing companies that are not yet ready for the Main Market. It’s lightly regulated, largely because AIM-listed companies are not subject to the more onerous EU securities law of the Main Market. Companies can also access capital more cheaply and quickly on AIM.
But, as you have a larger, more-developed company, you will be better off listing your company on the Main Market. This is a bigger market, and you will be able to raise more money from a wider pool of investors. You will also benefit from the reputational value of listing on the Main Market as your company has to adhere to higher regulatory standards.
Why have an IPO?
The primary reason companies go public is to raise capital. By accessing the public markets, your company can raise more money from a far wider pool of investors than a private investment. You can then use this money to fund your growth and international expansion plans.
There are also other benefits from an IPO:
Once your company’s shares are listed on a stock exchange, the founders, employees and investors of your company can sell and monetise the value of their shares. (Although, initially there is likely to be a lock-up period to prevent shareholders selling their shares immediately.)
The process of going public will attract press, which can raise your company’s profile across the market, which may be far beyond what you could have achieved through traditional marketing efforts. By being a listed company, you also publish regular financial information and you demonstrate that your company can comply with a stricter regulatory regime. This can provide your company with credibility when dealing with customers, employees and suppliers.
Now that you are listed on a stock exchange, you have easier access to the equity and debt capital markets. If you want to raise more money in the future, you can head back to the stock exchange to sell more shares in a secondary offering or issue bonds in the debt capital markets.
Once listed, your company can use shares and options as part of its remuneration package to employees. This can help your company to attract and retain key employees.
An IPO can make it easier to acquire companies because you can pay part of the acquisition price using shares. This means you don’t need as much cash upfront and the acquisition may be cheaper if your shares are attractively priced.
What are the costs of going public?
When your company goes public, you will face the burden and cost of complying with stringent rules derived from EU laws. These laws are in place in order to protect public investors who may buy shares in your listed company. These shareholders may be passive investors who aren’t involved in the day-to-day management of a company or unsophisticated investors who know little about investing. Either way, you will have to determine whether you want to be accountable to these investors.
Loss of Control
In an IPO, the existing shareholders of a company will have their shareholding diluted. That’s because new shares are issued, increasing the total number of shares and reducing the ownership percentage of existing shareholders.
You also need to prepare for the impact of an IPO on the running of your company. Your company will go from listening to a small number of private investors to being accountable to thousands of shareholders. These shareholders could have a substantial influence on the company if they buy enough shares or act together, such as voting to appoint or dismiss directors or voting to approve or dismiss a particular transaction.
When your company goes public, you can’t just head to the stock market to sell your shares: there’s no market for the shares. Instead, you will need to pay an investment bank (or a group of investment banks) to drum up interest and find investors willing to buy your shares. The investment bank is known as an “underwriter”, and they will help you to organise the sale of shares and determine the price you should sell your shares to investors.
Usually, companies will enter into an underwriting agreement with the investment bank. This may involve a firm commitment, where the underwriter agrees to buy your issued shares and re-sell it to the public. If this is the case, the underwriter guarantees that your shares in an IPO will be sold and holds on to any unsold shares. On the other hand, you may only agree a best efforts underwriting, where the investment bank agrees to do their best to sell your shares to the public.
Underwriting fees are usually the largest direct cost of an IPO. The London Stock Exchange estimates this is an average of 3-4% of the total IPO proceeds for European exchanges and 6.5-7% for US transactions.
A company will also appoint other external advisers:
You will hire an accountant to audit your financial statements and ensure you have published accurate financial information in your prospectus. Accountants will need to work to strict deadlines for the IPO timeline and they will usually produce multiple reports, which will be partly used as the basis for the financial information needed in the prospectus. Accountants may also advise on taxation and strategic issues, if, for example, you had to restructure your company before the IPO.
Legal advisers are crucial to the IPO process. They will undertake a rigorous investigation of your company – called legal due diligence – with the aim of understanding your company, evaluating any risks and preparing your company for the IPO. Lawyers will also draft and review the IPO documents, including the prospectus, to help your company comply with the relevant regulation, and ensure any statements made by your company is accurate.
When you list on the Main Market, you must choose whether to have a standard listing or a premium listing. If you choose a premium listing, you will have to appoint a sponsor, which is usually an investment bank. Sponsors will coordinate the parties in the IPO and advise your company on how to comply with the Listing Rules.
As I mentioned, because the general public can invest in listed companies, these companies are held to a higher standard by regulators.
Regulations apply when you want to list on a stock exchange. For example, you must produce a prospectus – which is, in effect, a marketing document for investors – that complies with all the legal requirements.
There are also obligations that continue to apply once your company is listed. For example, listed companies must publish regular financial reports, disclose how they apply the Corporate Governance Code, and must ensure at least 25% of its shares are in the public hands at all times.
Two months before Snap went public, a former employee filed a lawsuit alleging Snap had inflated its user metrics to mislead investors.
Going public opens up a company to liability risks. A shareholder may accuse information in a prospectus to be misleading. A director may trade on inside information. Appropriate information about a company may not be disclosed.
The company is also open to scrutiny. Listed companies must disclose information about their business, such as their remuneration policies and their financial information to the public. This transparency means competitors, customers and suppliers have access to valuable information about the company. If a company suffers from a poor financial quarter, it won’t be long before its share price plummets.
Why are law firms floating on the stock market?
It all started with the Legal Services Act 2007. For the first time, law firms could convert to an alternative business structure, and accept investment from non-lawyers. The act had made law firm IPOs a possibility.
Then in 2015, Gateley, a mid-market law firm, kicked things off when it became the first UK law firm to float. At the time, some spectators believed Gateley’s listing was about to start a flood of law firm IPOs. But, it took two years for the next one. In 2017, Gordon Dadds and ‘virtual law firm’ Keystone Law also listed on the UK’s junior stock exchange, raising £20m and £15m respectively.
2018 was the first sign that this might be changing, which is why law firm IPOs may have been on your radar recently. Rosenblatt Solicitors raised around £43m in May, closely followed by Knights who raised £50m in June, in the largest-ever legal float.
Towards the end of June, DWF announced it was entertaining the prospect of an IPO, and rumours suggested Fieldfisher was also exploring a float. This was an interesting proposition. Both firms are bigger, and far more international than the rest. If they listed, it would be a radical change in the legal market.
Now, why would a law firm want to IPO?
Much for the same reasons a company would. An IPO means a law firm can raise a substantial sum of money, without having to rely on debt finance or partners’ capital. The money can then be used in a variety of ways. Keystone Law used some of the proceeds to pay off its debt. Knights said it plans to acquire three companies over the next two years. Rosenblatt said the IPO would allow the firm to better align employee remuneration with firm performance.
There are also benefits to being a listed company. The disclosure rules for public companies mean that clients and lawyers can see how well a law firm is doing, which can enhance its reputation in the market. This level of information is generally kept under wraps by law firms.
But, as we know, IPOs are expensive. Law firms must restructure their partnership model, hire advisers and comply with onerous regulations. It also paves the way for shareholders to scrutinise and influence how a law firm is run, which could – at least in theory – run into conflict with the partnership way of running a law firm.
Despite all this, it remains to be seen whether the top end of the legal market will consider an IPO. Many law firms are reluctant to move away from the partnership structure. Other firms don’t need an IPO to grow their business, especially when the costs are so high.