Spring 2022 Final Exam on Company Flotations- Corporate Finance, Georgia State University
When a company is going public, the team involved highly influences the outcome of the floatation. State and explain the roles played by the different members of the team when a company is going public.
- The company
- Merchant bank
- Reporting accountants
- Lawyers
- Stockbrokers
- Valuers
The company team typically consists of about four people. The decision to go public is usually a highly personal one. Very often the founder, major shareholder, chairman or chief executive will be directly involved. In a private company, the same person may well fill all these roles. As it is easy to be discouraged by the length and difficulty of the process of going public, his determination and enthusiasm will be of the utmost importance.
As well as the vital involvement of a very senior company executive, there are many more routine tasks for the company to undertake. The accounting department will be heavily engaged in producing past and projected financial information in conjunction with the reporting accountants and it is usual for the finance director or chief accountant to take a leading role. The company secretary is likely to be responsible for reviewing the legal aspects of the flotation, including producing details of the corporate history and liaising with the outside lawyers.
In addition, it is useful for one or two junior executives to be assigned as progress-chasers and coordinators. As soon as confidentiality permits, they should be involved full-time as the more senior members of the company team will inevitably have urgent and unpredictable calls on their time during the period the prospectus is being prepared.
The first party to be involved outside the company is likely to be the merchant bank selected to manage the flotation and act as the underwriter. This choice is usually the first one as the merchant bank takes a central role in putting together the prospectus for the issue. It can also give, in the preparatory stage, a view on whether the flotation is feasible and at least an indication or moral commitment on underwriting. The merchant banks alone of parties involved in flotations are actively involved in marketing the idea to flotation candidates. Consequently, it is quite possible that a company which is beginning to be known in its industry will be itself approached by merchant banks to discuss the possibility of going public. This is increasingly so as the competition between merchant banks becomes more intense.
The obvious candidates are the group's traditional auditors who may be close business advisers to the private group. They start with the advantage of a good base of knowledge of the group and the way it has developed so that everything does not have to be explained from scratch. However, they may not be great large enough to devote a team of experienced staff to complete rapidly the great amount of accounting work which will be required. If the firm is not already well- known, its name may not be wholly acceptable to the merchant bank or give sufficient confidence to investors. It may therefore be necessary to appoint a larger accounting firm, either to replace the existing auditors, or to report on a joint basis. A joint appointment increases costs somewhat but allows the company to have the best of both worlds in terms of accumulated knowledge and reputation in the market. Usually little problem is experienced in establishing a smooth working relationship between the two firms of accountants.
A company which has an eye on eventual flotation may appoint an internationally known firm some years in advance or cultivate relationships with such a firm while not at that stage of appointing them auditors. In the absence of such contacts, the company will have to rely on the advice of the merchant bank in the choice of reporting accountants.
The reporting accountants will be instructed to report to the directors of both the company being floated and to the merchant bank. In addition to their report for inclusion in the prospectus they may also (depending on market practice) prepare a more detailed 'long form' report. This covers not only the financial position of the company but describes its business, management and systems. Some recommendations for change may be made.
The reporting accountants may be able to give valuable advice on any reorganization of the group to be accomplished prior to flotation. If companies are purchased at above net asset values, goodwill may arise. Retained profits of companies acquired may be 'frozen', unavailable for distribution to the public company's shareholders. There are different possible accounting treatments of goodwill on consolidation and preacquisition profits and steps may be taken with the advice of the accountants to minimize these two problems, which can prove troublesome.
The accountant's report is the element of the prospectus which typically takes longest to produce and provides the raw material for much of the remainder of the prospectus. It therefore needs to be commissioned in good time. If the results show up some weaknesses, they should be highlighted as soon as possible so that the problems can be tackled or the flotation reconsidered.
well as producing the accountant's report, the accountants have other major responsibilities. If there is a forecast of profits they will be heavily involved in checking and substantiating it. They may also be asked to check the statement of borrowings, contingent liabilities and commitments and to provide comfort to the directors on their statement concerning the adequacy of working capital. Their advice may be taken on taxation problems or planning for the company. If there is a trust deed or any loan agreement which contains limits on borrowings or other financial covenants, the accountants will check that these have not been breached. They will also have a major role in the verification of the prospectus in general and particularly as regards all figures and calculations.
As a separate matter, the accountants will produce a statement of adjustments setting out the adjustments they consider necessary from the audited accounts as produced by the company prior to its flotation. If the reporting accountant has been the auditor to the group over the period it is unlikely that there will be any material adjustments, except if accounting policies have changed. The statement of adjustments is normally filed with the stock exchange or other regulatory authorities.
It is likely that the promoters will have their own contacts with solicitors. The legal work involved in a prospectus is specialized and not all firms of lawyers will have suitable specialists available to work on a full-time basis. Again the merchant bank may be involved in introducing an experienced firm.
There are two separate aspects to the legal work in a prospectus, one for the company and its directors and the other for the merchant bank. While it is possible for different partners at one firm to carry out the two roles, it is more usual to appoint separate firms to ensure that no conflict arises. While for most purposes the company and merchant bank have similar interests, as regards pricing and the underwriting agreement they are on the opposite sides of the table. The merchant bank is likely to have a close relationship with a number of firms of lawyers specializing in corporate issue work.
The legal work in the prospectus starts very early with preparing a group structure. Formal sale and purchase and other agreements will be needed to document any acquisitions of companies or assets. The lawyers may be able to contribute helpful suggestions for simplifying the methods used for the reorganization and in minimizing tax and other costs the work proceeds, the lawyers will be generally responsible for ensuring that all disclosures required by statute are included in the prospectus. Information which is not covered in other parts of the prospectus may be gathered for convenience in an appendix often headed 'Statutory and General Information'. This may include, for example, a summary of the new articles of association which will be appropriate for a public company, details of material contracts the group has been a party to and disclosure of directors' interests. Lawyers will also draw up the company's board minutes for the various corporate decisions and approvals required and will draft notes of evidence that all material points in the prospectus have been verified. Lawyers may also draft the share certificates and handle liaison with the legal authorities with whom the prospectus needs to be cleared or filed.
In most markets it is required or highly desirable to have a sponsoring stockbroker for the issue. The broker will make the formal application for listing and handle relationships with the people in the stock exchange responsible for scrutinizing new listings whom they will probably know on a personal basis. This relationship can be very valuable in ironing out problems on timing, procedures or documentation before they become major obstacles. The brokers will, if necessary, discuss with the stock exchange the mechanics of share registration, delivery of share certificates, dealing and settlement. The brokers should be closely involved in sounding out large potential shareholders to evaluate their interest in the issue and be in a position to advise on pricing. The people they contact may also form the backbone of the sub- underwriting syndicate which, depending on market practice, the broker may take the lead in putting together. Very often a general market view will emerge on a reasonable level of price for the issue which it is dangerous to ignore even if it is out of line with the price fundamental analysis might suggest. The brokers may be able to set the scene for the issue by publishing a helpful background circular on the sector or industry of the company going public. At the time of the flotation, they may circularize clients recommending the issue. Subsequently they serve as an effective channel of information on the company's progress to clients and shareholders.
It may be required by regulation or desirable from a marketing and information point of view to show recent valuations of major assets. In the case of a property company, the report of the valuer is likely to be the portion of the document which sets the tone for the whole issue.
The reputation and standing of the valuer is vital. The valuer should be recognized as a leader in his profession. There should be no question of his independence from the company. When the properties concerned are located in different countries, it is advantageous to use an international firm or one with strong international affiliations to ensure a consistent approach to valuation is adopted.
Other assets which are regularly revalued include ships, mines and quarries. Plant and equipment are not normally revalued. In choosing valuers for other fixed assets, the same general criteria will apply as for property revaluations. It must be recognized, however, that there may be some disagreement on the basis of valuation and its validity where a revaluation is carried out on a category of asset which is not regularly bought and sold in the open market.
Who are some of the professionals that a company may engage when deciding to go public? What are some of the roles that these professionals play during the floatation?
- Public relations
- Receiving bankers
- Registrars
- Printers
It may be useful to engage a press and publicity agent. Their role can stretch from sowing the original seeds of interest in the months before the prospectus to an intensive media operation at the time of going public. A press conference to announce the issue can be very effective in obtaining coverage which the availability of a certain amount of food and drink does nothing to hinder. At a more nuts and bolts level, the prospectus will usually be reproduced in one or more newspapers and advice may be needed on the effectiveness of various alternative advertising strategies.
The application forms with the cheques attached will normally be delivered to a bank specializing in receiving and checking such documents. The bank chosen may be the clearing bank of the group or may be recommended by the merchant bank. Banks who specialize in this role have pools of experienced staff who can be drafted in to help at short notice in the event of a high level of applications. The bank will charge a flat fee per application form processed. It may also act as a temporary registrar for an initial period.
After applications have been received (and the cheques detached), they will be passed to a registration company. It is their responsibility to tally the applications and carry out the procedure decided on for allocation. They will then draw up the first register of members. It is unlikely that a private group will have any existing contact with a registration company. Such companies are often affiliated with firms of accountants or with banks. The company will normally act on the recommendation of one of its other advisers in choice of registrar.
Although the role of the printer may not seem glamorous, their help with eleventh-hour changes to the documents is often vital. Their in updating and circulating the many proofs required is also a considerable factor in the smooth running of the operation.
What are the major criteria used to choose the merchant bank to manage and underwrite an issue?
- Experience
- Size and reputation
- Chemistry
It is essential that the merchant bank should have been actively and recently involved in the market. The number of flotations in a normal year is not very large and it may be surprising to find that even quite well-known names have handled rather few recent issues. Some claim an expertise which may barely exist in an active form and they will be, in effect, using the flotation to brush up their technique.
As well as the number of issues, it will be relevant to look at the results. It must be recognized that the outcome of a flotation depends quite heavily on short-term market forces which may be outside the power of the participants to control. However, a series of under-subscriptions would be of concern as would large premiums on the first day of dealing, indicating that the promoters could have obtained a better price. It is also instructive to look at the price say six months after the start of trading, adjusting for movements in the level of the market in general over the same period.
A major role of the investment bank, no doubt the single most important feature from the point of view of the company going public, is that it should be able to get the issue underwritten at a satisfactory price. This means it should either have the financial muscle and resolution to stand behind the entire issue if necessary or have reliable institutional connections and other placing power sufficient to find a safe home for the issue. Most commonly, a combination of the two is involved. Once an issue is underwritten and receipt of funds guaranteed, the company going public can take the attitude of an interested spectator in the actual level of subscriptions.
A flotation requires long hours to be spent by the senior management of the company with the merchant banking executives involved. There will normally be a team of say three or four bank executives and it is important to meet at least the leader of the team. Without a personal meeting, it is impossible to know whether a good working relationship can be established. Many problems will have to be tackled during the course of the flotation. Some of these will be sensitive matters for people who have not previously had to disclose substantial amounts of information about their operations to the public. A sympathetic approach is required to avoid turning drafting meetings into confrontations.
The rest of the team of professionals to work on the prospectus may well be drawn from the traditional connections of the company and its management. The merchant bank involved will be able to offer suitable introductions if required. A number of promoters, however, are uneasy at the idea of one professional adviser in effect appointing others and prefer to choose 'their own man.