Private equity fund-sponsored IPOs remain at healthy levels.
There has been a growing number of private equity fund-sponsored companies launching IPOs. Depending on the sector, private equity fund-sponsored companies can account for 25% to 35% of current IPO activity1. This has contributed to a noticeable resurgence following a period where IPO activity in capital markets had slowed down considerably.
There are compelling reasons why private equity backed companies have engaged in a significant ramp-up of IPO activity. Strong valuations for businesses and increased appetite for public market investment are generating healthy returns relative to other options, leading to an environment where interest is outstripping supply.
Depressed oil and gas pricing is another key factor that has driven investors to diversify away from resource-based investments to more traditional, less volatile businesses that demonstrate stability and potential for EBITDA (earnings before interest, taxes, depreciation and amortization) growth, such as business in the retail, foodservice and office services industries among others.
In response to this growing investor interest, private equity funds are evaluating their portfolios more closely for strong IPO candidates; seeking out sizeable businesses with an established pattern of stability and growth that can sustain the rigours of a public offering and attract significant investor interest.
This does not mean however that any large – or growing business for that matter - within a portfolio is a qualified candidate. In addition to strong revenue and growth numbers, a business must also have the appropriate infrastructure in place in terms of resources, systems, processes and internal controls to successfully operate as a public company.
One should always keep in mind that an IPO is a relatively long process from the time the decision is made to go public and the actual launch – at least three to four months and likely longer. During that period, there is a great deal of fine tuning and exploratory work to be done to help ensure optimal outcomes.
One factor that distinguishes a private equity fund-sponsored IPO is that it does not constitute a complete exit on the part of the private equity fund. Unlike an outright third party sale, in which the private equity fund liquidates its entire investment, an IPO typically involves the private equity fund sponsor maintaining a significant interest in the company. The private equity fund sponsor is aligned with the public investors in helping maximize shareholder value and will generally continue to help provide strategic advice and other assistance in contributing to the company’s future growth. This can hold significant appeal for investors, as it helps provide additional assurance in terms of stability, as well as helping to increase the potential for the company to maintain and grow its value.
One item of note that is generating interest in Canada and possibly worth consideration depending on the business is the use of tax receivable agreements (TRAs). These are becoming a relatively common part of private equity fund-sponsored IPOs in the U.S. and garnering interest on the part of their counterparts in Canada. In an IPO that incorporates a TRA, the IPO is structured in a manner where the public company is entitled to deductions for income tax purposes after the IPO process is completed. A portion of the income tax saved from these deductions (which is frequently 85% in U.S. IPOs) are paid to the private equity fund sponsor through the TRA, and the remaining benefits are retained by the public company generating more funds for both parties. Private equity funds in Canada are now considering the concept and the structural requirements to execute it.
While private equity fund continued involvement offers a significant value add in the IPO process, companies undergoing an IPO must also keep in mind that becoming a public company is different than having the full support of a private equity fund. Once companies enter the public realm, they must be prepared to face new standards for internal controls, financial reporting, and enhanced disclosures about the compensation of key executives.The increase in private equity fund IPO activity in Canada is a welcoming sign during a time of volatile market conditions. The key to success lies in assessing the ideal candidates with the right foundational elements for stability and continued growth.
For more insights on capital markets activity in Canada visit our IPO Services site at kpmg.ca/ipo.
1Source : KPMG