In our experience, even an IPO that’s priced attractively to the buy-side won’t necessarily draw investors who can’t grasp the strategy and fundamentals that underpin the financials and valuation. In order to expand on the aspects of the equity story that matter to investors, we’ve examined six key questions investors consider in their investment decisions. These questions were drawn from interviews with private equity investors on what they ask management of companies considering going public.
Investors are looking to understand how your business fits within existing business models—at this instant, as well as over time.
Consider the following two investor findings. When it comes to the attractiveness of an industry (industry differentiators), more investors cite barriers to entry and industry growth rates as important considerations compared with other factors. When it comes to company-specific factors (company differentiators), investors want to hear about product integration and scalability as well as addressable market size. Put another way, investors are looking for the product’s potential to grow and dominate within a promising growth industry.
Investors don’t like surprises, and the JOBS Act, which eased certain disclosure requirements, has made it harder to assess the predictability of a company’s earnings potential. Reduced disclosure is the largest area of concern, with 23% of investors saying that fewer years of disclosed financial reporting has made the decision on whether to invest more difficult. Less financial information makes it more difficult for investors to see trends so executive management needs to give institutional investors confidence that management can accurately forecast financial results.
Institutional investors give equal weighting to the soft assessments of management trustworthiness as to the numbers. When asked what’s important in roadshow meetings, they said: Management’s confidence and conviction (96%), experience and credibility (93%), as well as their facility with the numbers (91%).
Going public places two new obligations on top management. The first is well understood: they can expect to spend more time personally addressing investor and analyst needs. The second is equally important, and relates to the ability of the company’s business systems and internal accounting processes to meet Securities and Exchange Commission (SEC) reporting and other compliance requirements. Among respondents, 42% cited ‘lack of regulatory compliance’ as a red flag when reviewing an IPO’s prospectus. This is not the box-checking exercise it seems. Investors want to know whether the company processes and the people behind them work effectively to flag as well as address emerging risks. For example, the disclosure of material weaknesses, along with a plan for remediation, is increasingly common. Most of the investors we surveyed indicated that they would still invest in a company that disclosed a material weakness in the prospectus. Investors value transparency as well as internal capabilities when it comes to weighing a company’s internal reporting processes.
To become comfortable with an IPO’s valuation, investors want to know what forward multiples and financial ratios a company plans to present regularly. They’ll want to understand how to assess the company against its comps. Forward multiples and key performance indicators (KPIs) that matter to investors vary depending on industry and market trends, as well as maturity of the business. In making decisions on investing in IPOs, respondents say some metrics are more important than others.
Investors are clearly more comfortable with seasoned directors at the helm as a company goes through the IPO.
Half of the institutional investors surveyed are looking for at least 20 years of executive experience from board members. The average age of a company director in public offerings in 2015 was 53, according to S&P Capital IQ.
Investors will also want to understand the company’s plans to transition to a board with the independence that matches corporate governance standards for public companies. Listing requirements stipulate that a majority of the directors on a public company's board be independent and that the audit committee be entirely independent. However, it is important to note that there are exceptions to the majority board independence requirements for controlled companies.
This report sets out our findings on how institutional investors come to a decision on investing in a public offering. As we’ve seen, investors have more opportunities to interact with company executives today, and they are taking full advantage of early-stage ‘testing the waters’ meetings to form a better view of the experience and trustworthiness of the people behind the equity story.
They’re also awash in information about company, industry and macroeconomic trends, to which they’re adding their own internal equity research and analysis. As a result of these two important factors, the IPO decision-making process is accelerating and increasing in complexity. In all likelihood, there’s no turning back from this heightened set of expectations institutional investors have for the IPO process. For company executives working toward an IPO, these dynamics underpin the importance of preparation, clarity, and consistency in articulating the equity story.