In recent years, financial markets have witnessed the re-emergence of a technique born during the bull run of the late 1990s: the dual track sale process. ‘Dual track’ means pursuing a listing on the stock exchange and a trade sale simultaneously, primarily to create a competitive process between stock market investors and trade buyers to enhance the price and terms of sale. Dual tracks owe their revival, in part, to the increasing power of private equity investors who are keen to secure a profitable exit from their investment.
This article examines the principal differences between an initial public offering (IPO) and a trade sale, the factors that may tip the balance in favour of one route and practical issues to consider when embarking upon a dual track strategy.
IPO v Trade Sale
The ultimate goal of a vendor will always be to realise its investment for the best price and terms. To achieve this goal, a seller’s main considerations are likely to include:
- due diligence process;
- contractual and other residual liability;
- restrictions on exit; and
- timing and costs.
While the above considerations will be familiar to sellers both in IPOs and trade sales, each has very different dynamics.
Due diligence
In an IPO, a company normally assembles a data room and its accountants will provide certain reports (such as long form, short form and working capital). The company’s lawyers and underwriter counsel will undertake due diligence and on many of the larger IPOs, typically where there is a
One practical point to consider on due diligence is that in an IPO the prospectus and related due diligence tend to be historical, while trade buyers are very much focused on the forward view and having access to business plans and budgets. Therefore, you might want to consider the timing of releasing forward-looking information since, if the trade sale fails, a question sometimes asked is whether the potential purchaser can still invest in the IPO if it has received more information than is disclosed in the prospectus, thereby having an unfair advantage over other potential investors.
Contractual and other liabilities
A key factor in determining whether to pursue an IPO or trade sale is contractual and residual liability. Parties who are ‘on the hook’ can be very different depending on the route and a seller might accept a marginally lower price if it has a clean exit with no or limited contractual exposure for a period after the sale.
In an IPO prospectus and underwriting agreement liability will be a key focus for the company, its directors and any selling shareholder. The prospectus rules require a responsibility statement by the directors of the company to be set out in the prospectus in which they state they have taken all reasonable care to ensure the information contained in the prospectus is in accordance with the facts and contains no omissions likely to affect its import. Each director is required to accept responsibility in the terms of the responsibility statement, even though they may not have been involved in the detailed drafting of the prospectus. Under the Financial Services and Markets Act (FSMA), ‘persons responsible’ for a prospectus are liable to pay compensation to any person who acquires shares and suffers loss as a result of any untrue or misleading statement in the prospectus or the omission from it of any matter required to be included by virtue of the general duty of disclosure.
The other main liability associated with IPOs arises out of the underwriting agreement. It is customary in a float for the underwriting agreement to contain a full suite of business warranties given both by the company and its executive directors. It is market practice for non-executive directors to give a more restricted set of warranties. Shareholders would ordinarily only be expected to give warranties where they are selling shares in the IPO — otherwise they are not ‘on the hook’.
Contrast the position with a trade sale where the company’s shareholders will be expected to give a full set of business warranties with no warranties being given by either the company or its directors. The position on a trade sale quickly changes when there are private equity sellers. As a starting point, a selling private equity house will not give warranties or indemnities on the sale (other than warranties as to title to shares, authority and capacity to enter into the sale agreement). The main reason for this is that the funds must be able to distribute proceeds from the sale to their limited partners. Private equity houses, therefore, tend to resist signing up to any arrangements whereby disposal proceeds are either tied up in any type of escrow or retention arrangements or are potentially subject to clawback.
Accordingly, the terms of sale vary extensively between an IPO and a trade sale, and between a trade sale with a corporate seller and a trade sale with a private equity seller.
Restrictions on exit
A key concern for a vendor (especially private equity) is whether it sells all of its shares and, if not, how quickly it can take its money off the table on exiting. In an IPO selling shareholders will almost certainly be subject to lock-up arrangements — the market standard is one year. On a trade sale a seller can usually exit its investment immediately at closing unless specific escrow or retention arrangements have been put in place. This is a major advantage of a trade sale.
Timing and costs
An IPO typically takes three to six months. A trade sale can be more straightforward and completed on a shorter timetable. However, a dual track process is expensive and labour intensive, as well as extremely tiring and unsettling for management who are uncertain until very late in the day as to whether they will be going on roadshows and running a listed company or are likely to be sold, which could result in some of them being sacked or kept on and re-investing.
In an IPO the company and its directors/managers will face increased burdens due to the ongoing regulatory requirements imposed on listed companies.
IPO or Trade
So what is the bottom line? Our experience at Linklaters is that most dual tracks tend to result in trade sales rather than IPOs. This is often because of:
- a higher price — no IPO discount;
- it is easier to restrict liability on company and sellers;
- sellers can exit the entire investment at closing; and
- management often favour the trade sale with an ability to make real money, away from public markets.
But before embarking on a time-consuming dual track process, a seller should consider the following:
- the need to dedicate time and resources to setting up a data room. The better the data room, the easier the transaction. With dual track, given the potential number and geographic spread of the purchaser(s), a seller should consider having an electronic data room;
- consider at an early stage whether vendor due diligence reports should be produced;
- ensure each external adviser’s engagement letter deals adequately with the dual track process;
- plan the due diligence process so that synergies can be created between the two tracks. If carefully managed most of the review can satisfy an underwriter’s IPO due diligence and the vendor due diligence on a trade sale
(if an information memorandum is prepared on a trade sale, a good deal of the information can be recycled for the prospectus);
- ensure external advisers have experience on both IPOs and M&A;
- consider the type of contractual protection the seller is willing to provide on an IPO and on a trade sale;
- decide upon a date for a decision and stick to it; and
- last, but not least, consider whether management can deal with the strains of a dual track.
Charlie Jacobs is a corporate partner and Simon Branigan a managing associate at Linklaters.
