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Negotiating with venture capitalists – guidance for pre-IPO companies

Negotiating with venture capitalists – guidance for pre-IPO companies . Alex Woodfield Partner Head of CIS Business Team. www.ffw.com/CIS Date June 2008. Table of content. Venture Capital: Buyouts How is a venture capital funding structured? Exit strategies and structures Why IPO?

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Negotiating with venture capitalists – guidance for pre-IPO companies

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  1. Negotiating with venture capitalists – guidance for pre-IPO companies Alex Woodfield Partner Head of CIS Business Team www.ffw.com/CIS Date June 2008

  2. Table of content • Venture Capital: • Buyouts • How is a venture capital funding structured? • Exit strategies and structures • Why IPO? • IPOs – Conflicts and Alignment • Board restructuring pre-IPO – Legal Issues • Markets choice

  3. Cass Business School Report • Key findings include: • private equity-backed IPOs outperform other IPOs by more than 9% one year after their public listing • they also outperform the FTSE ALL Share Index by 20% over the same period • venture capital-backed IPOs typically spend up to five times as much on R&D as their non private equity-backed counterparts at the time of flotation • typical private equity-backed IPOs spend twice as much on capital expenditure in relation to total assets as non private equity-backed companies. * The report was commissioned jointly by the British Private Equity and Venture Capital Association and the London Stock Exchange, and covers the period January 1995 to December 2006 , available from www.bvca.co.uk

  4. Cass Business School Report The report also shows that: • private equity-backed IPOs account for more than 50% of the total number of companies in the consumer services, industrials, healthcare and technology sectors in the Main market. The majority of venture capital-backed IPOs are in the health and technology sectors • out of 1,735 IPOs on the London Stock Exchange Main and AIM markets between 1995 and 2006, private equity-backed IPOs accounted for 22% of the number of IPOs and 27% – or £18.9 billion – of the total sum raised • the average length of time a private equity firm invests in a company before flotation is 4.5 years for venture-capital-backed IPOs and 3.8 years for PE-backed IPOs • IPOs in the Main Market perform relatively better than their AIM counterparts • the PE firm typically holds an average of 33.2% in venture capital-backed IPOs and 59.2% in PE-backed IPOs just before flotation. Immediately after flotation, these holdings are at  19.8% and 28.5% respectively, showing the continuing involvement that the original investors have in the business. * The report was commissioned jointly by the British Private Equity and Venture Capital Association and the London Stock Exchange, and covers the period January 1995 to December 2006 , available from www.bvca.co.uk

  5. Situations funded • Existing company and managers seeking growth capital • MBOs (Management buyouts) • MBIs (Management buy-ins) • BIMBOs (Buy-in/management buyouts) • IBOs (Institutional buyouts)

  6. (1) How is a VC funding structured? Private Equity Fund New Managers Key terms of a VC financing: • Debt and equity • High leverage • Cost of financing • Tax rate on investment • Tiers of lending • Liquidation preference on Exit (based on ongoing investment) • Board representation Existing Owners FundingTarget

  7. (2) Final Structure -ownership Private Equity Fund Managers/ Owners Debt Providers Newco 1 Newco 2 Target Co

  8. (3) Final Structure - Financing Private Equity Fund Owners/ Managers Debt Providers prefs mezzanine Newco 1 Newco 2 Target Co

  9. (1) How is a VC funding structured? Private Equity Fund New Managers • Competing interests of debt/equity providers: • Costs of funding • Tax Structuring • Priority of security/tiers of lending • Board Representation • Leverage Existing Owners Funding Target

  10. (2) Final Structure -ownership Private Equity Fund Managers/ Owners Debt Providers • Participation • Ratchets for performance • Liquidation Preferences Newco 1 Newco 2 Target Co

  11. (3) Final Structure - Financing Private Equity Fund Owners/ Managers Debt Providers • Tiers of lending • Leverage • Cost • Deductible Payments prefs mezzanine Newco 1 Newco 2 Target Co

  12. Exit Strategies • IPO • M&A / Trade Sale • Dual – track strategies (IPO and Trade Sale) • But, traditional exits are not the only options

  13. Exit Strategies • Consolidations • Secondary buy-outs / re-caps • Break-up and distribution of proceeds • Redemption of shares • Portfolio sale (VC1 to VC2) • Portfolio merger (intra-portfolio) • Insolvent liquidation • Accelerated IPOs

  14. Why IPO? • Clean exit? But lock-ins • Higher valuations? • Access capital markets • Liquidity • Prestige • Use of paper for M&A post-IPO • But: cost, compliance, publicity, board restructuring

  15. IPOs – Conflicts and Alignment • Pre-IPO restructuring • Conflicts and tensions on commercial terms and ongoing roles and obligations: • Founders • Directors • Early investors (seed, angels, early-stage VCs) • Late-stage VCs • Scientists • Option-holders • Timing: • Pressure for exits on any terms? • Market issues • Role of investment banks • Impact on option holders

  16. Structure: • % free float • Pricing • Underwriting • Lock-ins • Irrevocables • Terms of preference shares • Conversion • Liquidation preferences • Consents / vetoes • Reps and warranties

  17. Board restructuring pre-IPO – Legal Issues • Corporate Governance for listed companies • The Combined Code • When does it apply? • Official List or AIM • Non-executives • Directors’ interests • Incentives • The Model Code • Committees

  18. Markets Choice • Official List or AIM: • Depends on the company’s size, development stage, growth strategy, capital requirements • Different admission criteria • Different regulatory regime • Different listing options available

  19. Key distinctions between AIM and the Main Market Main Market AIM Minimum market capitalisation of £700,000. No minimum market capitalisation. Normally three year trading record required. No trading record requirement. Minimum 25% shares in public hands. No minimum shares to be in public hands. Pre-vetting of admission documents by the UKLA. Admission documents not pre-vetted by Exchange or UKLA. Sponsors needed for certain transactions. Nominated adviser required at all times. No prior shareholder approval for Class 1 transactions. Approval only required for reverse takeovers. Prior shareholder approval required for Class 1 acquisitions and disposals. (25% on class tests)

  20. Field Fisher Waterhouse LLP • Full service European law firm • AIM Lawyer of the Year – 2007 • Equity Markets Practice provides advice to a strong client base of fully listed and AIM listed companies as well as a wide range of investment banks, brokers and nominated advisers • Dedicated CIS Business Team - active involvement in the CIS for major Russian, Ukrainian, Kazakh and other CIS businesses • Advising CIS listed companies If you would like more information about Field Fisher Waterhouse LLP CIS Business Team, please follow the link: www.ffw.com/cis or alternatively contact Alex Woodfield or Arik Aslanyan on +44 (0) 207 861 4000

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