How private companies can choose the right path on the IPO journey

After a bumpy ride marked by high inflation and rising interest rates, the IPO market offered hope of a rebound when three highly anticipated deals stirred up activity in Q3 2023. Those three companies each raised over $500 million, and one of them became the biggest IPO since 2021.¹ However, significant challenges still remain before we see a broader recovery.

A panel led by EY leaders in the Financial Accounting Advisory Services practice shared insights into the current IPO market and explored how to assess IPO readiness during an Emerging Venture Capitalists Association webinar. The panelists examined the pros and cons of three main public listing alternatives, the economic forces that fuel IPO activity, and how to prepare for the IPO journey.

Choosing a route to the public markets

Despite the precipitous drop-off since the IPO boom of 2021, the allure of going public remains strong. Raising private capital can take a long time, especially in challenged market environments. For private companies looking to go public, being able to raise capital more efficiently in the public markets is a key driver. Another lure is acquisition currency, the ability to have a liquid public stock to offer to potential M&A counterparties, which allows companies to pursue inorganic growth strategies more effectively. Going public also serves to build brand awareness, with the buzz in the press leading up to the celebratory ringing of the bell at the stock exchange.

Once a private company decides to go public, they reach the first fork in the road: Should they go the traditional IPO route, or would a SPAC merger or direct listing offer a better path?

“As you think about the ability to raise primary capital, there's a big difference across that vector,” says panelist Stephen Lambrix, EY US Managing Director, Ernst & Young LLP, with the EY IPO and Private Transactions Advisory in the Financial Accounting Advisory Services practice.

For a traditional IPO, the company should have a strong track record, attractive balance between growth and profitability and a clear use of proceeds, says Lambrix.

While SPAC mergers also can bring a new capital injection, deal dynamics in that market are less attractive right now because of the challenges in getting Private Investment in Public Equity (PIPE) financing across the finish line. “In 2020 and 2021, when we had a very active stock market, PIPEs were a lot easier to get done at attractive terms,” says Lambrix. “That has totally changed. The complexion of attractive SPAC candidates, interestingly, has shifted towards earlier-stage companies where you can articulate the long-term vision and strategy of the company's growth story, because you are able to include projections in a SPAC context.”

The third alternative, direct listing, is best for companies that don't need primary capital. These companies typically have a well-established shareholder base and are looking for immediate liquidity for existing investors and employees, says Lambrix.

Taking stock of the current IPO market

While the recent high-profile IPO deals injected a dose of cautious optimism, the market is far from the peak of the IPO boom in 2021, when 300 deals raised over $150 billion. The extreme bouts of inflation that hit a 40-year high and the Fed aggressively increasing rates led to a staggering drop in 2022 with only 25 deals raising $8 billion. After a quiet first half of 2023, the semiconductor chip manufacturer that went on to become the biggest IPO in two years and the 17^th largest of all time² kickstarted Q3 2023. That deal was followed by two more closely watched IPOs, a grocery delivery company and an e-commerce marketing automation SaaS company, which priced above their initial offering range and traded up in the first week of the aftermarket.

These traditional IPO deals shared certain features in common, noted panelist Kevin Tooke, EY US Senior Manager, with the EY IPO and Private Transactions Advisory in the Financial Accounting Advisory Services practice. All three companies had name-brand recognition and proven business models, he said, adding, “They were pre-selectively marketed to a small handful of investors. And once those investors saw the opportunity to get their trading books back in the black for the year, they took advantage of that.”

SPAC mergers, on the other hand, have not experienced the same boost. The first half of 2023 saw only $2 billion in proceeds across 17 SPACs. Post-merger stock performance has generally been very poor, Tooke said, declining more than 85% on average from the peak in December 2021. As investors continue to lose money on these deals, redemption levels at the merger are also at an all-time high. “If there is any reason to be positive in the SPAC world, it is that there still are a ton of SPACs out there looking for merger targets,” says Tooke. “More than 200 SPACs today are seeking a partner and about half are focused on tech specifically. But it is definitely harder to find the silver lining in this backlog.”

Launching a successful IPO deal

After seeing an uptick in companies filing to go public, it might be tempting to race ahead and dash down the IPO path. But it’s important to remember that successful IPOs are usually the result of slow, steady preparation. A common pitfall is underestimating the complexity and intensity of the IPO process, says panelist Condola Brivitte, EY US Senior Manager in the Financial Accounting Advisory Services practice.

“We view IPOs as a transformational process for the company and that journey typically starts two years out,” says Brivitte. “Even with the market being down, for a lot of these companies that have come onto the market, the planning started at least two years back.”

In the planning and readiness stages, Brivitte says companies should determine which exchanges to be listed on, what structure to go with, and who the key players will be in the IPO process. They should also identify any major gaps across the enterprise, and consider the following questions:

• Are the company’s financial statements up to public company standards?
• How many years of audits will be required?
• Are IT systems going to be able to scale up? 
• Is the new public company going to have additional human resources needs?

At least six months out, the company should start operating like a public company. “That way you're working on the gaps between being private and becoming public,” says Brivitte.