Reg A+ Mini IPOs and Institutional Investors – A Reality Check
Many years after the JOBS Act was signed into law in 2012, one element, more streamlined capital raising for small growth companies, has resulted in a scant number of so called “mini- IPOs” utilizing Regulation A+. On the one hand, optimizing capital formation for small businesses will undoubtedly assist job growth and innovation. But the reality of mini-IPOs to date, however, has been a mixed picture.
One clear pattern has emerged thus far: institutional investors have taken little to no part in these IPOs for several reasons that have gone largely unsaid.
Since the beginning of 2017, nine companies have undertaken mini-IPOs, or Reg. A+ financings coterminous with listing on a national exchange (i.e., Nasdaq or NYSE). Here are some data points about these companies (as of publication).
- Nasdaq has halted one company’s (LongFin) trading due to possible management improprieties, and the SEC has brought legal action against the company and various associated individuals.
- On average, the other eight companies are down 48% from their respective IPO prices*. For comparison purposes, small-cap indices are up 12% since the beginning of 2017, and the average IPO (i.e., non-Reg A+ mini IPOs) was up 20% in 2017.
- Only one of the companies has material sell-side equity research – to be fair, this does not differ greatly from many other micro-cap and small-cap companies.
- Institutional ownership of each of the eight companies is 2.7%, on average.
- None of the eight companies are profitable, and the average revenue of each for the past reported year was $9.58m (median was $3.1m).
There are three primary reasons why institutional investors have avoided mini-IPOs.
Most investors don’t even invest in larger, less risky IPOs. According to Professor Jay Ritter’s IPO data, IPOs during the period 1980 – 2014 have underperformed other similarly sized public companies by an average of 3.0 percent per year during the five years after issuance. Many investors are cognizant of these risks, and rarely invest in IPOs. If myriad institutional investors abstain from investing in IPOs of much larger companies that are supported by equity research analysts and investment banks with substantive balance sheets used to support post-IPO trading, it is logical that those same investors are unlikely to partake in an IPO with none of the aforementioned characteristics.
Wait for the sale price. Just like countless institutional investors weren’t keen on being guinea pigs in Spotify’s recent direct listing, savvy investors would rather sit back and observe how mini-IPOs trade in the weeks and months after their initial offerings. Based on the limited data set available today, this has been the most prudent choice; there has been limited financial incentive to invest in mini-IPOs. In fact, the incentive is the opposite: If you are keen on a Reg. A+ mini-IPO candidate, wait and possibly buy the stock on sale from its initial listing price.
Impending dilution. When IPO issuers have diminutive revenue, are unprofitable, and are raising comparatively small amounts of money in their IPOs, the signs all point to the same conclusion: this is a company that will need additional financing. Forgetting for the moment that it’s a challenging proposition to succeed as a public company, even for larger profitable companies, potentially interested investors may choose to pass on the mini-IPO and wait to invest in a subsequent financing (which might involve inducements like downside protections or warrants). This is no different than the way many investors treat already public companies who will clearly need to raise additional capital in the near-term.
So what does all this mean for mini-IPOs and service providers?
For prospective issuers, capital markets precedent is more important than the advice from service providers, who are going to benefit financially from your potential listing. This isn’t intended to smear the integrity of these service providers; rather it’s just a recommendation to research what has happened to companies like yours that have walked a similar path. In fact, issuers should reach out to the CEO or CFO of companies similar to theirs that went the mini-IPO route, and simply ask them about their experience. If they were given the chance to do it all over again, would they opt for the mini-IPO or go some other route? These could be highly valuable insights.
For Reg. A+ service providers, the takeaway from the first wave of mini-IPOs was astutely summed up by Mark Elenowitz (CEO of Banq and a well-regarded Reg. A+ expert) when he recently stated “We need to see more successful offerings and better quality issuers.” If service providers devolve into indiscriminate cheerleaders to garner near term fees, mini-IPOs on the whole are going to suffer, with high net worth and institutional investors by and large dismissing the offering before doing any research.
Aiding capital formation for emerging growth companies is as American as apple pie, and couldn’t be more important for the economy. But what remains uncontroverted is that just because a company can go public doesn’t mean they should. Being publicly traded is only appropriate for a certain cross-section of companies.
On the bright side, through education and due diligence issuers can understand the best path to become public entities in a way that makes sense for their unique situation, even if that means tapping capital markets differently or holding back on their IPO until they are more well prepared.
Institutional investors don’t necessarily want more public companies. What they do want is to invest in exquisitely run ones.
*as of publication, 4/27/18