Private companies without the means to go public can still get themselves listed on the stock exchange. This is called a back door listing, where private companies merge with public companies. This strategy can be favourable for shareholders and owners, but can often result in a less than favourable outcome.
At Nash Advisory, we talk with many business owners who dream of “listing on the stock exchange”. We don’t know what draws them to this. Perhaps it’s the allure of meeting fund managers, or presenting at an Annual General Meeting. In our opinion, these are all generally reasons to not list on the stock exchange.
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Options for stock listings
When it comes to listing on the stock exchange, businesses have two options: front door and back door.
- Front door listing is the traditional route of joining the stock market, where businesses fill in paperwork and engage in an initial public offering (IPO).
- Back door listing is where a business circumvents the IPO process and is immediately included into the stock market, usually by merging with a separate, already public company.
Front door listing
As a general guide, a front door listing requires 12 months of preparations and will cost $2 million for a $20 million capital raise. An official listing on the Australian Stock Exchange (ASX) requires:
- A detailed prospectus
- Audited accounts
- A fundraising road show
- Significant legal diligence.
Back door listing
A back door listing is where an existing ASX listed company (often referred to as a listed shell) acquires the vendor's business, and the vendor's business makes up the majority of the new group. This type of listing is sometimes thought of as easier and less time consuming that a front door listing.
However, it does not have the lustre of a front door listing, and is usually only performed for relatively small capital raises. This type of listing typically takes 6 months and will cost $1.5 million for a $10 million raise.
This relatively higher cost is because:
- The capital raise is smaller
- The brokerage being used is smaller
- The commission rate is typically higher
Benefits of back door listings
Back door listings are an easier, more cost-effective way for a business to go public. This process removes the need for extensive regulatory filings and considerable fundraising efforts.
The company and its shareholders may also find value in the merger. If the synergies of both companies align, both businesses will continue to add value and grow.
Drawbacks of back door listings
In our opinion, a back door listing should not be undertaken in 99% of circumstances. A front door listing should only be attempted if your company is worth over $100 million, or if there is a superb growth story.
Back door listings can also result in:
- Decrease in shareholder trust and satisfaction
- Dilution of shares, which can decrease shareholder power in the company
- Falling profits for both private and public company
- Potential suspension of trading for the publicly listed company until the merger is complete
The solution is typically to take on a private funding partner, or to sell to a trade buyer.
A common back door listing scenario
Nash Advisory has first hand experience with this type of scenario. Below are hypothetical statistics for situation we have witnessed. The business in question is here referred to as Company Alpha.
Company Alpha was owned by a 40 year old founder. They were seeking access to $3 million of growth funding, and $3 million of cash proceeds.
They were offered two solutions by their advisor:
Option 1
A private party was committed to investing $5 million for a 60% shareholding in the company. The transaction would have been completed in 90 days and was highly certain of completion. The founder would have:
- Been on a salary of $200,000 per year
- Received $2 million in cash proceeds
- Retained 40% of the shares in the company
Option 2
Instead of taking the above deal, the founder could go through a back door listing process, which would take 11 months to achieve. The backdoor listing would raise $5 million of capital, and the founder would receive:
- A fixed salary of $135,000
- Received $2.5 million in cash proceeds
- Kept 20% of the equity in the company
The decision
In the end, the founder took Option 2 — the lower salary and 20% of the shares in the company, instead of 40% shares and a strong remuneration package.
The only benefit they received was a higher upfront cash component. Going forward, the founder will have to report to a listed board, the ASX, shareholders and comply with many listing rules.
In our opinion this was a poor, risky decision. The process timeline was lengthy and the costs incurred were high. The founder has lost control of his company, and now has limited long term upside.
