A perspective from Joshua Woo of JW Legal
Direct listing is becoming a common way for companies to get listed on the NZX Main Board. The post listing conduct of these companies are also becoming topical. I have attempted to set out below what’s involved in a direct listing on the NZX, focussing on the company’s decision to list and what this means for retail shareholders.
- A direct listing is a fast and streamlined way to get listed. It does not involve raising new money from the public.
- A listing provides access to public capital markets and liquidity for existing (pre-listing) shareholders. It may be an attractive option for companies that find it difficult to find private exit opportunities.
- Listing criteria on the NZX include initial market capitalisation (minimum of $10 million), shareholder spread (at least 20% of the shares being held by 100 or more non-affiliated holders) and strict corporate governance and reporting requirements.
- There may be more suitable alternatives to listing on the NZX – Catalist, Syndex, ASX and other private market options.
- Retail shareholders face a number of risks buying into directly listed companies, mainly around price and corporate governance.
A direct listing is where a company becomes publicly listed and its shares are tradable on the stock exchange. The company is listed without making a public offer of securities, which is the norm with traditional initial public offerings (IPOs). Also called a “compliance listing”, the purpose of a direct listing is to gain status as a listed issuer and for a company to prove itself to the public market. The listing provides liquidity to the founders, employees and other early shareholders, and also helps the listed company to access the public capital markets for new capital in the future.
A direct listing is a common way for often widely-held private companies to list on the NZX. This is mainly due to its faster and streamlined process, and the perception that the listing is less affected by the public market conditions. In the last 2 years, NZX has accepted five direct listings of Trade Window, Radius Care, NZ Automotive Investments, Third Age Health and Greenfern Industries.
A company’s decision to list
Let’s start with a company’s decision to list. A direct listing is most suitable for companies who may want to access the public capital market in the future for growth or acquisitions. (There is a 3 month wait period after listing before you are allowed to raise money from the public). The public capital market is in theory much deeper than the private market, which is generally restricted to wholesale investors.
They may also want to provide liquidity for founders, employees or early shareholders through the public market. These shareholders may have found it harder to sell their shares in a private company. On listing, they have the option to sell down their stake slowly over time if they still want to be part of the business and also diversify their wealth.
As with liquidity, there is also better price discovery because the shares are traded continuously and transparently. For example, mature businesses that have strong cash flow but have low-to-medium growth may not be an attractive target for private M&A transactions. Direct listing can be preferable than accepting a low valuation on a private exit scenario. Once listed, these businesses can prove their strong cash flow (consistent dividend yield) and existing shareholders can sell at a price that reflects the strong yield in the public market.
For others, a direct listing will not make sense. They may be in a fast-growing industry and have strong private equity or trade buyer interests. So there could be readily available alternatives (including attractive exit opportunities) to a direct listing option. The existing shareholders will be hesitant to commit to the cost of going through a listing and of ongoing compliance costs afterwards. Also, if the company does not have a wide shareholder base, the illiquidity of shares will be an issue. This could result in wild swings in share prices after listing as the lack of transacting parties will affect price discovery.
Another key factor when deciding to list is whether the company can practically meet the NZX listing requirements and the ongoing obligations of listed issuers. These include:
- Market capitalisation: On listing, the company must have an initial market capitalisation exceeding NZ$10 million. While this is the minimum requirement, a market cap of NZ$50 million would be more reasonable to justify the listing and even then may not be enough to attract institutional investors’ interest. Unlike in an IPO where the investment bank will engage the market for an acceptable valuation (prior to listing), the initial market capitalisation for directly listed companies is self-determined and then tested (or “discovered”) on listing by the market of sellers and buyers.
- Spread requirement: At least 20% of the shares in the company must be held by at least 100 people that are “Non-Affiliated Holders”. These are shareholders other than those who hold 10% or more of the shares or have the power to appoint one or more directors. The spread requirement ensures that the shares have a level of liquidity and are not thinly traded from day one. However, it can also be an issue for companies that are closely held and considering a listing. How does a company, say, with 5 shareholders increase its shareholder base to 100 or more? To solve this issue, companies often carry out look pre-listing capital raises to wholesale investors, their employees and other close business associates to increase the spread prior to listing. Another way to meet the spread requirement is to seek NZX’s confirmation that the company will have an appropriate spread to ensure a sufficiently liquid market. This is essentially a waiver to the technical minimum spread requirement. The confirmation is not easily given, and the company must be able to show a credible liquidity plan, for example, of future sell-down by existing shareholders or new share issues to achieve the spread within 12 months of listing.
- Governance: Among other governance requirements, the company must have at least two independent directors, and have subcommittees as mandated under the NZX Listing Rules and NZX Corporate Governance Code. These are not necessarily deal-breakers to a listing. However, the effort and time needed to put in place the right corporate governance structure prior to listing cannot be underestimated.
- Financials and audit requirements: As part of listing, the company needs to publicly share its audited historical financial statements. Most private companies are not likely to have had their financial statements audited, so some planning will need to go into place here. However, like the governance requirements, the preparation of financial statements are not deal-breakers and can generally be worked through as part of the listing process.
Depending on what exactly a company needs, there may be alternatives to direct listing that make better sense. These include an IPO-path, private exit/capital raise options, continuing the status quo or listing on alternative stock exchanges – such as ASX, Syndex and Catalist. Syndex and Catalist are marketed particularly for small to medium businesses and structured so that the company can transition to the NZX later on. Businesses serious about the listing should engage the NZX Relations team, and the representatives of the alternative exchanges, to think through the listing options.
Risks and opportunities for Retail Investors
For retail investors, investing in a directly listed company involves both risks and opportunities. The key topics are around price and governance structure.
Share prices of direct listed companies are not set by any market discovery mechanism before listing. The share price can swing wildly on listing as market trading helps discover the price. If caught in the wrong swing, investors can quickly see their investments lose significant value. There is also (arguably) a negative longer-term price trend. Four out of five directly listed companies in the last two years were trading significantly below their listing prices, wuth the only exception being Third Age Health. (This stat should be read in the wider context – companies listed via the more traditional IPO route in the last few years are not doing any better and there is the wider concern over the recessionary environment).
However, the price movement is both an opportunity and risk for investors. Because there is no initial public offering – which locks investors into the listing price – investors can wait and see what the trade volume, liquidity, price range and other factors look like once a directed listed company starts trading. Directly listed companies must also prepare robust listing documents. These are listing profile and historical financial statements, which must be of substantially the same calibre as if the company was undertaking a traditional IPO. With the right due diligence – at minimum, the review of the listing documents and price movements after listing – investors can make calculated investment decisions.
The other topic is around corporate governance. Directly listed companies often have less spread of shareholders at least initially, and also concentrated shareholding within the founder group. The founder group will likely have enough shareholding to control the board. If not managed well, this can result in corporate indigestion post listing. NZX Listing Rules require appointment of independent directors and the recommendation that they form the majority of the board. It is fair to expect a period of adjustment (and disagreements) between the independent directors and the controlling founder team. The issue can be particularly nuanced where the independent directors have no experience in the relevant industry of the listed company.
The problem is when the indigestion issue becomes public. For example, there may be director resignations or, more embarrassingly, directors failing to be re-elected at the company AGM. The public perception of the board breakdown will likely have negative impact on the share price – whether or not the breakdown affects the underlying financial performance of the company. Unfortunately, this type of corporate indigestion risk is not going to be disclosed in any public listing document. To the contrary, listing documents will likely list the biographies of the founders and the new independent directors in the best light as possible. So it is only time and perhaps investors’ caution that will tell the magnitude of this risk.
Direct listing is an exciting event for investors. The market is introducing a new company, potentially in a new industry. With the right due diligence, the investors may find that they have an interesting investment opportunity in front of them. However, there are real risks around price discovery and corporate governance. These are not risks that can be uncovered on day one.
Joshua is a founding director at JW Legal, specialising in capital raising, exit and other corporate transactions. He has close to a decade of transactional experience, including listing a few companies on the NZX, capital raises, and business sales and purchases of all sizes.
Prior to founding JW Legal, Josh worked at specialist corporate transactions firms in Auckland, including Harmos Horton Lusk and Webb Henderson. Josh is one of the solicitors approved by the NZX to provide opinions on listed entity governing documents. Outside of JW Legal, Josh is the legal advisor to TEDxAuckland and also a volunteer lawyer at the Auckland Central Citizens Advice Bureau.