An IPO or an RTO, That is the Question

On January 3, 2019, the Financial Post reported that 54 new equity issues on four Canadian exchanges raised a total of $2.2 billion dollars in all of 2018, approximately less than half of the $5.1 billion generated from the 37 initial public offerings (“IPOs”) in 2017. According to Go Public in Canada, between the two most popular methods of taking a private company public—an IPO or a reverse takeover (“RTO”)—it is estimated that 65 to 70 per cent of companies that go public in Canada have done so by way of an RTO. Given their undeniable popularity, in this post I will examine the advantages of both.

Overview of IPOs and RTOs

RTOs are known as “back door listings” or “reverse mergers” of companies already listed on an exchange with a private issuer. RTOs are done in a number of ways with exchange structures or amalgamations being the most popular techniques. An IPO, on the other hand, is a listing that a private company achieves on its own merit through a prospectus offering and organic shareholder growth. Despite the statistical preference in favour of RTOs, there are many advantages to having an IPO.

In a Bloomberg interview, GMP Capital Inc., called the Canadian market for public offerings “a junior market that’s more comfortable with risk than other parts of the world”. Canada’s risk appetite favours, in part, IPOs since the chance of a successful IPO may be greater domestically than compared to foreign markets. Further, an IPO is preferred for a number of additional key reasons: (i) an IPO is always a capital raising exercise that can satisfy immediate financial needs; (ii) an IPO creates the necessary platform for easier access to future financings with a heavy upfront cost but a relatively lower cost later given the prospectus (and continuous) disclosure already in place; (iii) a managed increase in the shareholder base of the company through a number of controlled private financings leading to the public offering may allow major shareholders to retain a better equity position in the listed stock; and (iv) there is a heightened opportunity for a reputational boost through the increased level of IPO publicity. Although there are many benefits to an IPO, cost and speed favour an RTO.

Unlike an IPO, which permits private companies to independently achieve a public listing, RTOs require a public “marriage” between a listed issuer—a company that is often financially limited or without an active business—and a growing private company that may have the financial resources to successfully carry the collective enterprise forward without the need to access public funds. In addition to having the necessary shareholder base that allows the resulting issuer to meet listing requirements, the public “shell” offers the financial history required to support a public listing and a management team that can assist the “marriage” in its first public steps, if necessary. An RTO rarely requires a prospectus and an underwriting team unless immediate access to public funds is necessary. This significantly improves the cost and speed with which a public listing can be achieved in addition to the lesser degree of regulatory scrutiny given the lack of a prospectus involved in most cases. Subject to finding an eligible suitor, start-ups and private issuers with funds (or ability to raise funds privately) may find an RTO a better fit, with lower cost and quicker access being key.

Timing, Pricing and Other Considerations

With liquidity and access to capital, together with increased investing confidence in the listed issuer being a primary motivator to going public, it is worthwhile noting that a listing also offers insiders a market to exit (which many times is the main motivator in the process) and, in some instances, an ability to position the company for a more aggressive and opportunistic sale of the business through a take-over bid process.

In both cases and regardless of the method used, private companies have to arm themselves with patience and faith in market conditions as pricing of the offering in an IPO and/or an RTO (if a capital raise is required) is one of the primary motivators guiding the timing of the initiative with a minimum 6 to 8 months to a year of lead time to achieve the goal. Academic studies on the timing and underpricing of IPOs have suggested that an average of 18 per cent underpricing is to be expected at the time of listing to trigger decision making to go public (see Jay Ritter on Initial Public Offerings: Underpricing). This concept is based on the premise that the listing price should always be lower than the first day market closing price to allow an immediate market recognition.

IPOs Come in Hot and Cold Waves

In a Journal of Finance analysis of managerial decision-making in the initial IPO process, the authors contend that public offerings come in hot and cold waves. The number of new equity issues in 2018 suggests that we were riding on a “hot market” in 2017, with some uncertainty as to whether the trend will continue based on observations of the lesser dollar value raised comparatively. The openness of the Canadian Stock Exchange to listings of US cannabis companies in the last quarter of 2018 as reported in a December 18, 2018 Bloomberg story, however, provides evidence of a new “hot wave” in the making which can carry the market through 2019.

Regardless of the trends, the benefits of a public listing are undeniable and the timing of such an initiative being crucial to its success. The methodology engaged may offer an advantage with respect to cost and speed with an RTO perhaps being the quicker and more economic “way through the [public listing] door.”

What are your key questions and concerns about using RTOs or IPOs? I welcome your feedback and questions regarding this post.  Please post your comments on our LinkedIn page at: Dickinson Wright Canada on Twitter at: @DWrightCanada or on my personal LinkedIn Page at: