No (corner)stone left unturned in UK and European IPO market
The recent rebound in UK and European Initial Public Offerings ("IPOs") has brought with it a rise in the prevalence of cornerstone investors, something that has been an important feature of Asian capital markets for many years. Issuers to announce recent UK listings backed by cornerstone investors include The Hut Group, Trainline, Trustpilot, Network International, Moonpig, Dr Martens and Auction Technology Group.
Bringing cornerstone investors on-board allows an issuer to gather real momentum behind its IPO, generating positive sentiment and PR, as well as helping to de-risk the IPO process. Whilst there can be drawbacks to using cornerstone investors, particularly if they are given too large an allocation, in most cases the positives will outweigh the negatives.
Whilst there are broader macroeconomic factors helping to supercharge this emerging trend, as issuers, underwriters and the UK and European market more generally become increasingly familiar with the benefits of cornerstone investors, we expect them to be an increasingly common feature of the UK and European IPO market.
What are cornerstone investors?
In the context of an IPO, a cornerstone investor is an investor (typically a large institution) which agrees to subscribe for or purchase a minimum value of shares as part of a company's IPO offering in advance of the formal roadshow.
While the exact percentage will vary depending on a number of factors (including the level of demand, macroeconomic factors, the premium placed on increased certainty and anticipated liquidity post-admission), the underwriter will typically look to place somewhere in the region of 25% to 40% of the total offering with cornerstone investors, as illustrated by the recent examples of Main Market listings below:
How do they work in practice?
Prior to the issuer's management team commencing the "investor roadshow" and publication of the prospectus, and typically around the time that an issuer publishes its registration document, management will meet with would-be cornerstone investors and deliver a "deep-dive" presentation, to help those potential investors better understand the issuer's business.
Following those meetings, an issuer, and often the larger selling shareholder(s), will discuss the proposed involvement of cornerstone investors with their financial advisors and the underwriters co-ordinating the IPO offer. Once the investors have been selected, they will then negotiate and sign a "cornerstone investment agreement" which will oblige the investor to commit to a minimum allocation in the bookbuilding process, as well as providing customary representations and warranties in favour of the issuer and the underwriter.
Details of cornerstone investors will need to be disclosed in the prospectus, as the cornerstone agreement will constitute a material contract. Additionally, it is common practice, and generally part of the purpose of obtaining cornerstone investors, to include details of the names of cornerstone investors and minimum commitments secured by the issuer in RNS announcements relating to the listing.
What are the advantages of cornerstone investors?
Positive momentum and PR
A key benefit of securing cornerstone investors is demonstrating and communicating positive momentum for an IPO. This is particularly the case where an issuer has been able to obtain high quality investors, which it will then seek to publicise via its IPO announcements. Other potential investors in the wider market can take some comfort from the fact that high profile investors have committed to invest for specified allocations. An issuer may also be able to generate additional PR coverage by securing key cornerstone investment.
Reduced pricing risk and execution risk
For an issuer or a selling shareholder (such as a founder or an exiting private equity house), cornerstone investors provide greater certainty of success for an IPO. Committed minimum allocations ensure that a significant proportion of the book is covered early in the process, thereby de-risking the bookbuilding exercise in the wider market. Setting a price earlier in the process can help an issuer to "lock-in" the value and help to generate the demand from other would-be investors through the halo effect.
Enhanced engagement with interested investors
A corollary of the rise in cornerstone investors is the development of the "deep-dive" presentation. As the name suggests, this presentation typically provides more detail on the issuer than a typical management roadshow presentation, providing institutional investors early access to management teams. Whilst all material information provided in these meetings will need to be disclosed in the prospectus in due course, the real benefit for both an issuer and its directors of these meetings is that they present a strong opportunity to engage with an experienced would-be investor.
Even if they are not ultimately selected as a cornerstone investor, this early engagement will help management to refine its sales messaging as well as providing a good basis for shareholder engagement post-listing, should the investor participate in the bookbuilding in any case.
What are the potential risks of using cornerstone investors?
Whilst relative scarcity of shares is likely to improve the prospects of an issuer's share price in the market post-listing, cornerstone investors will acquire a sizeable stake in an issuer, which in turn will reduce the percentage of equity available for sale to other would-be investors and potentially diminish the breadth of an issuer's shareholder base post-listing.
Additionally, larger investors may only be interested in participating in a bookbuild if they can be sure of obtaining a certain level of shareholding. Careful consideration therefore needs to be given by the issuer, in close consultation with its advisers, as to the level of any cornerstone investment.
Potential price drag
The cornerstone process is usually carried out following publication of a registration document prior to publication of a prospectus and, consequently, to the pricing of the IPO. Many cornerstone investors will only be willing to commit to a minimum allocation on the basis of a specific valuation range or up to a certain maximum valuation, the details of which will need to be disclosed in the prospectus as a material contract.
Current market practice in the UK and Europe is that general investors participating in the bookbuild will be unlikely to accept a higher offer price than that offered to cornerstone investors. It is therefore important to consider pricing carefully at an earlier stage in the process, before the management roadshow and consequent pricing feedback, as it is very difficult to subsequently increase the offer price if demand in the wider market proves to be higher than anticipated.
Choosing the wrong cornerstone investors
Since cornerstone investors on IPO will hold sizeable stakes in an issuer, it is important for directors to take the time to understand the reasons behind a would-be investor's interest in the company and their investment goals.
Lock-ins, where new investors are restricted from selling their shares for a minimum period following IPO, are not general market practice in the UK and European cornerstone investment market, although they are common in Asian capital markets. A potential cornerstone investor's motivations should be considered carefully with an issuer's advisory team, who will be able to provide a broader view on general investor and market sentiment.
How popular are they in the UK?
Historically, cornerstone investment is a concept that has struggled to gain traction in the UK and wider European market. In the last five years, just 13 of over 130 UK Main Market IPOs involved a cornerstone investor.
However, their recent growth has been dramatic - in the last 12 months alone eight Main Market IPOs have made use of cornerstone investors, including household names such as Trustpilot, The Hut Group, Moonpig and Dr Martens.
We have a range of experience advising issuers, selling shareholders and underwriters in relation to cornerstone investors. For example, we recently advised Auction Technology Group (ATG), operator of world-leading marketplaces and a proprietary auction platform for curated online auctions, on its £600 million Main Market IPO, which included £125 million in aggregate of cornerstone commitments from major institutions – BlackRock, Merian Global Investors/Jupiter Asset Management, Caledonia and Capital World Investors – and we are increasingly being asked about cornerstone investments in our discussions with investment banks, underwriters and potential issuers.
Why is this an emerging trend?
In addition to the growing market awareness of the benefits of cornerstone investment detailed above, we believe there are several broader factors driving this trend:
- a key part of the growth in cornerstone investment is due to the changes in the FCA's Conduct of Business Sourcebook (COBS) in 2018, which were intended to provide additional information to potential investors earlier in an IPO process. The result of these changes was that registration documents have quickly become a feature of UK IPOs, increasing the timetable between the market becoming aware of a potential IPO and a company actually being admitted to the market. This has had the dual effect of encouraging issuers to seek greater certainty (to counterbalance the increased uncertainty arising from the lengthened public timetable) by using cornerstone investors, whilst also providing investors with the opportunity to express interest in issuers earlier in the process on the basis of an approved registration document and thereby "lock down" their allocation in a popular IPO;
- 2021 looks set to be a bumper year for IPOs in the UK and Europe and it has been widely reported that this year could be one of the biggest single years for public listings, particularly of technology businesses, for a long time. In such a crowded marketplace, having one or more "banner" cornerstone investors can help an issuer to stand out and generate additional PR coverage; and
- on the flipside, whilst the world is still in the midst of the COVID-19 pandemic (albeit with glimpses of normality on the horizon) many investors are understandably cautious about investing in newly listed companies. The added comfort of demonstrable backing from major institutional cornerstone investor(s) can help to provide comfort to potential investors and thereby support an issuer's ability to execute a successful IPO.
What does the future hold?
In the short to medium term, we expect that the use of cornerstone investors in UK and European IPOs will continue to grow, in large part due to increased awareness and the need for a new public offering to differentiate itself in a crowded IPO market.
To date, the rise of cornerstone investment in UK IPOs has only gone as far as the Main Market of the London Stock Exchange, due to the benefits and wider factors set out above. Historically, whilst AIM IPOs may have had cornerstone investors, they have rarely been marketed as such to the market and have instead been used almost exclusively as a method of de-risking the bookbuilding process. Notwithstanding the typically smaller capitalisation value of AIM companies (which may put off some larger institutions) and the loss of privacy through disclosing a proposed IPO publicly before it is strictly required, we believe that there is scope for AIM IPOs to capitalise on the enhanced publicity provided by securing cornerstone investors and enabling confident and larger AIM applicants to send a clear, positive message to the market.
In the longer term, it will be interesting to see how the recommendations of Lord Hill's UK listing review (for further details, please see our briefing Listing review recommendations - Keeping the UK's markets on top) will impact the current cornerstone investment trend, given Lord Hill's call for a review of the IPO rules on unconnected analysts, which helped to drive the initial spike in cornerstone investment. If a review ultimately removes the market practice of publishing a registration document prior to a prospectus, this is likely to slow the rise of the cornerstone investor, but the benefits are now well understood by the market and we believe that this is a concept which is here to stay.
We have extensive experience in this area, having advised on 13 AIM and Main Market IPOs since January 2020, with an aggregate market capitalisation of more than £15.8 billion, acting for issuers, selling shareholders and underwriters. We will continue to work closely with our clients and the wider market to monitor this key emerging IPO trend.
This briefing was written by Fabian McNeilly.