Emerging Growth Companies (EGCs) are unique business animals. At times EGCs are viewed as ‘in-between’ more common business categories like start-ups, privately held mature, or established public companies. One common thread that nearly all EGCs have is an aggressive appetite for capital - but what type of capital best suits an Emerging Growth Company? There is no one right answer, but understanding the landscape of financing options available to EGCs should enable you to make an informed decision.
While start-ups often rely on Angels and Venture Capital investors and mature modest growth companies typically look to banking and Private Equity relationships, EGC’s have the unique need and ability to combine many more financing options to meet their diverse growth capital needs. We will take a look deeper at the broad financing landscape.
Emerging Growth Companies (EGCs) have long been a topic of interest in investor circles and have historically been strong financial performers. However, over time, the true meaning of the term EGC has changed, and possibly even become diluted. So, let’s start at the beginning - what exactly is an Emerging Growth Company and what are the financing mechanisms that support them?
Under the Jumpstart Our Business Startups Act (the JOBS Act) a company qualifies as an emerging growth company (EGC) if at the time of its initial public offering (IPO) total annual gross revenues were less than $1 billion during its most recently completed fiscal year. This technical definition only scratches the surface of what an Emerging Growth Company really is. And, most believe that any Company with a $1 billion in revenue is not ‘Emerging’, even if it still is ‘Growth’...
We define Emerging Growth as companies valued between $50 million and $350 million. On average, they will have attracted $20 million of historical invested capital and will require $20 to $70 million of additional financing over 12 to 24 months in order to achieve an exit which will generate 4x to 6x MOIC over a 4 to 6 year period. These characteristics make Emerging Growth distinctly unique from any other investment category.
For example, Emerging Growth is sometimes compared to the Middle Market, particularly in target valuations. But, EGCs deviate from similarly sized Middle Market companies in a number of ways. The two biggest points of differentiation between Middle Market and Emerging Growth Companies as follows:
EGCs grow faster and (as a result) have a greater appetite for capital.
While Middle Market companies certainly require capital, the need is often varied. Middle Market companies are predominantly profitable, whereas their Emerging Growth counterparts may not be. Middle Market companies attract debt financing. Emerging Growth companies gravitate to equity. Middle Market companies have predictable, moderate growth, whereas an Emerging Growth Company should be growing 25-100% year-over-year.
Access to capital for Middle Market companies also serves a different purpose. While Middle Market companies may be pursuing new capital avenues to reducing costs, to restructure a balance sheet or to build more strength in reserves, EGCs just have to grow.
Emerging Growth generates superior returns to the Middle Market. But, EGC’s are more risky. While in the Emerging Growth category comprises 63% of total capital raised, a dollar first invested at a valuation between $50 million and $350 million will generate 73% of total investment returns.
In short, the deployment of capital into an EGC is generally more critical to the company’s overall success and provides both investors and founders with more ‘bang for your buck’ than capital deployed into similarly sized Middle Market Companies.
Scaling EGCs requires access to a global, more robust set of financing tools as compared to Middle Market companies.
EGCs often struggle to identify the correct resources (bankers, advisors etc.) because they can be perceived as being too ‘in between’.
Consider this - Your EGC is growing and you know you will need a number of capital solutions. You are thinking long term about IPO but have pressing needs today that need to be addressed. Naturally, you would want to contact an upmarket service provider - an investment banking group that can help you with the big goal - the IPO. Surely they can help you take the needed intermediary steps in between then and now…
Herein lies the rub. Most “bulge-bracket” investment banks (JPMorgan, Goldman Sachs etc.) will prioritize on the $500 million deal, as arithmetic on their cost structures dictates higher minimum fees. In short, they can't afford to serve the EGC market consistently, even if your company is on track to grow into an ideal client long term.
Parallel this to the Middle Market bankers (Jeffries, William Blair etc.) who are generally focused on $350 million-plus transactions and quickly you realize that EGCs are distinctly underserved in areas that are vital to their success.
Addressing the needs of EGCs on an accomplished and consistent basis requires global scale and expertise that is unique to EGCs. Access diverse capital sources, worldwide including: Angels, High Net Worth Individuals, Multi-Family Offices, Corporate Partners, Venture Capitalists, Sovereign Wealth, Foreign institutions, Structured Debt providers, pre-IPO investors, leveraged lending, asset managers and strategic buyers.
While the market may struggle to understand how to meet the unique needs of Emerging Growth Companies, we have spent our whole careers in this market. We have developed a global service model specific to companies that have historically been underserved in the marketplace.
Let’s take a look at the broad financing landscape for EGCs below:
Founders - Almost always the first capital in, founder capital is typically valued most highly. Generally speaking, maintain as much control in your company as possible is very attractive. That said, many founders look to internally meet as much of the company’s financing needs as possible, but as is the case with most rapidly growing businesses, most founders will hit resource limits early on.
Angels and High Net Worth Individuals - Think of Angels and High Net Worth Individual investors as micro or early Venture Capitalists. These investors often invest as part of a larger diversified portfolio either as individuals or in small syndicates. Investment sizes vary but can start as early as seed stage with some tens of thousands of dollars and can scale up to many hundreds of thousands if not millions of dollars at early or early growth stage. These investors tend to invest in line with the broader Venture model and look for high returns from a few hyper-performing investments in their broader portfolio to help offset losses and underperformance from the majority of these high-risk investments. Angel Investors tend to have more flexibility on term and time horizon than institutional investors.
Family Offices - Family offices do more than represent a High Net Worth Individual. To understand Family Office investment let’s compare Family Office to Venture investing. Venture Capitalists have one job - to deploy capital. Family Offices, on the other hand, have a very different charter - to preserve asset value long term. As such, it is no surprise that many Family Offices invest in verticals they have direct experience in and are also historically big investors in conservative, long-term categories like real estate.
Venture Capital - Most conventional Venture Capital firms look to deploy capital at early growth phases of a company’s lifecycle investing many hundreds of thousands to many millions of dollars. Venture firms most often buy equity in portfolio companies but many also have some sort of debt offering. Venture firms look for hyper-growth companies that can scale rapidly and often participate in additional financing rounds as needed to secure growth. The network access and visibility that often come with a Venture investor can often greatly impact the business far beyond the value of the capital sourced. Venture firms also tend to play a more active role in business management through board seats or formal advisory positions.
Growth Equity - Growth equity represents the intersection of Venture and Private Equity investments. Most growth equity providers are investing in more mature businesses that require significant additional capital to capture new growth. Many Private Equity firms have growth equity arms as do some Venture Capital firms. Valuations and return expectations are often slightly more modest than that of a true early stage investment due to established track records, profitability etc. Where traditional Private Equity investors look for significant non-control or full control positions, growth equity tends to come by way of smaller minority equity positions.
Partnerships - Funding growth does not always require an infusion of capital. Strategic partnerships can provide a powerful alternative to raising money. Key partnerships can give EGCs access to production capacity, sales channels, and industry expertise. Strategic partnerships can also be a great prelude to an M&A transaction with partners down the road.
IPO - The big daddy of capital sources is the public equities market. IPO funding is very flexible and can allow the company to repay debts, fund R&D and make acquisitions with little restriction. While raising capital through IPO is very attractive, it does come with a slew of requirements including tax, accounting, and compliance considerations. While some of the above capital sources can be managed by internal staff, an IPO absolutely requires an expert team of bankers to ensure the offering's success.
M&A - Many EGCs make attractive candidates for acquisition allowing a buyer to purchase market share and IP that may cost significantly more to innovate in-house. Similarly, merging with adjacent competitors or industry participants can allow companies to become worth more than simply the sum of their parts.
Keep in mind, the full spectrum of financing options for EGCs reaches beyond this list. With so many options available it is paramount that your advisory team fully understands the unique nature of Emerging Growth Companies and has a fully developed skill set to lever the diverse option pool available to them. We have developed a global service model specific to EGCs that is best is class.
The Singapore Pre-IPO/IPO pathway features a series of financing events which are perfectly aligned with mainstream global alternatives e.g. NASDAQ, M&A. In contrast to the typical preferred structure, Pre-IPO securities typically involves convertible securities. These securities are typically unsecured debt note that are conditioned upon an IPO. This structure allows issuers to validate geographic interests and the business model prior to committing to a public market. Investors can also focus on company’s revenue inflection and IPO likelihood to maximize investment returns. Effectively, the structure enables issuers to achieve the best valuation (through a blend of Pre-IPO and IPO valuations) that is compatible with and complimentary to complex capital structures and existing alternatives.
With the series of financing events, a Pre-IPO/IPO process consists of 2 key financing events – a private offering and an initial public offering.
A private offering (Pre-IPO) process mostly resembles that of a typical private placement, which involves deal documentation, marketing phase, due diligence, and closing documentation. This process normally takes between 4 to 6 months to complete.
The later part of the Singapore partway features a capital market solution. The issuers go through the IPO process on SGX (or on alternative boards), by which the geographic interests and business model has already been validated by interests from the cornerstone investors. This process involves an IPO preparation and registration, the Initial Public Offering, block trades / common executing broker agreement, cross-listing to NASDAQ, and M&A. The total process of IPO funding typically takes between 18 to 24 months to complete. While issuers and investors can stay on the pathway to complete all steps mentioned, each stage allows for off ramps and exit alternatives that optimize financing opportunities and align with all stakeholders.
Much has been written about the time it takes to file an Initial Public Offering. Often overlooked is the pre-file planning which can take as long as many years. So, how far in advance should you plan your IPO?
The short answer is you should prepare as much as 36 months in advance. While the tail end of this preparation period will be consumed with the formal filing preparation including negotiating with bankers, compliance, road shows etc., much of the early preparation involves ensuring that your company has the needed structure and resources to be successful come filing time. We’ll cover on how you should prepare for the IPO in the next question.
While there is no exact timeline for advanced IPO preparation, the sooner you start the process the easier it will be during the challenging, time intensive and costly months that immediately precede your offering.
The following recommendations should be considered a minimum of two years prior to filing:
#1 Hire a CFO with real public company experience
The required skill set of a high growth private healthcare company CFO is significantly different than that of one which is public. It is paramount that you hire a CFO that has public company experience and ideally has previously survived the IPO process, soup to nuts.
Public company CFOs need to focus their efforts on making internal controls part of every single day and must be familiar with the requirements of the Sarbanes-Oxley Act of 2002 and the Jumpstart Our Business Startups Act of 2012 among other key regulations. Learning such nuanced elements of the process on the job is an IPO killer.
#2 Build systems early and integrate into your normal processes
As the old M&A adage goes - ‘Build it today like you are selling it tomorrow.’. Something similar can be said about IPO prep.
Companies should develop the needed systems, in particular financial controls as early as possible. This most commonly serves as a mechanism to purge any problems with systems or controls that exist far earlier than may otherwise be possible.
CFOs will need to address gaps in controls by completing a risk assessment, and should also finalize disclosure processes, which is the quarterly equivalent of the Section 404 yearly disclosure, as early as possible. Additionally, by adopting proper systems and processes into your month and quarter end periods your team can ‘practice’ working within a simulated post IPO environment. This experience can help ease the shock of the formal process changes post IPO.
Prior to completing a successful IPO you will be required to do this work. Preparing in an environment that affords you the needed time and focus to do so correctly will pay future dividends.
#3 Build a board with public company experience
The strength of your board of directors can significantly impact the success of your future IPO. Be sure to recruit members with public company experience who can directly support the growth of the business. Board members with specific skills needed post IPO are also preferred (like someone to sit in as the audit chair, for example). While initial pricing is based on many other factors, do not discount the idea that your board can directly impact the interest in and price of your IPO in a very real way.
#4 Address the costs early on
Running an IPO process carries significant costs. Understanding these costs and budgeting for them as far in advance will ensure that they do not become burdensome in mission critical times. All IPOs have both a fixed and variable cost component. While the variable cost piece is paid from proceeds, the company filing will have to carry all fixed costs including listing, legal, underwriting, due diligence. These fixed costs can range from hundreds of thousands to millions of dollars depending on the company, so plan accordingly.
This Emerging Growth segment needs a credible IPO alternative. For issuers venture capital and structured debt are available, but often inappropriate from a valuation and risk perspective. Global wealth can access Emerging Growth through blind-pool 10 year closed-end, 2% and 20% funds, but would prefer greater deal visibility, more active deal management, better downside protections, lower management fees, and shorter hold periods. Our deals and funds can offer these features.
With the support of SGX, Third500’s Singapore Financing Pathway meets the needs of issuers and investors. The Pathway starts with a standardized pre-IPO convertible linked to an SGX IPO. Post-moratorium the Pathway creates structures and incentives for research supported block trades from the institutional inside to long-term global public holders. Through global fund buyer validation and a rising market cap, issuers can take advantage of efficient SGX cross-list policies to support a Nasdaq dual listing.
Over the past 5 years, Third500 has established strong relationships with many strategic partners, from medical device manufacturers, global pharmaceutical company, to an IT infrastructure conglomerate in Asia. These relationships not only add value to the financing event at hand, but also add long term strategic values to emerging growth companies, inspiring growth and revenue infliction. In 2016, Third500 worked with Nautilus Data Technologies, an innovative data center operator based in Pleasanton, CA, to go through Series C financing with key strategic investors from around the world. One of the lead investors was Keppel T&T, a leading infrastructure conglomerate in Asia. By adding strategic capabilities on the cap table, this allows for transfer of knowledge in key operational areas including, shipbuilding, data center operations, and REITs. Nautilus and Keppel Data Centres will benefit from the development of innovative and sustainable data centre technology that has great potential for commercial application.
Third500 and SGX designed the Pathway for Emerging Growth companies at a specific development stage. Our clients have typically raised US$40 million, need to raise a further US$10-40 million, have trailing revenues of US$5 million, and are in a high growth phase. While tightly defined, Emerging Growth is a deep market of roughly 6,000 companies that comprise $360 billion of invested capital seeking to raise an additional $180 billion and adding and shedding roughly 1,200 companies per year.
Over the past 20 years, the effects of regulation and financial reform have transformed the nature of growth investing and significantly constrained access to capital for the fastest growing, most valuable companies in the world. In the face of these challenges, Third500 is dedicated to making the global emerging growth capital markets more dynamic, accessible and efficient. Our proprietary platform is based on 3 governing principles:
Through these principles, Third500 has aligned our interests and expertise, not only to our clients but also stakeholders in the emerging growth markets. We’ve worked with top-tier venture funds, growth equity investors, leading strategic players through private placements and M&A. With this experience, we have gained a special appreciation for the importance of ECG investors, the formula for success, and the challenges of achieving it.
Third500 provides financing, partnering, and M&A solutions for Emerging Growth companies. In close partnership with SGX, we have developed what we are calling the Singapore Financing Pathway. This novel private-to-public financing pathway provides Emerging Growth companies an additional financing option to complement late stage venture and structured debt.
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