It’s obvious…and it isn’t…
You have built your business, firstly through bootstrapping it in its start-up phase and then taking it through pre-IPO rounds. But what exactly are you going to IPO? Defining “what” it is that will ultimately list is absolutely necessary for streamlining the financial reporting which goes into an IPO Prospectus.
So, to explore this further, a little precis of what we at William Buck see as typical corporate structures that figure in the life-cycle of start-up to listing entity and how this relates intimately to this very existential problem.
At start-up phase
Often at start-up phase the enterprise is in one corporate, trading vehicle. Activity at this stage is characterised by a high degree of transactions with the founder, aided by the capital from family and friends, as she bootstraps her business.
Having succeeded in early milestones, our founder has now developed an asset (technology, tenement etc…) of value and may be pursuing avenues for legally protecting that asset. When legal protections are obtained, they may be parked into a vehicle separate from the trade in the business – often known as an IP Entity. Usually the IP Entity will not have a direct ownership relationship with the trading entity – instead it will be owned by another vehicle (i.e.: Family Trust) of the Founder. Any seed investors coming in will seek assurances that the enterprise will continue to access the IP which is now in the separate entity. This often results in the formation of an Exclusive Licence between trading enterprise and IP entity for the use of that IP.
At this stage, corporate advisors often recommend listing the entity through a separate Listco – that is, a listing company. To successfully IPO, it is essential that the Listco owns outright the trading enterprise and the IP entity. To do this requires the formation and execution of scrip-for-scrip (non-cash) share purchase agreements that have the effect of structuring the trading enterprise and IP entity as wholly-owned subsidiaries. Often these share-purchase agreements will include a condition-precedent clause, specifying that the transaction is not legally binding until the successful completion of the IPO.
So, instead of one entity, we have three: a trading entity, an IP entity and a Listco; and all three are still legally unconnected entities pre-IPO. Which of these requires the disclosure of historical financial information under ASIC’s regulatory guide 228 (Prospectuses: Effective disclosure for retail investors)? RG 228 is explicit in referring to financial information of the business, not of the corporate listing entity. But should the business include the IP entity? And what about the Listco? There is a specific carve-out of the Listco under RG 228 for its need for financial reporting, but only when it is effectively a shell with no material assets or liabilities. But what if that Listco has been used as a vehicle for a pre-IPO capital raise (and therefore has material assets)?
In this situation, it is useful to note that Accounting Standards do not prescribe what an entity is…so this allows some flexibility in dealing with the problem of what the entity is that is listing.
Introducing the combined entity – that is, rather than focusing on reporting on the results of a consolidated legal entity, instead report on the results of a combined entity. So in this instance, it is the combined entity consisting of the following legal entities: the Listco, the IP entity and the trading entity. This is notwithstanding that these entities do not have any direct legal ownership relationship. Any transactions between such entities, like for instance the licence fee charge from the IP entity to the trading entity are eliminated on consolidation within the group.
From a commercial perspective, this reporting has much more relevance to investors – instead of three sets of audited financial reports for 3 entities that they need to read and understand, there is only one combined set, which will give a much more appropriate representation of the historical performance of the entire enterprise.
The use of IP entities and Listco companies going into IPO is increasing more and more in prevalence each year. As such, it is important that preparers of financial reports consider and make allowance for such structuring complexities. Using a combined entity approach to financial reporting can potentially be a panacea to this problem – not only in navigating the legal requirement to showcase the financial reporting of the entire enterprise pre-IPO, but also in providing succinct and understandable financial information to prospective investors subscribing to shares of the Prospectus.