Dotcoms eye next IPO wave

Companies still looking to list on secondary boards in Asia need to prepare now to be ready to catch the next wave.

As if the ailing fortunes of the Growth Enterprise Market (GEM) and Nasdaq aren't enough to tell you what's hot and what's not, only about 20 out of several hundred attendees at the Internet World conference turned up to a session on fund raising in the equity markets.

"I realize that this topic may not be of too much interest at this period of time," Mason Ching, senior associate at Baker and McKenzie began. "But companies can catch the next peak if prepared properly, and this is the time to prepare."

Ching says that recently, many potential IPO candidates have either suspended or cancelled their financing plans altogether. Companies targeting consumers and internet incubator companies are among those who have retreated from this funding alternative. A number of business to business (B2B) model companies and internet infrastructure providers still have IPO plans, and there are even a few, says Ching, that plan to list by the end of this year.

The road to listing is fraught with obstacles. Ching sought to highlight those in relation to the GEM (Hong Kong's secondary market). 

Accessing the market

There are three ways to access the equity markets:

  • Getting a listing status. The GEM has more relaxed rules than the main board. A company need only have a one-year operating history, and need not have shown any profits. The main board requires that a company be in operation for three years and have earned at least HK$20 million ($2.56 million) in the most recent year and an aggregate of HK$30 million in the two preceding years.  
  • Taking over an existing listed company (known as a "back door" listing). "This is the less expensive and less stressful way," says Ching. Here, the internet company injects assets into the listed company in return for shares. There is no need to issue a prospectus, which can be a source of civil and criminal liability, and which can be very expensive. 
  • Merging with a listed company. Unlike a back door listing, it is likely that the listing company will lose majority control of its business to the listed company.

GEM listing requirements

"Some can be waived. Just look at Tom.com," says Ching. But the waivers afforded to Tom.com proved unpopular within the industry, he adds. Since then, the Hong Kong Securities and Futures Commission (HKSFC) and the Stock Exchange have been having a closer look at reducing the requirements for all companies. For GEM, the main rules are:

  • Profit requirement - there is currently no profit requirement, however, Ching says that the Stock Exchange is considering imposing a minimum requirement. 
  • Operating history - initially, the requirements were two years of operating history, that is two years of "active business pursuits", this has been reduced to one year. 
  • Statement of business objective – the company must have plausible business objectives that are achievable. The company must explain how the objectives are to be reached for two financial years after the IPO. 
  • Management – The company must be under substantially the same management and ownership during its track record of active business.  
  • Minimum public float – The minimum public float for companies with less than HK$1 billion market capitalization is 20%, subject to a minimum of HK$30 million. 
  • Majority shareholders – shareholders with 5% or more interest in the company or with influence over management, is subject to a lock-up of 2 years. The Stock Exchange has now reduced the requirement to 6 months.

Going through the back door

Ching has some practical points on going through the back door. 

  • Do a thorough due diligence on the listed company. 
  • Should the listing company shares acquired new shares or buy existing shares in the listed company? Ching warns that where 35% or more of voting rights are effected in the takeover of shares, it will be mandatory to offer all existing shareholders the same terms of the buy-out. But, an internet start up will not usually have enough funds to buy out all shareholders. The exception to this rule is a "whitewash" waiver. This necessitates the listed company issuing new shares to the company seeking a listing and independent shareholders without an interest the transaction must approve the new shares. Where those two requirements are met, the Stock Exchange will grant a waiver of the mandatory takeover rules. 
  • Where the net tangible assets, or profits of the listing business is more than the net tangible assets or profits of the listed company, the Stock Exchange will consider this a "very substantial acquisition" and shareholder approval must be gained. The Stock Exchange will treat the business seeking a listing as a new entrant. 
  • Consider a migration of business assets rather than an injection. For example, the listing business could license the domain name to the listed company, and the listed company would receive fees in return for running that property.

Potential IPO obstacles

Receiving funding from a venture capitalist (VC) can be a two-edged sword. "They may be too aggressive and want to impose restrictive rules on what the business is able to do," says Ching. A venture capitalist with a significant stake in the company is subject to a six-month lock up of the shares. Therefore, the VC must be willing to place their shares with a custodian bank for that period of time.

Furthermore, changes in management of the listing company as initiated by a significant VC may also violate the GEM listing rule which specifies that the company must have substantially the same ownership and management during the course of its active business. A change in ownership and management may also occur where several rounds of financing have taken place and a number of VCs take stakes in the company.

Where the investor is not a venture capitalist but a strategic investor, that company may be listed and therefore subject to the listing rules itself. One rule provides that the listed company cannot disclose price sensitive information about itself before making a formal announcement. Therefore, the listing company has to consult with the strategic investor on its plans, in case it indirectly causes the investor to violate the rule. 

Ching concludes with a warning on a new rule instituted by the Chinese Securities Authority: every issuer that has an interest in a Chinese entity and is listing abroad has to obtain a letter of "no objection" from the Chinese authority.