Do Robust Incentives Drive IPO Success?

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Private equity (PE) backed IPOs have tended in our experience to adopt a more proactive and robust management incentive framework pre-IPO.

Success

Given the nature of and rationale for the investment by PE organisations, this incentive framework also tends to be put in place significantly earlier than a corresponding framework within a non-PE backed company.

This observation puts an interesting spin on a recent study that IPOs backed by PEs outperform comparable non-PE backed IPOs over the short and long term.

The study, released on 10 April 2014 by the Australian Private Equity & Venture Capital Association, examined ASX-listed IPOs since 2003 with an initial offer size of at least A$100 million. As at the end of February 2014, PE-backed IPOs have posted an average return of 95% since listing compared to a 2.2% decline for non PE-backed IPOs. The difference in returns is particularly marked for investment periods over a year.

The study also considered weighted average returns, based on IPO market capitalisation, and found that PE-backed IPOs since 2003 were outperforming non PE-backed IPOs and similar sized ASX-listed companies (as represented by the S&P/ASX Small Industrials Index).

It is not surprising that a sample of companies that generally practice early implementation of proactive and robust incentive frameworks outperform those who appear less likely to do so.

The structure of the incentive framework reinforces the criticality of and rewards management for achievement of desired strategic, growth and profitability priorities over the period leading up to the company’s IPO. Reward is strongly geared to sustainable improvement.

As importantly, once the Board has decided to go down the IPO route, this framework is reviewed and revised as required to incorporate the proposed listing structure (including selldown and escrow arrangements) and post-IPO performance and retention objectives.

Given the significant number of recent IPOs and the positive indications of more and larger transactions in the next six to twelve months, we expect prospective investors (particularly, institutional investors and their advisors) to devote greater attention to the nature and extent of the existing and proposed incentive framework for management.

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