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Why are tech start-ups opting for a backdoor listing rather than an IPO?
You’ve probably heard of a company resorting to a ‘backdoor listing’ or a ‘reverse takeover’ or for US investors a Special Purpose Acquisition Company (SPAC) instead of using the traditional IPO (front door) method to list on the ASX or other markets. Contrary to popular belief, the process is completely legitimate and a viable pathway to capital for those less interested in the entire IPO process. It is actually an essential pathway for start-ups to gain capital faster and cheaper than having to IPO via prospectus which can take months and is counter productive when time is of the essence.
According to corporate lawyers Gilbert + Tobin, “A backdoor listing is effectively a way for a private business or company (PrivateCo) to obtain a listing on ASX via a disposal of the business or shares in the company to a pre-existing ASX-listed entity (Shell), as an alternative to undertaking a conventional initial public offering (IPO).” Shell is usually a company that has had its securities suspended from trading i.e. a mining exploration company that has failed.
The end of the mining boom left a graveyard of mothballed and failed exploration companies that lay dormant. It has been the perfect picking for tech, cannabis and healthcare companies looking to list as quickly as possible. According to ASX data well over 50 backdoor listings have occurred on ASX in the past year. And for a start-up, a backdoor listing makes sense. A good example is the Buy Now Pay Later phenomenon brought on by Afterpay (ASX:APT). The success of Afterpay almost instantly triggered an onslaught of copycat platforms, all wanting to list on the ASX to raise capital. Two successful fintech’s that have used backdoor listing route are: IOUpay (ASX:IOU) and Douugh (ASX:DOU). Both companies were able to raise capital quick and easy, without time spent on prospectus or extra compliance regulations required for an IPO.
There are several steps that the ASX will require for a backdoor listing such as, shareholder approval and that the new company re-complies with ASX’s IPO admission requirements. The shell company will also need to issue securities to the private company or its shareholders as consideration for the acquisition of shares of the shell company. And finally, a significant change to the nature of the shell company’s activities involves a major change in the character of the shell company’s business activities, whether as a result of one or a series of transactions. Details of this change must be provided to the ASX.
So why would you go down the backdoor listing route instead of an IPO?
Faster and cheaper than IPOs – Overall a backdoor listing is a cheaper process because it only involves restructuring the share ownership of the listed company. With an IPO, a substantial investment of time and resources is required. The underwriting broker fee typically is the largest direct cost as it goes through an IPO. The legal, accounting and tax costs are also consequential. According to Nash Advisory, “As a general guide, a front door listing requires 12 months of preparations and will cost $2 million for a $20 million capital raise.”
Less work & compliance than IPOs – An official listing on the Australian Stock Exchange (ASX) requires the following a detailed prospectus, audited accounts, a fundraising road show and significant legal diligence. A backdoor listing will still require extensive work via an information memorandum, or sometimes a prospectus if capital is being raised. But by and far they offer the best value. Compliance can be avoided with Chapter 1 and Chapter 2 of the ASX Listing Rules.
Minimum share price, the 20 cent rule – The ASX usually requires shares to be issued at least 20 cents per share. However, with a backdoor listing if a shell company wants to undertake a capital raising, the ASX may grant a waiver from the 20-cent rule. The shell must, however, not offer its securities for less than 2 cents per security. The lower price has no bearing on the company’s value, so listing at 2 cents attracts speculators.
Listing Rule 1.1, Condition 7, requires an entity seeking admission onto the ASX to have 400 security holders. It is most likely that a shell company will have more than 400 shareholders whose parcels of shares valued at the price the shell raises capital meets the minimum $2,000. More often that not, a shell company that has the right shareholder base can offer significant value.
Downside to a backdoor listing
Risks can arise when the private company acquires all the legacy assets. If there any issues or problems with the shell company, they are all inherited by new management. They also inherit the existing shareholder base which can be tricky but is also an attraction given the fact that the chosen ASX company has a large spread of shareholders.
The biggest drawback is that a backdoor listing doesn’t attract the same attention as an IPO that has been marketed to the general public. A backdoor listing is done almost in silence without any real fanfare. The shell company suddenly re-emerges after the successful acquisition, having been given a second chance. All in all, a backdoor listing is an attractive option for smaller start-ups, especially for technology start-ups without a large shareholder base.
