Andrew Wood, former CFO of Oxford BioMedica plc (LSE:OXB) outlines some research into the direct costs of share issues on public markets.
As CFO of a public UK biotech company where the availability of cash has been a key limiting factor in R&D investment, I have long been concerned by the amount of cash that is absorbed by the process of equity fund raising.
My own experience comes from Oxford BioMedica plc (LSE:OXB) between 1996 and 2012, in which time we undertook 9 rounds of share issues raising a total of £127 million. Subsequent to my leaving OXB in 2012, it raised a further £12 million in a 10th public share issue.
The experience of OXB was that share issues with a pre-emptive element (i.e. where part or all of the issue was offered to existing shareholders pro-rata to their holdings at the time, either in a rights issue or an open offer) were on average almost three times as expensive as share issues that were wholly non-pre-emptive. Indirect costs, particularly management time, were significantly higher as well.
Although non-pre-emptive issues can clearly be more cost-effective, they depend on the willingness of shareholders to set aside their rights of pre-emption. Despite a DTI-sponsored review by Paul Myners in 2004 and the issuing of new principles in 2005, the amount of funds that can be raised by UK public companies in this way is still very limited – in the case of OXB the limit is still 5%.
A secondary (and expected) observation from the OXB share issues is a clear trend for larger issues to be more cost-effective than small ones.
An extended survey of 19 public issues of shares by UK listed biotech companies confirmed the findings from OXB, although in this sample the cost differential between pre-emptive and non-pre-emptive issues was less extreme.
A review of published commentaries from the USA and other territories suggests that the direct costs of IPO and public secondary offers in the UK are not out of line with costs elsewhere. Non-pre-emptive issues in the USA are more widely used, with most companies having a 20% dilution limit rather than the norm of 5% in the UK. The US PIPE (Private Investment in Public Equity) market is interesting, providing access to significant amounts of capital from qualified investors to public companies, usually structured as direct placement of equity shares. However, in contrast to what I have found in the UK biotech sector, investment banking fees for PIPE transactions tend to be higher for PIPEs than in public secondary issues of shares.
A final thought. I have looked at direct costs here, but indirect costs – especially the money ‘left on the table’ in discounted share issues have an equally serious negative impact on the funds that companies are able to raise through the issue of shares.
The OXB case study
OXB first issued shares on AIM (IPO raising £5 million in 1996), followed by 4 further issues between 1998 and 2000 raising £24 million in total. In 2001 OXB moved to the LSE Official List, raising £36 million. 4 subsequent issues on the LSE raised a further £84 million. We used a total of 5 brokers, all London-based, over this period.
OXB raised £148 million in 10 rounds over 16 years, incurring costs of £12 million (average 8.2% of proceeds). Costs ranged from as little as 3.0% up to 13.5% of funds raised. The IPO in 1996 was the most expensive at 13.5%. The average cost of 7 subsequent share issues with a pre-emptive element was 8.6% (range 7.0% to 12.8%). In contrast, 2 share placings in 2000, where OXB used a shareholder approved disapplication of pre-emption rights, cost only 3% of funds raised.
For the placings in 2000, OXB shareholders had approved a 10% limit to non-pre-emptive share issues. This limit is renewed each year, and in recent years shareholders have been more cautious, only approving a 5% limit.
Looking into the components of the costs of the IPO and the pre-emptive share issues up to 2011, 72% was taken up by brokers’ fees (corporate fees, sales commissions and broker’s legal costs). Company legal costs were 11%, reporting accountants 8% and all other costs 7%. Some of these cost elements are clearly variable, such as sales commissions, while others are essentially fixed (i.e. they are not set by reference to the amount of funds raised). As one would expect from this mix of fixed and variable costs, there was a trend that smaller share issues had the highest cost in terms of funds raised.
Comparison to other UK biotech share issues
I examined a sample of nineteen share issues by other listed biotech companies in the UK between 2004 and 2012 to look for validation of the OXB observations. The public statements about these transactions identified ten of them as placings – from Aortech, Antisoma (2 issues), E-Therapeutics, GW Pharma, Proximagen, Reneuron and Summit (3 issues). The other nine were either IPOs or placings and open offers – from Allergy Therapeutics, Ark Therapeutics (3 issues), Summit Corp. (2 issues) and Vernalis (3 issues). These transactions were broadly comparable in size to the OXB issues above, ranging from £5 million to £69 million.
The trends shown by the OXB share issues were mirrored by these transactions. Large transactions were more cost effective than small ones, and non-pre-emptive issues were generally cheaper than issues with a pre-emptive element. However, the difference in cost between pre-emptive and non-pre-emptive issues was somewhat less polarised in the wider sample.
The 10 transactions described as placings raised £140 million and cost on average 4.2% of funds raised (a little higher than the 3.0% for 2 OXB placings). The range of costs was from 1.9% (Proximagen £50 million in 2009) to 8.9% (Summit £5.0 million in 2012). These two extreme cases may atypical due to their particular circumstances. The average cost of the other 8 transactions was 5.4% of funds raised.
The 9 share issues with a pre-emptive element raised £298 million and cost on average 5.9% of funds raised. The range of costs was from 3.8% (Vernalis £69 million in 2012) to 9.9% (summit £10 million in 2010). The costs of the recent Vernalis issue may have been exceptionally low due to its particular circumstances. Excluding this transaction, the average cost of the remaining 8 was 6.5% of funds raised – lower than the OXB experience.
Comparisons to other markets
A brief review of commentaries from other territories shows that the direct cost of share issues in the UK is not out of line with those elsewhere. I would caution that some of the data here are quite old, so may not be wholly reflective of current trends.
IPOs are relatively expensive in most territories. Lee, Lochhead, Ritter & Zhao (1996) reported the direct costs of 1,767 US IPOs between 1990 and 1994 with a median value of $24.4 million to be 11% of proceeds, whereas 2,387 US follow-on issues had average costs of 7%. Chen & Wu (2002) reported a sample of 281 Hong Kong IPOs costing an average 10.44%. Koolie & Suret (2002) reported a sample of 224 Canadian IPOs costing an average 14.39%.
The use of shelf registration in the US can lower investment banking fees in secondary share issues. However, this facility may not be available to all issuers, particularly small companies.
A more recent report on the US PIPE (Private Investment in Public Equity) market provides an interesting perspective. Companies in the USA are generally able to issue up to 20% of existing shares in non-pre-emptive placings, and they raise significant amounts of funds in this way. Generally PIPEs use a placement agent, typically an investment bank. Dai & Chen (2008) reported that agent fees for PIPEs were on average 230 basis points higher than for follow-on equity issues in the USA (6.8% vs. 4.5%). This is in contrast to lower costs for the UK share placings reviewed above.
Financing through the issue of equity is a highly regulated and relatively expensive process, and it seems that this is the case across the world. However, for certain companies, particularly higher-risk early-stage development companies, it remains one of relatively few sources of capital for growth. The cost and complexity of public market share issues in the UK can be a barrier to firms accessing capital. Pre-emption rights, which serve the legitimate interest of protecting shareholders from unwanted dilution of their investments, are a significant issue in this regard in the UK. Financing through placing of shares which bypass these shareholder rights is nearly always quicker, and usually cheaper than a ‘conventional’ rights issue or open offer. However, companies are limited by the percentage dilution that such a placing would cause, and a 5% limit is the norm in the UK. This seriously restricts the usefulness of non-pre-emptive share placings. In contrast, the norm in the USA is a 20% dilution limit, and over there, significant amounts of finance are raised in Private Investments in Public Equity. Despite a positive review and new guidelines issued in the Myners report of 2005, little has changed in the UK. A re-examination of the restriction caused by pre-emption limits in the UK would be welcome. A relaxation of the currently low limits could provide a life-line to emerging companies that need capital for growth.