IN PRACTICE
Herbert Smith LLP is a leading international law firm with over 1,400 lawyers working together globally, offering a
distinctive balance of transactional, projects and dispute capability to its clients worldwide. The firm’s international
coverage spans Europe, Asia, the Middle East and Africa. Its international capability is further enhanced by its formal
associations with leading law firms Al Ghazzawi Professional Association, and Hiswara Bunjamin & Tandjung in
Saudia Arabia and Indonesia, respectively.
In Practice
Author Will Pearce
Pre-IPO financing and cornerstone investors: Asian influences in
European equity offerings
Will Pearce explores the recent trends of issuers raising
funds through pre-IPO capital raisings, shareholders sellingdown stakes in the run-up to an initial public offering (IPO)
and issuers and underwriters seeking commitments from
cornerstone investors at the time of an IPO – in each case, with
a view to de-risking the IPO and drawing on both established
and developing Asian equity market practices.
PRE-IPO CAPITAL RAISINGS
Key considerations for global investors
The nature of any pre-IPO investment will depend on the stage of the
issuer’s commercial development (and its requirement for funding),
any proposed IPO timetable and the investment policy of the relevant
investor.
As regards the latter, “global investors” – including the leading
private equity players and sovereign wealth funds – have distinct
institutional policies on the maximum size of any investment, whether
they require active board and management involvement, and expected
legal and contractual protections. In the context of any investment, they
will focus on:
the proposed IPO process – investors may want a degree of control

over timing, choice of listing venue, hiring of advisers and costs;
liability considerations – investors will want to limit any exposure

to IPO liability and, where they are exposed, maximise the
availability of any due diligence defence; and
the relationship post-IPO – for example, board representation

and any lock-up on investment.
Venture capital and private placements
Over the past 20 years, the approach to pre-IPO investments
has changed dramatically in the UK. Through the 1980s and
mid-1990s, pre-IPO investments were often made at an early
stage and individually negotiated, actively managed (with board
representation), and commonly included hurdles or milestones that
triggered further investment rounds with additional investor rights
added at each funding round. From the mid-1990s through to the
mid-2000s pre-IPO private placements, driven by the technology
sector and the requirement for capital to grow businesses before
bringing them to the market, were commonplace with multiple
investors investing on common terms set out in a private placement
memorandum.
Pre-IPO convertibles
Since the mid-2000s, there has been a distinct increase in the use
of pre-IPO convertible bonds as a favoured method of making a
pre-IPO investment in an issuer, led by sovereign wealth funds
as investors and Asian issuers (following common use of pre-IPO
506
September 2012
convertibles in the Asian tech boom). Over recent years notable preIPO bonds have included Golden State Environment Group (2006,
Asia), Greentown China Holdings (2006, Asia), Angara Mining
(2006, Europe), Dubai Ports World (2006, Middle East), Las Vegas
Sands (2009, Asia), Glencore (2009 and 2010, Europe), JACCAR
Holdings (2010 and 2012, Europe), Sea Trucks (2011, Africa), Bio
City Development (2011, Middle East) and Banco Mare Nostrum
(2011, Europe).
From the issuer’s perspective, a convertible is arranged by advisers
and can be issued to one or more investors on similar terms: if issued
to a number of investors or listed on an exchange, the issuer will
prepare some form of offering circular and there will be no ability
for individual investors to negotiate their own terms. In addition,
the coupon may be lower on a pre-IPO convertible than on a bank
loan as a result of the attractiveness of exposure to the forthcoming
IPO and the chance for investors to receive payment of a coupon and
guaranteed equity on IPO. Further the bond will commonly have
none of the performance-based covenants usually associated with
bank finance.
From the investor’s perspective, as noted above, it will benefit
from a regular interest payment on the amount of the outstanding
bonds, the “coupon”, and the right to convert the bonds into equity
on IPO, without the risk of holding equity in the intervening
period. Specific points of note for an investor on a pre-IPO
convertible (as distinct to a convertible issued by a listed issuer) will
include:
the coupon – a convertible bond will usually have a fixed or

floating (by reference to an agreed base rate) coupon, whereas
the coupon on a pre-IPO convertible is often set to incentivise
the issuer to complete an IPO or refinance the bond within a
particular time frame, for example through a ratchet or step-up
on the coupon that penalises the issuer if an anticipated IPO
timetable is not met;
security – in order to avoid the erosion of assets and any change

in shareholding structure, issuers of pre-IPO convertibles will
typically be required to provide some form of security, which may
or may not survive an IPO, to a trustee acting on behalf of the
bondholders;
undertakings from the issuer – the issuer will be subject to a

broad set of undertakings and covenants to protect the investor
(who will not benefit from the protections that it would ordinarily
have from the disclosure and other continuing obligations of a
listed issuer);
events of default – the investor will be focussed on what its

remedies are if it becomes increasingly clear that the issuer is not
going to IPO or another adverse material event occurs (such as a
change of executive management) and so may ask for an ability to
Butterworths Journal of International Banking and Financial Law
force the issuer to redeem the bonds (generally this right is solely
reserved for listed issuers and not an investor);
conversion price – as opposed to an initial conversion ratio usually

set at the time of the issue of the bonds, pre-IPO convertibles
will generally convert at a price that is at a discount to the IPO
offering price (or sometimes by reference to the volume weighted
average price of the issuer’s shares in the period immediately
following closing of the IPO); and
post-IPO lock-up of shareholding – while ordinarily on

conversion a bondholder would be free to sell any shares received
on conversion, a lock-up may be imposed on the shares received by
an investor on conversion of a pre-IPO convertible.
With the increased use of pre-IPO convertibles, certain securities’
regulators and stock exchanges – notably the Hong Kong Stock
Exchange – have issued market guidance and/or developed rules to
regulate such bonds recognising that the conversion feature can have
a material impact on the structure and successful execution of an
IPO. It remains to be seen whether the UK Listing Authority and
"Limited bank financing and sparse
M&A activity has made it harder
for investors to exit assets."
other European regulators will take a similar approach as pre-IPO
convertibles become more widely used.
PRE-IPO SELL DOWN BY SHAREHOLDERS
As well as securing pre-IPO financing for an issuer, one of the other
issues that has arisen for private equity backed issuers in particular
has been how to guarantee a suitable exit for selling shareholders.
Limited bank financing and sparse M&A activity has made it harder
for investors to exit assets through a traditional sale process and, if
the investor pursues an IPO as an exit route, it has been difficult to
bridge the valuation gap between the selling shareholders and new
IPO investors and to reach agreement on a suitable level of selldown,
with new IPO investors requiring selling shareholders to leave more
value on the table and to retain greater stakes in the issuer.
Formula One (2012, Asia) recently used a structure that could
address some of these issues: CVC Capital Partners reportedly
significantly reduced its shareholding in Formula One through a sale
of part of its shareholding to global investors Blackrock, Norges Bank
and Waddell & Reed, referred to by some in the press as “anchor
investors”. With the promise of a long-term holding in a “to-be-listed”
issuer, certain global investors are happy to take the risk on an equity
investment in a private company in exchange for a guaranteed equity
holding at a pre-IPO discounted price. In theory, if and when Formula
One moves forward with its IPO, it will benefit from having a broader
shareholder base, although the price of the investment will set a floor
for the IPO price arguably reducing its flexibility.
Butterworths Journal of International Banking and Financial Law
IN PRACTICE
In Practice
CORNERSTONE INVESTORS
The converse to facilitating the exit of selling shareholders is to
ensure sufficient demand from new investors at the time of the IPO.
By building a book of interest from global investors, referred to as
“cornerstone investors”, an issuer and the bookrunners of the offering
are able to demonstrate interest in the offering to the broader market
and thus increase the chances of favourable pricing and improve the
chances of the transaction closing.
If global investors view the issuer and the offering as a good
long-term investment with the possibility of value growth, they may
irrevocably commit to take up a maximum number of shares or a
maximum percentage shareholding in the issuer at the time of the
IPO and, in exchange for the guaranteed allocation, to be referred
to in the IPO offering documentation as a committed investor and
to agree to lock-up their investment for a customary period of time
(usually between 90 and 180 days). While the investor may have had
access to a management diligence session, the issuer and bookrunners
will structure the cornerstone investment agreement with a view to
ensuring that the investor has no additional rights over and above
any other investor investing in the IPO off the back of the offering
documentation.
Recent examples of the use of cornerstone investors have included
the IPOs of Glencore (2011, Europe and Asia), Nomos Bank (2011,
Europe), Polymetal (2011, Europe) and reportedly the aborted IPOs of
Graff Diamonds (2012, Asia) and Evonik (2012, Europe).
CONCLUSION
Today’s global investors are interested in investing in IPO candidates
that they view as having good long-term prospects – they are
generally not interested in exercising control or seeking board
representation, particularly post-IPO, and are not deterred by lockups. Notwithstanding the advantages that the additional liquidity
from a pre-IPO sell down by controlling shareholders can bring
(and the likely corresponding reduction in the size of any secondary
offering at the time of IPO, which could make a real difference
to pricing discussions and the achievability of the deal) and the
confidence that can come from pre-covering an IPO with cornerstone
investors before formal launch, European IPOs still require willing
sellers and buyers to agree on valuation. With the continued
uncertainty of the European capital markets, this has not been an
easy task as a number of large issuers such as Evonik in Germany that
was seen by market commentators as a certainty for IPO this year,
have found out in the first half of 2012.
n
Biog box
Will Pearce is a partner in the corporate team at Herbert Smith’s
London office. He advises on a wide range of corporate finance,
public and private M&A and capital markets transactions for
corporate and investment banks, with particular experience of
advising on takeovers, M&A and restructuring transactions
for listed companies and international securities offerings and
listings. Email: william.pearce@herbertsmith.com
September 2012
507