A growing number of small technology companies are using backdoor listings to gain a foothold on the ASX. Tony Featherstone explains what this growing trend means for directors and how they govern.
Much has been made of the boom in disruptive technology companies. Less considered is the interaction between governance and early-stage listed tech ventures and how boards can nurture the next generation of tech firms and entrepreneurs.
This is a critical issue for Australian business. More than 100 tech companies have listed on ASX in the past two years through initial public offerings (IPOs) or backdoor listings, in which a dormant listed shell company typically buys the assets or shares of a private enterprise.
Dozens of tech listings are expected in 2016 as investors allocate greater capital to tech companies in search of the next great disrupter. Although the rush of tech listings has traits of a bubble, it looks like an emerging trend where ASX develops a long tail of early-stage tech companies, much as it has in the resources sector for decades.
For the governance community, that means a new wave of listed tech companies requiring formal boards and directors who can straddle technology, the needs of entrepreneurial ventures, and ASX Listing Rules. It also means greater investor focus on the governance of tech firms.
“I see no reason why the tech boom cannot continue,” says Howard Dawson, chair of migme, a fast-growing, Asia-focused social entertainment services company that listed on ASX in August 2014 through a backdoor listing. “There will be an inevitable slowdown and consolidation as the boom matures, but the long-term fundamentals for tech listings are strong.”
Governance opportunities will abound as the listed tech sector becomes a bigger source of board formation and director appointments and turnover this decade. Such boards are likely to attract younger, emerging directors and those with deeper technology skills, in turn contributing to the age, gender and skill diversity of Australian boards generally.
In time, boards of early-stage tech ventures, the disrupters, could help solve a problem for large ASX-listed companies, the disrupted. There is growing concern that boards of ASX 300 companies will struggle with the digitisation of business models because of a lack of technology skills among directors. As more directors join the boards of early-stage tech ventures, a larger pool of tech experts with governance experience will emerge, for established companies to draw on.
Moreover, expert governance in listed tech ventures, tailored to their entrepreneurial needs and nuances, could help more of them becoming globally significant companies. Boards can help early-stage tech ventures develop organisational structure to aid rapid growth, coach the CEO, have closer involvement in strategy, and guide emerging ventures that at times resemble rollercoasters.
David Kirk, co-founder and partner of Bailador Technology Investments, says tech ventures must have a board before his firm will invest in them. “We need to know the numbers are correct during the due diligence phase and form a view on the quality of directors. But we recognise that these firms are usually run by the founder and have not had a need for formal governance structures. If they have a board, it usually consists of the founder and angel investors.” Kirk also chairs ASX-listed Trade Me Group and Kathmandu Holdings.
Bailador requires a directorship and often chairs firms that it invests in. Bailador, the market’s first tech-focused listed investment company and a prominent investor in early-stage tech companies, raised $25 million through an initial public offering and joined ASX in November 2014. It has examined about 450 tech companies since listing, and invested in seven.
A large investor requiring a seat on the board of an emerging tech firm, primarily to protect their investment, is common. But Bailador goes a few steps further: it requires governance structures, such as audit and remuneration committees, and often helps tech ventures it invests in develop governance procedures from scratch. Typically, the formality of governance systems increases as the venture grows.
Bailador usually invests in tech firms in the expansion phase: those with established products and revenues that are beyond the start-up phase, but yet to list. Developing governance systems is part of the process of getting these companies ready for the next phase, often an IPO, and allowing Bailador to exit and reinvest capital.
Kirk, a former CEO of Fairfax Media and a former captain of the New Zealand All Blacks rugby union team, says it is important that tech companies develop governance structures early. “You don’t want too much governance formality when companies are still in the start-up phase. But once they have millions of dollars of revenue, several investors and a clear growth path, governance systems need to be clearly established.”
Directors that suit emerging tech companies need experience in growing early-stage companies and reasonable technology knowledge, Kirk says. “Directors don’t need to be experts who can debate technology in great detail with the founder, but they must be able to understand the big picture for the technology and how it interacts with the organisation’s product and market strategy. They also need good business judgement in entrepreneurial ventures, must be capable of advising and coaching the CEO, put in the required time and effort, and introduce the company to their networks and connections.”
Governing early-stage tech ventures can be daunting. Similar to junior mining companies, tech companies usually have limited funds, shallower management depth, low governance resources and require directors who are hands-on and willing to help on executive tasks. Some tech firms live or die on their ability to raise capital, have low market profile and volatile share registers.
Growth in tech backdoor listings on ASX adds other governance challenges. The end of the mining investment boom has left ASX with a long list of junior exploration companies that are running out of funds and need to find new assets with higher growth potential. More mining companies are offering their listed shell to private tech firms that want to raise capital and join ASX through a backdoor listing, or reverse takeover. More than 40 backdoor listings, mostly tech, on ASX last year was a record.
There is a perception that backdoor listings are faster, cheaper and require less compliance than IPOs, but that is not always the case. ASX requires a listed company to seek shareholder approval for executing a backdoor listing and for the company to re-comply with ASX admission requirements. From a regulatory perspective, there is little difference between a backdoor listing and an IPO (frontdoor listing).
From a governance perspective, consider a dormant junior mining company that buys the assets of a private technology firm and raises capital through a backdoor listing, after shareholder approval. Upon relisting, the mining company might change its name, operational focus, assets, management, board and control. Long-suffering shareholders might sell when the deal is done and new shareholders will join the register.
Directors of the dormant explorer must serve the interests of all shareholders, conduct detailed due diligence on the tech assets to be acquired, and maximise value for the company. They also must be prepared to retire from the board if their skill set does not align with the needs of the tech venture being acquired.
Meanwhile, directors of the private tech company must conduct strong due diligence on the listed shell. Unlike an IPO, which starts with a clean corporate structure, the tech company inherits all the shareholders and potential legal liabilities of the listed shell. Unsuspecting directors who join the board of a backdoor listing can find that the shell company has legacy assets or liabilities that cause significant problems.
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Migme’s Howard Dawson joined the board through his chairmanship of Latin Gold, the junior explorer that was the shell for migme to list on ASX. He had the delicate task of balancing the needs of Latin Gold shareholders with those who joined through migme. Fortunately, the social entertainment company has soared since it listed and rewarded Latin Gold investors who kept their stock.
Dawson says strong due diligence on backdoor listings is critical. “Before agreeing to join the board, directors must have access to a solid independent report on the technology, an understanding of the balance sheet and capital structure, the monthly cash-burn rate, and whether the tech company has sufficient internal capacity to execute its plan.”
Understanding the shareholder base is another consideration, Dawson says. “Generally, investors in the smaller end of the market (below $50 million in market capitalisation) are there to make quick money. They want directors to give things a shake, not govern a company that goes into hibernation to preserve cash while they earn board fees. You have to accept that a number of shareholders will sell if the share price rises and are not there for the long term. That’s part of governing any speculative company.”
Dawson says board changes must occur early in a backdoor listing. “Board renewal has to be a condition of the deal. You can’t have directors who put their interests first and stay with a company so they can keep earning fees and have the kudos of being a company director. All the governance heavy-lifting needs to be done at the time of the deal, so that the backdoor listing starts life with the best possible board.”
Faster board renewal is another feature of emerging tech companies, Dawson says. “Very successful tech companies are constantly changing. The natural tenure of a director of a young tech company is probably no more than three to four years. As the company rapidly evolves, so too should the board, to ensure the right directors are in place for the next stage of that company’s evolution.”
Executive change is another constant in start-up tech companies. Theo Hnarakis MAICD, chair of Crowd Mobile and a non-executive director of Newzulu International, two fast-growing backdoor listings on ASX in the past 18 months, says boards must expect the CEO’s role to evolve rapidly. “As a director, you have to expect the founding CEO is only there on an interim basis. They might move up to become executive chairman or leave the company as it gets to its next phase.”
Hnarakis, a former CEO of Melbourne IT and one of Australia’s most experienced directors with start-up tech companies, says the board’s relationship with the CEO has three stages.
The first is input on strategy and operational matters. “At the start, the board is effectively an extension of the management team because the company has limited resources. The CEO almost uses the board in a consulting capacity to test and shape the strategy. As a director, you have to be prepared to invest a lot of time and be available for the company when it needs you. You’re usually doing a lot of work in between board meetings helping the CEO; you can’t be on the board of a tech start-up if you are juggling lots of other board roles and have limited time availability or flexibility.”
The second stage is succession planning. “The board must focus on this early on and help build the executive team’s capability and ensure there is significant management depth,” Hnarakis says. “You have to ask, what happens if the CEO is hit by a bus? Things can go wrong very quickly in a start-up if something happens to the founder who inspired the business and drives it every day.”
The third stage is ensuring the CEO and organisation can transition to being a listed company, if that is part of its strategy. “Often the founder has never run a larger organisation or had exposure to ASX Listing Rules,” Hnarakis says. “The board must ensure the company has appropriate governance systems and structures and that the CEO is personally ready to run a listed company. The board plays an important mentoring role.”
Hnarakis’ approach is working with Crowd Mobile. After raising $4.5 million and listing through the shell of Q Ltd in January 2015, shares in the operator of mobile question-and-answer apps have rallied. Hnarakis agreed to join the board after attending its strategy off-site, as part of his due diligence. “As a director, you need to know you can add real value to the executive team and help the organisation build its capability and sustainability over a journey that can be very uncertain at times,” he says.