The initial public offer of Glencore in 2011 is often heralded as the arrival of cornerstone investments to initial public offerings (IPOs) in Europe. At that time, commentators were ready to suggest that cornerstone investments – where one or more investors agree in advance of an IPO to acquire a certain number or value of shares – may become the new norm in the European markets, mirroring practice in Asia.
With a marked improvement in European IPO activity after 2013, cornerstone investments did not take off as some had predicted. This is perhaps surprising, given that the cornerstone model had been developed in Asia to respond to a bull market in which investors were frustrated by an inability to participate in IPOs. In such circumstances, participating as a cornerstone investor guaranteed a full allocation of an order in a well-supported IPO.
However, in Europe the cornerstone model has been put to use in a different way. When market conditions become more challenging, European issuers and their shareholders have looked to cornerstone investments to de-risk an IPO by guaranteeing some demand and also flagging to the market the involvement of a high-quality investor. Where markets are more buoyant, they are perhaps perceived as less desirable as issuers and selling shareholders focus on broadening the share register and increasing liquidity on IPOs.
The market environment in the second half of 2019 appeared to support this thesis, with four of the largest European IPOs in 2019, including two of the largest UK IPOs (Trainline and Network International), having support from cornerstone investors.
A cornerstone investor is brought into the IPO process before the formal book-building process has begun. A cornerstone investor can be differentiated from an anchor investor which typically agrees to make a large order in the book during the public marketing phase of the IPO. The cornerstone investor benefits from a contractual right to receive the full allocation of the shares it offers to acquire, while an anchor investor's order may be reduced, depending on the demand for shares from other investors.
There are no specific regulations governing cornerstone investments and therefore the nature of the investment will be subject to commercial negotiation between the parties.
Areas of focus of that negotiation could include:
- the imposition of a lock-up on the shares acquired by the cornerstone investor;
- any discount on the price paid for the shares at IPO;
- the right to appoint directors to the board of the issuer; and
- access to conduct due diligence on the issuer prior to confirming the investment and any warranties to be provided to the cornerstone investor.
The final agreement is typically recorded in a cornerstone investment agreement between the issuer, any selling shareholders and the cornerstone investor.
The ability to agree bespoke arrangements with cornerstone investors sets the European approach apart from the tightly regulated cornerstone process in Hong Kong, where the receipt of direct or indirect benefits (other than guaranteed allocation in the IPO) by the cornerstone investor is expressly prohibited, and the cornerstone investor must pay the IPO offer price for its shares, agree to a lock-up period of at least six months following listing and forego any board representation.
With regard to the four 2019 cornerstone investments referred to above, it was only the one strategic investor, Mastercard, which participated as a cornerstone investor in the Network International IPO, that was subject to a lock-up on its shares, while the institutional investors that participated as cornerstone investors in the Trainline, Traton and Marel IPOs were free to trade from admission of the shares to market. The difference in approach on the Network International IPO may well be a product of the strategic nature of Mastercard's investment. The trend for no lock-ups for institutional cornerstone investors reflects a developing market practice in Europe with investors appearing to have become increasingly reticent to guarantee not to deal in their securities in the IPO aftermarket.
A post-IPO lock-up is clearly a good marketing tool for the issuer as it shows the strength of commitment of the cornerstone investor. It also avoids any public relations embarrassment should an investor benefit from selling down following a bounce in the share price on listing. That lock-ups are not currently a regular feature of a cornerstone investment in European IPOs supports the view that, generally speaking, the guaranteed participation in the IPO is more valuable to the issuer and the selling shareholders than any promise of guaranteed allocation is to the investor.
Discounts to IPO offer price
Market practice in the United Kingdom has been for cornerstone investors to participate in an IPO at the same price as other investors, but this is not a requirement. The approach is driven by a concern that offering a discount may act as a price drag for the IPO as other investors would be reluctant to accept a higher valuation. If a discount was to be offered, it would be expected that the cornerstone investor would agree to a lengthy lock-up on its shares to avoid its ability to short the share price immediately following admission.
Director appointment rights
While none of the cornerstone-supported IPOs in 2019 had the feature, a cornerstone investor may wish to seek director appointment rights if its participation in the IPO is significant enough to merit such involvement.
Investors will differ in their views as to the benefit to having a nominated director. Given restrictions on the sharing of inside information under the EU Market Abuse Regulation (596/2014) and the need therefore to control information sharing between the director and the nominating investor, having a board representative may not provide the insight that an investor might expect. However, it should provide the investor with a voice on the board that is at least understanding of the investor's strategic vision for the company, which, if the cornerstone investor plans to hold its shares for a lengthy period of time, may be considered important.
A board representative can be considered unhelpful to an investor that wants the flexibility to exit its investment at a time of its choosing. While an investor is not, by virtue of its board representation, prohibited under the EU Market Abuse Regulation to deal in the issuer's securities during a 'closed' period (ie, 30 days before the publication of annual or interim results) as the director will be, the issuer may require the investor to agree to such restrictions in return for the director appointment right. Even if that is not the case, the market may not respond well to an investor marketing a potential disposal of shares during a closed period.
Due diligence and warranties
As the cornerstone investor is participating in the IPO alongside other investors, an issuer must give careful consideration to the information it provides during discussions with such investor. As all material information with respect to the issuer is to be included in the prospectus, the typical approach is to provide the investor with a draft prospectus (first, in a well-developed draft and then, prior to execution of the cornerstone investment agreement, the version to be approved by the competent authority) and the other key marketing materials.
More detailed non-material information may be provided (eg, the underlying documents for which summaries are included in the prospectus), but in every case the information provided should be reviewed and the prospectus amended if the information is material and therefore required to be disclosed to all investors. Unless they are included in the prospectus, business plans and future projections should generally not be shared with such investors.
The warranties provided to the investor in the cornerstone investment agreement are typically very limited on the basis that the investment decision is being made on the information contained in the prospectus. This mirrors the approach taken in the Hong Kong market, but the requirement to treat every IPO investor in a similar fashion does not apply in the United Kingdom and therefore wider protections could theoretically be sought by the investor.
If an investor is to take up more than 5% of the offer (which would typically be the case with a cornerstone investor), the EU Prospectus Regulation (2017/1129) requires the issuer to disclose this information in the prospectus. Equally, the cornerstone investment agreement is typically considered a material contract, and details of any key provisions such as lock-ups or director appointment rights need to be included in the prospectus.
A drawback of any cornerstone investment is that it puts a significant number of shares in the hands of one investor and does not provide breadth to the shareholder register.
This potentially harms the liquidity of the shares and, notwithstanding the potential benefit to the IPO given by a good-quality investor guaranteeing to invest, may be unattractive to other potential investors. Concerns around liquidity can be compounded if a cornerstone investor agrees to a lock-up.
Further, in most cases the participation of a cornerstone investor does not assist the issuer achieve the necessary free float requirement to list. Any person with an interest of 5% or more of the listed shares, or who is locked up for more than 180 calendar days, is not entitled to be included in the issuer's free float, which for the vast majority of shares admitted to trading on the Main Market for listed securities is set at 25% of the listed shares. As such, if the pre-IPO register is tightly held, an issuer will still have to find sufficient demand for other investors whose holdings do count towards the free float, in order to meet the eligibility requirements.
As issuers and selling shareholders seek to de-risk IPOs in the United Kingdom, it is likely that there will be further cornerstone investments when the IPO market returns. While the absence of regulation raises the possibility of further developments to market practice in this area, it remains to be seen whether investors will leverage market conditions to extract more favourable terms for their investment and, if so, how those terms might influence the participation of other potential IPO investors.
The impact of the COVID-19 pandemic on both the capital markets and the economy more generally may well mean that cornerstone investments become even more critical to the successful execution of IPOs.