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How start-ups are using the back door to list on the ASX

Summer reading | 20 August 2019

Victoria Clout

Senior Lecturer

Despite regulatory concern, it's a legitimate and viable pathway to capital

So-called backdoor listings on the share market – where a company comes to the stock exchange by using the 'shell' of an inactive company – have a bad reputation among some investors and regulators.

A key aspect of backdoor listings is that they require less disclosure to investors than initial public offerings (IPO), usually with no prospectus, or just a limited prospectus ahead of the transaction. This makes them cheaper and faster and so they are appealing to small firms, such as tech start-ups.

But this can lead to market perceptions that they are more risky.

With this in mind, Victoria Clout, a senior lecturer in the school of accounting at UNSW Business School, and her co-authors take a closer look at backdoor listings in the paper, Sliding doors: Comparing backdoor listing and front door listing for Australian start-ups.

Typically, when a company lists on the Australian Securities Exchange (ASX) it makes an IPO where shares are offered to members of the public for the first time. Such companies are required to release a large amount of information to investors via a prospectus and it is a time-consuming and expensive process.

Not so for backdoor listings where there are several different allowable transactions – including a reverse takeover, where the shell company acquires the new company and then hands over its shares to the owners of the new company and usually changes its name as well.

Clout and her co-authors offer the example of Spookfish, a start-up that provides aerial imagery. In early 2015, it was acquired in a reverse buyout by Whitestar Resources and the miner changed the name to Spookfish Ltd. It has since been taken over by US company EagleView Technologies and delisted from the ASX.

In fact, many backdoor listings since the cooling of Australia's mining boom have involved resource company shells becoming tech companies.

'Some shells are used more than once for backdoor listings, which always involve a market suspension'
VICTORIA CLOUT

Survival rate

The co-authors drew on 2012-17 company data to examine the survivorship of backdoor listed companies compared with those that had come to the market via an IPO.

Of the 190 firms that came to the market via the backdoor during that period, only 3.6% had delisted from the market. However, of the 458 firms that listed via an IPO, 6.8% had delisted.

Clout speculates that one reason companies are put through an IPO by their owners is so that they attract attention and become takeover targets – providing a windfall for the owners.

Backdoor listings don’t attract the same sort of publicity, so Clout suggests the owners of backdoor listed firms don’t want to be taken over and instead want to raise capital for future growth.

Further research will look in more detail at why those firms delisted, whether it be a takeover or the company falling into administration.

While the results may suggest that backdoor listings are indeed more secure, the data is a little more complicated, as 'surviving' firms can at the same time be suspended from trading on the exchange. In fact, during the timeframe, some 12% of backdoor firms were suspended compared with just 3.9% of IPO firms.

Clout says one factor in the higher rate of suspensions, is that some shells are used more than once for backdoor listings, which always involve a market suspension.

'The ASX needs to tread a balance between facilitating entrepreneurial access to capital and the traditional mandate to protect the integrity of the market'
VICTORIA CLOUT

Close the door

Despite the lack of empirical evidence that backdoor listings are more risky, the ASX has in recent years sought to limit their use via more stringent requirements around the required shareholder approvals, and compliance with readmission rules.

The crackdown – which comes amid concerns from the ASX and the Australian Securities and Investment Commission (ASIC) that there is inadequate financial and risk disclosure in backdoor listings – has led to a big drop off in such listings.

There were 55 backdoor listings in 2015 and 80 in 2016, but in the following year after the new regulations were introduced the number dropped to 30.

ASIC is concerned that the retail investors who own shares in a shell would subsequently have to deal with managers who were not good at keeping the market informed.

Against this, however, is the role backdoor listings can play in innovation.

The co-authors write that backdoor listings are “generally promoted as a legitimately viable alternative for start-up operations due to less regulation and disclosure compared to a float, or initial public offering (IPO) capital raising”.

“[But] there is inherent tension in commentary around the ASX decision to change its rules: on the one hand, there is the perennial ‘investor protection’ imperative; on the other, this tightening coincided with an overt government National Innovation and Science Agenda; according to which restricting access to the capital market appears inconsistent with the government agenda.”

'Skeletons in the closet'

While backdoor listings are seen as a cheaper and faster way to access capital, the co-authors suggests this is not always true.

They cite a guide from accounting firm Moore Stephens that suggests the lead time to raise capital following a backdoor listing is at least six months – “potentially that much longer than an IPO”.

They also note that backdoor firms may have “skeletons in the closet”. Because they already have listing history, they could have issues such as contingent liabilities or possibly a poor corporate governance record.

The paper is the first in a series that will provide empirical evidence about backdoor listings. Subsequent research will look at their record on disclosure and market reaction to their earnings announcements.

Thus far, however, the authors believe backdoor listings have an important role to play in capital raising for start-ups.

“Access to the ASX, Australia’s predominate capital market, is valued by the start-up community, and it appears from the documents analysed that regulators and professional services consultants view [backdoor listing] as a legitimate pathway to capital,” they write.

“Backdoor listing, with its opportunities and challenges, is fundamentally addressed to the start-up business community. The ASX needs to tread a balance between facilitating entrepreneurial access to capital and the traditional mandate to protect the integrity of the market.”

Victoria Clout's co-authors are Larelle June Chapple, a professor at QUT Business School; Alexandra Perry at UQ; and Thu Phuong Truong at Victoria University Wellington.

Finance Innovation Markets Shareholders Start-ups Regulation

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<h1>How start-ups are using the back door to list on the ASX</h1>

<figure><img src="https://assets-us-01.kc-usercontent.com:443/4df0558d-5779-0012-00f2-b3fa06d6c950/8f4e8931-1029-451e-9105-0194eb311c45/iStock-866662108.jpg?w=1320" alt="start-up stock" /><figcaption>start-up stock</figcaption></figure>
 So-called backdoor listings on the share market – where a company comes to the stock exchange by using the 'shell' of an inactive company – have a bad reputation among some investors and regulators.
A key aspect of backdoor listings is that they require less disclosure to investors than initial public offerings (IPO), usually with no prospectus, or just a limited prospectus ahead of the transaction. This makes them cheaper and faster and so they are appealing to small firms, such as tech start-ups. 
But this can lead to market perceptions that they are more risky.
With this in mind, Victoria Clout, a senior lecturer in the school of accounting at UNSW Business School, and her co-authors take a closer look at backdoor listings in the paper, <a href="https://eprints.qut.edu.au/125505/" data-new-window="true" target="_blank" rel="noopener noreferrer">Sliding doors: Comparing backdoor listing and front door listing for Australian start-ups</a>.
Typically, when a company lists on the Australian Securities Exchange (ASX) it makes an IPO where shares are offered to members of the public for the first time. Such companies are required to release a large amount of information to investors via a prospectus and it is a time-consuming and expensive process.
Not so for backdoor listings where there are several different allowable transactions – including a reverse takeover, where the shell company acquires the new company and then hands over its shares to the owners of the new company and usually changes its name as well.
Clout and her co-authors offer the example of Spookfish, a start-up that provides aerial imagery. In early 2015, it was acquired in a reverse buyout by Whitestar Resources and the miner changed the name to Spookfish Ltd. It has since been taken over by US company EagleView Technologies and delisted from the ASX.
In fact, many backdoor listings since the cooling of Australia's mining boom have involved resource company shells becoming tech companies.
<blockquote>'Some shells are used more than once for backdoor listings, which always involve a market suspension'VICTORIA CLOUT</blockquote>
<h4>Survival rate</h4>
The co-authors drew on 2012-17 company data to examine the survivorship of backdoor listed companies compared with those that had come to the market via an IPO.
Of the 190 firms that came to the market via the backdoor during that period, only 3.6% had delisted from the market. However, of the 458 firms that listed via an IPO, 6.8% had delisted.
Clout speculates that one reason companies are put through an IPO by their owners is so that they attract attention and become takeover targets – providing a windfall for the owners. 
Backdoor listings don’t attract the same sort of publicity, so Clout suggests the owners of backdoor listed firms don’t want to be taken over and instead want to raise capital for future growth.
Further research will look in more detail at why those firms delisted, whether it be a takeover or the company falling into administration.
While the results may suggest that backdoor listings are indeed more secure, the data is a little more complicated, as 'surviving' firms can at the same time be suspended from trading on the exchange. In fact, during the timeframe, some 12% of backdoor firms were suspended compared with just 3.9% of IPO firms. 
Clout says one factor in the higher rate of suspensions, is that some shells are used more than once for backdoor listings, which always involve a market suspension.
<blockquote>'The ASX needs to tread a balance between facilitating entrepreneurial access to capital and the traditional mandate to protect the integrity of the market'VICTORIA CLOUT</blockquote>
<h4>Close the door</h4>
Despite the lack of empirical evidence that backdoor listings are more risky, the ASX has in recent years sought to limit their use via more stringent requirements around the required shareholder approvals, and compliance with readmission rules.
The crackdown – which comes amid concerns from the ASX and the Australian Securities and Investment Commission (ASIC) that there is inadequate financial and risk disclosure in backdoor listings – has led to a big drop off in such listings. 
There were 55 backdoor listings in 2015 and 80 in 2016, but in the following year after the new regulations were introduced the number dropped to 30.
ASIC is concerned that the retail investors who own shares in a shell would subsequently have to deal with managers who were not good at keeping the market informed.
Against this, however, is the role backdoor listings can play in innovation.
The co-authors write that backdoor listings are “generally promoted as a legitimately viable alternative for start-up operations due to less regulation and disclosure compared to a float, or initial public offering (IPO) capital raising”.
“[But] there is inherent tension in commentary around the ASX decision to change its rules: on the one hand, there is the perennial ‘investor protection’ imperative; on the other, this tightening coincided with an overt government National Innovation and Science Agenda; according to which restricting access to the capital market appears inconsistent with the government agenda.”
<h4>'Skeletons in the closet'</h4>
While backdoor listings are seen as a cheaper and faster way to access capital, the co-authors suggests this is not always true. 
They cite a guide from accounting firm Moore Stephens that suggests the lead time to raise capital following a backdoor listing is at least six months – “potentially that much longer than an IPO”.
They also note that backdoor firms may have “skeletons in the closet”. Because they already have listing history, they could have issues such as contingent liabilities or possibly a poor corporate governance record.
The paper is the first in a series that will provide empirical evidence about backdoor listings. Subsequent research will look at their record on disclosure and market reaction to their earnings announcements.
Thus far, however, the authors believe backdoor listings have an important role to play in capital raising for start-ups.
“Access to the ASX, Australia’s predominate capital market, is valued by the start-up community, and it appears from the documents analysed that regulators and professional services consultants view [backdoor listing] as a legitimate pathway to capital,” they write.
“Backdoor listing, with its opportunities and challenges, is fundamentally addressed to the start-up business community. The ASX needs to tread a balance between facilitating entrepreneurial access to capital and the traditional mandate to protect the integrity of the market.”
Victoria Clout's co-authors are Larelle June Chapple, a professor at QUT Business School; Alexandra Perry at UQ; and Thu Phuong Truong at Victoria University Wellington.

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