How to avoid a bad IPO and pick a good one

Small cap IPOs in Australia are notorious for being a gamble, and the way to get a good one — or, at least, avoid the bad ones — is to do your homework, says one fund manager.

David McNamee, from Brisbane-based Altor Capital, says his main red flag is valuation.

“It’s very risky if you’re paying $200m for a company that has very little revenue and still has big cash outflows on the business, yet is not at a point where they have a base that they can then scale off,” he said.

It doesn’t mean investors should forget about them entirely, just that a better time to invest may come up in the future.

NcNamee says Raiz (ASX:RZI) is an example: it did some pre-IPO rounds, including crowdfunding, and listed in 2018 at too high a valuation and promptly sank. It has since secured some institutional support, delivered on its promises, and the stock is climbing.

He also looks at who has shares in the company and how much those shares were worth when they paid for, or were given to them, as well as whether promotional shares had been given away.

“You don’t want anything where a whole bunch of people have been given shares at a low valuation, for example Redbubble (ASX:RBL) when it listed,” he said.

The risk here is those investors might want to sell early if the on-market share price is high.

McNamee doesn’t like to see debt in early stage companies coming to market, and warns investors to investigate pre-IPO capital raises to find out how much shares had been sold for in the past and how much had been raised.

An institutional investor on the register is a good sign, a group of rich individuals is less good, as are equity crowdfunded rounds.

“You definitely have to be more wary of the crowdfunded ones that have come to market, because the register is generally not as stable thanks to a large number of retail investors,” McNamee said.

“The mere fact that a company has gone out and raised money through crowdfunding suggests that there hasn’t been a cornerstone or more professional investors happy to put money into the company.”