Back-Door Listing

What Is a Back-Door Listing?

In finance, the term “back-door listing” refers to an alternative strategy used by private companies that wish to become publicly traded. One such strategy consists of acquiring an existing publicly-traded company, and then continuing to operate under the acquired company’s ticker symbol.

Although back-door listings can be more economical than a formal initial public offering (IPO), they may nonetheless prove prohibitively expensive for the private company involved. Oftentimes, companies pursuing a back-door listing must rely on substantial amounts of debt in order to finance the acquisition of the publicly traded vehicle.

How Back-Door Listings Work

There are several key factors influencing the phenomenon of back-door listings. To begin with, companies may be attracted to the increased liquidity that can be available to public companies, allowing the private company’s founders to more easily cash out on their holdings. Moreover, public companies can sometimes benefit from more favorable fundraising terms, as many investors take confidence in the increased oversight and reporting requirements demanded of public firms.

For these reasons, many owners of private companies may feel that their business would benefit from being publicly traded. However, the actual cost of going public — in terms of both time and money — can be prohibitively expensive for most private firms. After all, the upfront cost of an IPO is typically around 5% of its total proceeds, with additional fees often amounting to several millions of dollars. Recurring costs, such as annual auditing fees and internal compliance costs, can also add hundreds of thousands of dollars to a company’s administrative expenditures.

In cases where a private company is able to shoulder these added costs, they nonetheless must contend with the formal listing requirements imposed by the various stock exchanges. For example, the New York Stock Exchange (NYSE) requires newly listed companies to have combined annual pre-tax earnings of at least $10 million over the past 3 years, among several other factors. The Nasdaq Stock Market also has its own requirements.

Real World Example of a Back-Door Listing

XYZ Corporation is a mid-size manufacturing company that has grown substantially under its current management team. The company’s management are feeling very optimistic, as they have generated record profits in each of the last three years, culminating with a recent annual profit of $3 million.

Encouraged by their recent success, XYZ’s managers believe that they are ready to make the transition to becoming a public company. After all, they reason that this will benefit their shareholders by providing increased liquidity, legitimacy, and access to economical fundraising. To that end, they set about arranging for an IPO on the NYSE.

Yet despite their recent performance, XYZ soon finds that they are still not eligible for acceptance by the NYSE. One reason for this is their current earnings: although their growth has been strong, they have still not generated a cumulative $10 million in pre-tax earnings in the last 3 years.

Faced with this situation, XYZ’s managers adopt an alternative strategy. Rather than simply waiting until they meet the listing requirements, they choose to engineer a back-door listing by seeking out a relatively inexpensive publicly listed company and acquiring it outright. To finance this, XYZ is forced to rely on substantial amounts of debt, making the acquisition a type of leveraged buyout (LBO) transaction. Once acquired, the newly-purchased company can serve as the public “vehicle” of XYZ, thereby allowing XYZ to obtain the benefits of public ownership without formally meeting the new listing requirements.