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Despite turbulent equity markets, many companies are considering the initial public offering market to obtain liquidity for their shareholders. The key to a successful IPO is hitting the market at the right time, with the right story and the right financial information. However, companies often fail to plan sufficiently in advance to be prepared to launch when favorable market conditions arise. Though companies commonly believe that they can prepare an IPO offering document in several months, preparation should begin at least a year before the targeted going-public date in order to avoid a number of possible pitfalls.
This article focuses on long-term planning measures that can position the company for a smooth and successful IPO.
Conduct a thorough IPO readiness assessment. Timing is key, and the best way to minimize surprises and ensure a smooth IPO is to conduct a thorough IPO readiness assessment that focuses on the going-public process and the being-public processes.
The assessment would identify critical issues as well as develop a detailed IPO plan and realistic timeline to the IPO launch and beyond.
Financial statements and internal controls. When the company decides on an IPO, it should contact its external auditors and consider engaging a second accounting adviser to begin a review of the company's current financial statements and to enhance its documentation of accounting policies in light of the offering. Auditors may need to take a fresh look at segment reporting and determine if pro forma financial statements or any separate financials for significant subsidiaries will be required. It may take a significant amount of time to prepare public company financials, and typically private companies do not have resources or technical depth in public company reporting to perform these tasks without outside assistance.
The company and its auditors must review the company's system of internal controls to ensure compliance with the Securities and Exchange Commission and other applicable rules, as developing, documenting and testing its system of internal controls could take six to 12 months. Auditors typically will not permit the company to go public until it has adequate internal controls, even before the Sarbanes-Oxley-mandated internal control auditor attestation deadline. It is important to determine whether any significant deficiencies or material weaknesses exist and begin the remediation process promptly.
Limit 'cheap stock' charges. The SEC focuses on a company's equity compensation programs and grants to employees, making it important that the company has adequate support for its option valuations or, if necessary, that it begins performing those valuations. The company should pay particular attention to "cheap stock" problems that arise in the months before the IPO. Such issues typically occur in the context of employee option grants, where options are issued during the 12 months preceding an IPO with an exercise price below the anticipated IPO price. If the company cannot produce reliable valuations of those options, it may be subject to a "cheap stock" charge and potentially even a restatement of its financials.
Publicity policy. The company should adopt a comprehensive publicity policy in order to avoid "gun-jumping" issues, which may cause the SEC to delay the timing of the offering. In addition to limiting the number of people who are aware of the planned IPO, the company should distribute its publicity policy to everyone who may speak to third parties about the company. While "ordinary course" discussions of the business can continue, discussion of the offering itself cannot occur.
Identify and review material contracts. It is important to determine early in the process which of the company's "material contracts" may need to be publicly filed and if they contain confidentiality provisions that prohibit public disclosure. The company may need to begin negotiating appropriate modifications or approvals to permit filing (or consider seeking confidential treatment from the SEC), as well as ensuring that future contracts contain carve-outs permitting filing.
Board of directors; look-back. It is essential to determine whether changes to the board are needed in order to comply with SEC or stock exchange rules or for marketing purposes. Most importantly, if a "controlled company" exemption does not apply, the company will eventually need to have a majority of independent directors. Director independence look-back provisions require early consideration of the board's composition. The company should avoid transactions with potential new directors, and directors should have time to become familiar with any potential liability issues. Further, companies should review existing directors and officers' insurance coverage and, if necessary, seek new or upgrade existing coverage appropriate for a public company.
Committees and charters. The company should review its current board committees and charters and determine whether modifications are necessary under SEC or stock exchange rules. The company will eventually need to have an audit committee composed of independent directors and, if a controlled-company exemption does not apply, compensation and nominating/governance committees composed of independent directors. All audit committee members must have accounting or financial experience, and the audit committee must have at least one "financial expert."
Related-party transactions. In addition to implementing a related-party transactions policy, the company should review such transactions within the past three years, if any, and monitor future transactions for potential public disclosure. In particular, before filing the registration statement, it is important to terminate loans to directors and officers, which are prohibited by Sarbanes-Oxley.
Review outstanding litigation and environmental matters. If the company is engaged in significant litigation or disputes that may lead to litigation, it may be desirable to settle such matters in advance of filing an IPO. Post-filing, the negotiating power often shifts to the opposing party.
Benefits and compensation. The company should also conduct a thorough review of its compensation and benefits plans to determine how it compares to those provided by comparable public companies and whether any at-will employees should enter into employment agreements. There are extensive executive compensation disclosures required in a registration statement, and the level and extent of these requirements frequently surprise IPO companies.
Existing stockholders. The company should identify its existing stockholders or option-holders. Underwriters typically seek to receive lockup agreements covering substantially all of the outstanding capital stock. It is typically easier to obtain lockups well in advance of the offering. Review the terms of any existing registration and participation rights and consider any changes, which are often easier to make far in advance of the IPO.
Consider changing corporate structure. The company should review its corporate structure to determine if any changes will be required, including any internal reorganization or recapitalization, subject to any potentially significant tax consequences. Similarly, the company should amend its charter and bylaws to reflect the proposed public company's capitalization and public company corporate governance provisions.
M&A activity. The company should monitor the effect any potential acquisitions will have on the IPO process. Most importantly, if an acquisition is probable and the target company is "significant," the registration statement must include audited financial statements of the target company for up to three prior years, prepared by an accounting firm acceptable to potential underwriters, as well as pro forma financial statements and narrative disclosures about the acquisition.
Prepare for due diligence. Finally, are the company's corporate records and documents ready for the due diligence investigation that will occur? If a company identifies any potential diligence or disclosure issues in advance, it may be able to resolve the issues prior to underwriters and other participants becoming involved.
If a company devotes attention to the above areas, beginning more than one year in advance of a potential IPO, it will be well-positioned to undertake the formal offering process without impacting its timeline, allowing the IPO team to focus on the offering document, road show materials and the underwriting process.
Stuart H. Gelfond and Vasiliki Tsaganos are corporate partners at Fried, Frank, Harris, Shriver & Jacobson LLP. Christy Gressman is a corporate associate at the firm. Mike Gould, transaction services of PricewaterhouseCoopers, contributed to this article.
