A flurry of initial public offering activity, which had been unseen since the beginning of the credit crisis, indicates a further sign of revival of the U.S. capital markets. The new IPOs should be good news to many companies that had been effectively shut out of various financing sources -- debt and equity -- over the past year. This year, more than 55 companies have filed IPO registration statements with the U.S. Securities and Exchange Commission. Most are U.S. companies, joined by a few foreign companies, especially from China. Many of them are REITs and technology-based services providers, with a few in the financial services, power, retail and other sectors. About 23 companies effectively completed their IPOs this year, a far cry from 2007's 282 IPOs or even 2008's 51 IPOs, but the recent increase in the number of IPO filings over the past few weeks is cause for optimism.
An IPO is a transformational event for a company, its management, employees and promoters, and the decision to go public is one that needs to be carefully weighed.
For promoters, an IPO may allow them to monetize their investment by selling down a portion of their holdings in the company at the time of the IPO, yet at the same time retain control of the company. Once the company is public, promoters may also find it easier to sell portions of their ownership over time in additional sales into the public markets.
For companies, an IPO allows them to access, in at times significant amounts, additional capital; raise their profile in the industry and with their clients; facilitate acquisitions and other M&A activity (publicly traded stock can be an attractive alternative to cash); in certain cases, obtain better loan terms from lenders; and give them additional incentives to attract and retain top talent. Once public, the company may also regularly tap the public capital markets to raise additional funds on an ongoing basis as its business and funding needs evolve.
These considerations must be carefully weighed against the challenges and costs of going public and ongoing compliance and regulatory burdens applicable to public companies, their directors, officers and principal stockholders. Some of these challenges and requirements include:
Independent board. Unless more than 50% of the voting power of the company is held by a shareholder following the IPO, a majority of the board of directors will generally need to be independent. The company will also be required to have a fully independent compensation committee and nominating/corporate governance committee (subject to phase-in periods). With the growing demands on independent directors, finding the right independent directors may be a difficult task, and the company will also need to procure director and officer liability insurance to attract new independent directors.
Audit committees. Public companies are required to have fully independent audit committees, with audit committee members who meet certain financial literacy requirements.
Independent auditors. The independent auditors of the company will need to be registered with the Public Company Accounting Oversight Board, or PCAOB. This may require the company to change its auditors and get new audited financials in connection with its IPO. The relationship of the independent auditor with management and the company is regulated, and audit committee preapproval of audit and nonaudit services provided by the independent auditors will be required.
Internal control over financial reporting. Public companies are required to maintain "internal control over financial reporting." Management must carry out an annual assessment of the company's internal control over financial reporting, which, in certain cases, will also need to be passed upon by the company's independent auditors. Those requirements are complex, time-consuming and costly.
Disclosure controls and procedures. Public companies must maintain "disclosure controls and procedures" that ensure internal procedures are in place to timely and adequately dispense information to the public. As with internal controls, these disclosure controls are also subject to effectiveness assessments.
Financial statements. The IPO prospectus will need to contain audited and unaudited consolidated financial statements of the company for the past three years (and any interim quarterly unaudited financial statements) and selected annual consolidated financial data for the past five years (of which the oldest two years may be unaudited).
Public Scrutiny. Public companies are subject to extensive ongoing reporting, disclosure and other compliance obligations. Among other requirements, the company must make annual and quarterly disclosures as well as ongoing periodic disclosures upon the occurrence of specific events. Those requirements can be difficult when the company is experiencing financial or business difficulties; contemplating a significant transaction; or entering into strategic agreements that it may have to disclose. The company will also become subject to rules regarding shareholders' meetings and proxy statements. In addition, it will need to file its material agreements with the SEC. The SEC standards for confidentiality of competitive and other sensitive information are difficult to meet.
Certifications. The CEO and CFO of the company will need to certify the company's periodic filings. A knowingly false certification could lead to criminal liability.
Loans to executive officers and directors. Any loan or advance extended to directors and executive officers will need to be repaid, forgiven or otherwise unwound as soon as possible prior to the filing of the IPO.
Stockholder reporting obligations. Executive officers and directors, as well as 10% stockholders, must publicly disclose their securities holdings in the company (including derivative securities). In addition, they must publicly disclose any trades that they make in the company's securities and will be subject to liability for "short-swing" profits they make on any sales and purchases of the company's securities occurring within a six-month period. Separately, any person beneficially owning more than 5% of the company's securities must publicly file statements disclosing his or her identity and stock ownership. Violation of these obligations could result in profit disgorgement and other penalties.
Hostile takeover and shareholder activism. Public companies are subject to hostile takeover activity and shareholder activism, both of which are on the rise. Anti-takeover defenses will need to be put in place to protect the continued growth of the business while balancing those needs against a successful marketing of the IPO, the requirements of investors and the positions taken by proxy advisory firms on corporate governance and takeover defenses. For example, opposition is growing against certain forms of takeover defenses, including poison pills, staggered boards and plurality voting.
Employment and benefit plans. Employment agreements for senior management and key employees and employee benefit plans (for example, incentive plans, stock purchase plans and director stock option plans) should be put in place at the time of the IPO for retention purposes, IPO marketing reasons and because it is more difficult to put those plans in place once the company has gone public. These arrangements should comply with the new corporate governance environment on say-on-pay and executive compensation.
Investor relations. Public companies need to release earnings on a quarterly basis and comply with complex rules on communications. An officer in charge of investor relations and an investor relations firm will need to be hired for that purpose.
Costs. An IPO is an expensive process with underwriter commissions of about 7% of the IPO proceeds and legal, accounting, stock exchange and other fees and expenses on top of that. Post-IPO, ongoing compliance and reporting costs can be burdensome, especially for smaller public companies.
Although taking a company public requires much consideration, it can be a very beneficial experience when done correctly. By carefully planning and scrutinizing each step of the process, management and stockholders can ensure that the best interests of the company and its stockholders are being served.
Valérie Demont is a partner in the New York office of Pepper Hamilton LLP. She focuses her practice on U.S. and cross-border mergers and acquisitions, capital markets, corporate finance and securities matters.