Roadmap for an Ipo a Guide to Going Public

8/3/2019 Roadmap for an Ipo a Guide to Going Public

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Roadmap for an IPOA guide to going public


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Contents

Introduction

01 The going-public decision

02 Preparing for a successful offering 1

03 Current regulatory and disclosures issues 2

04 The going public process 3

05 Life as a public company 5

06 Other considerations 7

Conclusion 7

Appendices

Appendix AThe kick-off organizational meeting and planning process 8

Appendix BGlossary 8

Roadmap for an IPO | A guide to going public


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2 PricewaterhouseCoopers

Introduction

Going public is a monumental decision

for any company. It forever changes howa company goes about doing business.A public company has access to more,and often deeper, sources of capital thana private company. The actual processof going public can be time-consuming

and presents certain unique challengesthat a company should be preparedto undertake.

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An initial public offering is a transformational event for an organization. Thepreparation for being public is just as important as the preparation for

going public. A company will need to meet additional requirements andcontinuing obligations as a public company that may require new skill sets,additional resources and changes to the business. Thinking through theserequirements in advance and developing an appropriate plan is the key to asuccessful entry into life as a public company and will reduce unexpectedpost-IPO issues.

As the number of companies looking to access the equity marketscontinues to grow, we are publishing this fth edition of Roadmap for anIPO, which address the US IPO process and the impact of going public.

This publication contains information that a company will need when itdebates whether to go public or to pursue alternate means to nance

growth. The purpose of the guide is to help companies make informeddecisions by addressing factors such as the advantages, disadvantages,costs, timing, and alternatives to going public. It outlines the processof going public and discusses the registration and ongoing reportingrequirements of a public company. Finally, the guide summarizes the mostsignicant accounting, compensation, and tax-related considerations ofgoing public.

We hope you nd this guide a helpful and an easy-to-use reference forplanning and executing a successful IPO as you determine the best pathfor sustaining your companys growth now and into the future.


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01 The going-public decision

What does going public mean? It is the process of offering securities generallycommon stock of a privately owned company for sale to the general public. The rst time

these securities are offered is referred to as an initial public offering, or IPO.


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During the IPO process,companies often underestimatethe requirements to completethe transaction in addition tothe ongoing obligations andscrutiny of life as a publiccompany. An early assessmentof a company preparing togo public could uncoverunforeseen issues, including:

Financial reporting

Tax Governance

Internal controls

Compliance

Human resources

Structuring (legal)

What is a public offering?

An IPO in which a company sells its unissued securities and receives all

the proceeds in the form of additional capital is called a primary offering.A securities sale in which securities held by the owners of the companyare sold, and from which the owners receive the proceeds, is called asecondary offering. IPOs are almost always primary offerings, but mayinclude the sale of shares held by the present owners.

Why am I going public?

The most important question a CEO should ask is, Why do I want to gopublic? Some of reasons include:

To access capital markets to raise money for the expansion of operations

To acquire other companies with publicly traded stock as the currency

To attract and retain talented employees

To diversify and reduce investor holdings

To provide liquidity for shareholders

To enhance the companys reputation

Other reasons may be private and personal. It is important to keep specicgoals in mind throughout the going-public process.

Is going public right for your company?

A company usually begins to think about going public when the fundingrequired to meet the demands of its business begins to exceed thecompanys ability to raise additional capital through other channels atattractive terms. But simply needing capital does not always mean thatgoing public is the right, or even possible, answer. There are a number ofquestions that a company should ask itself before deciding to go public.

Does your company have an attractive track record?

Generally, a company that outpaces the industry average in growth will havea better chance of attracting prospective investors than one with marginalor inconsistent growth. Investment bankers want the offering that theyunderwrite to be successful. Therefore, they look for companies that can

fulll several tried and true criteria to boost the chances for a successfuloffering and good performance in the aftermarket. Here are some of themost important factors:

An attractive product or service, preferably one with a competitiveadvantage and sufciently large market


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Companies need to objectivelyassess their readiness for life asa public company. Going publicrequires management to beprepared to meet shareholderand market expectations fromday one. Companies will needto address ongoing complianceand regulatory requirements,operational effectiveness,risk management, periodicreporting, and investor relations.

An experienced management team

A positive trend of historical nancial results

Favorable nancial prospects

A well-thought-out, focused business plan

Strong nancial, operational, and compliance controls

Though some companies may not currently meet all of these criteria,investors may perceive these companies as having enormous potentialfor growth due to the other favorable characteristics they possess (e.g., aproduct or service that is highly visible, unique, or of interest to the publicand capable and committed management).

Has your company reached the point at which prospects for maintaining astrong sales and earnings growth trend in the future are reasonably good?

Many companies that have successfully gone public have illustrated marketsupport for their product or service that would sustain an increasing annualgrowth rate over a period of time.

Are your companys products or services highly visible and of interest to theconsuming and investing public?

The established company can answer this question with historical salesdata, while the early-stage company must use market research projectionsand demonstrated product superiority. An early-stage company may qualifyas an IPO candidate due to the uniqueness of its product or service.

Is your company prepared to le timely nancial statements with theSecurities and Exchange Commission (SEC)?

Public companies need to le nancial statements on a quarterly andannual basis with the SEC, with prescribed data requirements and requiredadherence to rigorous SEC accounting and disclosure guidelines. Thesenancial statements are due relatively soon after each period end, so thereis increased time pressure on reporting compared to that of a privatelyheld company.

Has your company established the necessary nancial statement integrity

through the implementation of an effective system of internal control tosupport managements reporting obligations as a public company?

The passage of the Sarbanes-Oxley Act of 2002 raised the bar on theamount of advance preparation and planning necessary for a successful


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IPO in the U.S. capital markets. This legislation, among other things,requires CEOs and CFOs to explicitly evaluate and report to the public the

effectiveness of internal control over nancial reporting. The companysexternal auditor is required to annually attest to the effectiveness of thecompanys internal control over nancial reporting. In this publication,we use the term Sarbanes-Oxley to refer to either the legislation orits provisions.

Is leadership capable and committed?

In any public offering, the quality of the leadership team is a key factor.It is vital to ensure that the board of directors as well as managementhas the right blend of experience and skills to establish the optimalcorporate governance structure and ensure that the board committees areoperating effectively.

To gain credibility with the investing public, the organization must haveexperienced leadership that functions well as a team. Ownership bymanagement demonstrates to investors that it has a vested interestin the companys future. To have a successful IPO, management mustbe committed to the time and effort involved in meeting registrationrequirements, conducting analyst and other investor-facing meetings, andproviding nancial reports required by both the SEC and shareholders on atimely basis. It must also be prepared to upgrade the companys system ofmanagement controls and nancial reporting well in advance of the offeringto ensure compliance with full disclosure requirements and shorter nancialreporting deadlines, both of which are necessary to maintain credibility andinvestor condence after the IPO.

Do the benets outweigh the costs of going public?

Selling equity represents a permanent forfeiture of a portion of the returnsassociated with corporate growth. Also, raising equity capital in the publicmarkets can entail substantial costs, such as underwriting and otheradvisors fees and expenses. (See the discussion on costs in Pros, Cons,and Expenses of Going Public, p. 9.) However, the answer to whether thebenets outweigh the cost cannot be realistically known until several yearsafter an IPO.

Choosing a stock market

Each stock market has specic entry requirements, such as earningshistory, shareholders equity, market capitalization, number of expectedshareholders, and corporate governance. A company seeking to go publicmust choose the market that is right for its stock. A companys banking


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Beginning early to position yourcompany to go public will savefees and, most importantly,time. The sooner you areready to enter the market, themore exibility you will haveto be prepared to move onan opportune market and thegreater proceeds and marketvaluation that favorable marketconditions provide. By engagingexternal advisors early in the

IPO process, companies getan objective and professionalmechanism for assessing thestate of readiness for life as apublic company.

advisors can furnish in-depth information on the investor base in eachmarket and the markets likely appetite for the companys shares. A

company and its advisors should approach the stock market early in thecapital raising process to ensure the smoothest possible transaction. Asthe economy continues to become more global, companies consideringoverseas or dual listings will also need to evaluate the impact of IFRS onthe offering process.

Is the market right?

The demand for initial public offerings can vary dramatically, depending onoverall market strength, the markets opinion of IPOs, industry economicconditions, technological changes, and many other factors. Stock marketvolatility is one of the most unpredictable aspects of going public and itmakes timing the IPO key in achieving the best possible result. Although it

is impossible to accurately forecast the markets mood, a company mustconsider the importance of timing and be prepared to alter its timetable.When a bull market is booming, the market window for new corporateofferings tends to open and these new offerings enjoy bursts of popularity.In a declining market, however, the market window tends to close andIPO activity slows down and may even come to a stop. A company mustconsider the importance of timing and be prepared to alter its timetable.In general, from the initial meeting of all of the team members until the rstling, it can take at least three months (under the best circumstances),although the timeframe from the rst ling to the effective date can besignicantly longer.

At any time, an IPO window may be open for companies within certain

favored industries and sometimes the window may be open for companiesin all industries. Missing an IPO window by as little as a few weeks canresult in a postponed or withdrawn IPO or a lower market valuation.

Accordingly, in addition to reviewing how companies in a specic industryare faring, a company should also look at valuations in the overall market.

Hot markets accept many offerings, but companies do not want to be thedeal that is just one day too late. Recognizing the urgency of the registrationprocess is critical. Even in a slower market environment, there is what isreferred to as an industry pop or industry urry. Industry pops aretricky since some IPOs may be perceived as a me too company and notas strong as the leader, and when interest wanes, the window of opportunitycloses quickly. However, industry pops give the public investor goodcurrent information on comparable companies in order to make validpricing decisions.

Market conditions will also impact the valuation of a company and theeventual pricing of its stock.


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Other sources of capital

If a company is heavily encumbered by debt and/or is seeking to expand

rapidly, it may want to consider other alternatives such as commercial bankloans, exempt offerings, and private placements of equity or debt.

Pros, cons, and expenses of going public

All in favor

Increased cash and long-term capitalFunds are obtained to supportgrowth, increase working capital, invest in plant and equipment, expandresearch and development, and retire debt, among other goals.

Increased market valueThe value of public companies tendsto be higher than that of comparable private companies due in

part to increased liquidity, available information, and a readilyascertainable value.

Mergers/AcquisitionsThese activities may be achieved with stockconsideration and thus conserve cash.

Growth strategiesShareholders may achieve improved liquidity andgreater shareholder value. Subject to certain restrictions and practicalmarket limitations, shareholders may, over time, sell their stock in thepublic market. Alternatively, existing stock may be used as collateral tosecure personal loans.

Ability to attract and keep key personnelIf a company is publiclyowned, employee incentive and benet plans are usually established

in the form of stock ownership arrangements to attract and keep keypersonnel. Stock option plans, for example, may be more attractive toofcers and other key personnel than generous salary arrangements dueto the signicant upside potential.

Increased prestige/reputationThe visibility for shareholders andtheir company is usually enhanced. For example, a regional companymay more easily expand nationally following a stock offering due to theincreased visibility.

All opposed

Increased expensesMany factors play a role in determining the costof an IPO, but in all cases the costs of going public are signicant. Thesecosts will generally include underwriting fees (generally 5-7 percent ofthe gross proceeds), fees related to legal and accounting advisors, andprinting costs. In addition, there are other fees such as the SEC ling fee,the exchange listing fee (NASDAQ or NYSE), and any Blue Sky ling fees.


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Most expenses directly related to the offering in a complete IPO arereected as an offset to the proceeds received and a reduction of additional

paid-in-capital. IPO start-up costs are therefore not expensed in thestatement of operations. However, if the IPO is not completed, such costsare generally expensed.

Ongoing expensesPublic companies are required to report andcertify nancial information on a quarterly and annual basis. There willbe ongoing expenses related to these changes such as the expense ofindependent auditors. Administrative and investor relations costs includethose related to quarterly reports, proxy materials, annual reports,transfer agents, and public relations. A public company will now bepaying premiums for directors and ofcers liability insurance as well.Furthermore, compliance-related costs could also increase primarily inrelation to the Sarbanes-Oxley 404 certication requirements.

Loss of controlIf more than 50 percent of a companys shares aresold to just a few outside individuals, the original owners could losecontrol of the company. If, however, the shares held by the public arewidely distributed, management and the board of directors may maintaineffective control, even though they own less than 50 percent of theshares. Many companies structure their offerings so that after an initialoffering, the founder(s) still has control, and after subsequent offeringsthe entire management team maintains control.

Loss of privacyThe registration statement and subsequent reportingrequire disclosure of many facets of a companys business, operations,and nances that may never before have been known outside thecompany. Some sensitive areas of disclosure that will be available to

competitors, customers, and employees include: 1) extensive nancialinformation (e.g., nancial position, sales, cost of sales, gross prot, netincome, business segment data, related-party transactions, borrowings,cash ows, major customers, and assessment of internal controls); 2) thecompensation of ofcers and directors, including cash compensation,stock option plans, and deferred compensation plans; and 3) the securityholdings of ofcers, directors, and major shareholders (insiders).

Pressure for performanceIn a private company, the business owner/manager is free to operate independently. However, once the companybecomes publicly owned, the owner acquires as many partners asthe company has shareholders and is accountable to all of them.Shareholders expect steady growth in areas such as sales, prots,market share, and product innovation. Thus, in a publicly held company,management is under constant pressure to balance short-term demandsfor growth with strategies that achieve long-term goals. The inability tomeet analysts expectations of short-term earnings can dramatically hurtthe marketplaces long-term valuation of a company.


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Restrictions on insider salesStock sales by insiders are usuallylimited. Most underwriters require that a companys existing shareholders

enter into contractual agreements to refrain from selling their stock duringa specied time following the IPO, typically 180 days. This is called thelock-up period.

Investor relationsInvestors inquiries, investment-communitypresentations, and printing and distributing quarterly and annual nancialreports require a signicant time commitment by management. Theyoften also require additional personnel or public relations resources.

No turning backThe IPO process is essentially one-way. Taking acompany private can be difcult and costly.

Vulnerability to hostile takeoversHaving publicly traded sharesreduces the companys ability to control its ownership and exposes it tounsolicited acquisition threats.

Litigation riskBeing public increases a companys exposure toshareholder lawsuits, particularly since Sarbanes-Oxley was passed.

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All too often, going public isviewed as the only means,rather than one of severaluseful business alternatives, toachieve a companys objectives.

Advisors can provide theexpertise that will enable you tomake an informed, intelligent,and objective decision.


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IPO alternatives

IPO Alternative What is it? Advantages Disadvantages

Exempt offerings (144Aofferings)

Transactions where securitiesare sold on a restrictive basisto sophisticated investors withvery limited SEC ling andreporting requirements

Can be completed morequickly, as there is no SECreview process

Funds are raisedimmediately, but thepublic company reportingobligations are deferred(in cases where thesesecurities are exchanged forregistered securities later)

May result in lower pricingthan an IPO due to lessliquidity for investors

Potential investor baseis limited to qualiedinstitutional buyers

Cost could increaseresulting from preparationof offering memorandumplus subsequent registrationstatement

Reverse Merger / SpecialPurpose AcquisitionCompanies (SPACs)

A transaction in which aprivately held company mergeswith a publicly held company.

Lower cost and timerequirements than an IPO

No dependence on marketwindow

Underwriters are notrequired, but they can stilladd valuable support

No capital is raised

Difculty in nding theappropriate merger vehicle

Exposure to publiccompany risks for apotentially non-IPO readycompany

Private sale Sale of equity directly to aprivate buyer(s) outside of anexchange

Can usually complete alarger percentage sale ofequity initially

Lower cost and timerequirements (no SECreview)

Underwriters are notrequired, but they can stilladd valuable support

May result in lower pricingthan an IPO

Potential loss of future taxbenets

Smaller pool of potential

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A successful IPO requires careful planning. This requires two main tactics. First, a companymust prepare its management team and business units to begin acting like and functioning

as a public company, both internally and externally. Second, a company must identify the keyplayers in its going-public team, from the experts it will hire to the staff members who will

help prepare the registration and other sales documents.

02 Preparing for a successful offering


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Preparation is the secret to success

While the planning process for an IPO can start the day a company is

incorporated or as late as three months before a public offering, werecommend that an orderly plan be executed over a one- to two-yearperiod. This window gives a private company time to think, act, andperform as a public company.

Build an effective management team

As a company prepares for its IPO, it must expand its managementcapabilities. The investment community wants to be sure that themanagement running a company is not a one-man band. This mayrequire adding individuals with public company experience in marketing,operations, development, and nance. Many companies also want to put aCFO in place who has previously been through the IPO process. The teamneeds to be cohesive and share a long-term vision for the company toobtain maximum nancial return and valuation.

Develop budgets and measure performance

Throughout the IPO process, underwriters will ask for nancial projectionsand will compare a companys historical performance to its past budgets.

Accordingly, a company should establish a nancial planning and analysisteam, which should put a budget and forecasting process in place. Thecompany should get into the habit of preparing realistic budgets, updatedforecasts, and be able to articulate why variances have occurred. For theearly-stage company, projections and market share are the most important

measures of performance.

After a company goes public, budgets and projections will become animportant tool for research analysts. Furthermore, this information anda public companys ability to meet its own earnings estimates and TheStreets earnings estimates can have a signicant impact on its stockperformance. Therefore, accurate budgeting and forecasting is critical fora successful IPO, as the market gives very little margin of error in that areaand punishes the stock for any signicant underachievement.

Appoint independent members to your board of directors

One of the best sources of objective advice can come from an independent

or outside director. All of the major stock exchanges and markets require aregistrant to have a majority of independent directors. A company shouldnot wait until the last minute to begin its search for qualied outside boardmembers. A potential board member who is unfamiliar with a company maybe reluctant to join the board immediately prior to an IPO, since a directorhas personal liability for information contained in or omitted from theregistration statement.


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Create an audit committee

Audit committees have an essential role in ensuring the integrity and

transparency of corporate reporting. Investors now expect publishedinformation to be subject to objective, board-level review. Sarbanes-Oxley specically denes the role and composition of public companyaudit committees. Some of the key requirements for audit committees arethat they:

Are composed entirely of independent directors (To be consideredindependent, the individual may notother than in his or her capacityas a member of the audit committee, the board of directors, or anyother board committeeaccept any consulting, advisory, or othercompensation fee from the company or any subsidiary of the company.)

Have and disclose at least one member who is a nancial expert,dened as: 1) having experience as a principal nancial or accountingofcer, controller, accountant, or auditor; or 2) having experienceoverseeing or assessing the performance of companies with respectto the evaluation of the nancial statements; or 3) having other relevantexperience (investment bankers, venture capitalists, commercial bankers,nancial analysts)

Are directly responsible for the appointment, compensation, andoversight of the companys independent auditors

Have authority to engage independent counsel and advisors as deemednecessary to carry out their duties and establish procedures for dealingwith concerns received from employees and others regarding accounting,internal control, or auditing matters

Evaluate corporate governance principles and practices

Both the NYSE and NASDAQ have dened and published corporategovernance listing standards that need to be addressed in connection withan IPO and listing of a companys equity securities. These listing standardsaddress matters such as board composition, structure, and process,including the nomination of directors, compensation practices, and similarmatters, and are responsive, in part, to Sarbanes-Oxley. The standards,however, go beyond the provisions of Sarbanes-Oxley discussed previouslyand address such matters as the establishment of a code of businessconduct and ethics for employees and directors, the establishment of aninternal audit function for companies listed on the NYSE, and approval

of related-party transactions for companies quoted on NASDAQ. Giventhe level of interest by institutional investors and the investing public incorporate governance matters, it is important for companies to take a closelook at their corporate governance principles and practices when planningthe public offering process.


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If you wait until crunch timeto have multiple-year audits,you may face two nastysurprises: rst, the high costs

of the reconstructed nancialstatements, and second,gures that show the companymay be performing at a levelbelow expectations.

Build a positive public image

A positive image can enhance the initial sales effort and maintain the

publics interest in the stock in the aftermarket. Accordingly, mostcompanies will need to enhance or create such an image with those whowill buy the companys stock and those who inuence that buying decision(e.g., nancial analysts, stockbrokers, the nancial press, and industrypublications). A positive image cannot be developed overnight; it can takemonths or even years to accomplish, so the earlier a company gets started,the better. It is important that building a public image start well before thebeginning of the quiet period (see The going-public process, p. 38).

Creating or enhancing a companys image may require hiring a publicrelations rm well in advance of the public offering. This rm can help acompany get their story out prior to the offering and maintain positiveexternal communications and shareholder relations after it has gone public.

Other ways a company can enhance its public image include addinganalysts and business press editors to its mailing lists, participating in tradeshows and conferences that are attended by analysts, and publicizing keyemployee appointments.

Build relationships with an investment banking rm, law rm,accounting advisors, and independent auditor

These relationships will serve to establish a companys credibility. Factorsto consider when selecting such rms for an IPO process are discussed inlater in this chapter (The investment banker, p. 19).

Establish incentive compensation plans

Developing a long-term incentive compensation plan is critical to keepingmanagement and employees motivated. Today, many companies establishsuch plans for the benet of its management team and employees shortlyafter formation. As discussed in Current regulatory and disclosure issues,(p. 29) plans to grant equity securities (including options and warrants)within one year of an IPO should be carefully evaluated.

Have your nancial statements audited and resolve potential disclosureand accounting issues

A company that wants to go public needs to have audited nancialinformation. It is easier and more cost efcient to perform audits of nancialstatements in the normal course of business, rather than shortly beforegoing public. The existence of audited nancial statements gives companyincreased credibility. Issues can arise for separate nancial statements ofsubsidiary business that may have been previously audited in accordance

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Begin positioning yourcompany early! Have auditedannual nancial statements,reviewed quarterly nancialinformation, and a well-documented and conservativebusiness plan; ensure that legalhousekeeping is thorough;cultivate relationships withthe professionals who canand will help you, includingunderwriters, lawyers, and

accountants.


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Establish a strong projectmanagement function toensure initial and robust issueidentication, establish a plan,monitor progress, understandinterdependencies betweenworkstreams, and encouragecommunication within theproject team.

with AICPA standards and not those required by the Public CompanyAccounting Oversight Board (PCAOB). A company will want to ensure that

it discusses this issue early on with their auditor. Although this may notrequire a signicant amount of work on the companys part, the auditorwill have to go through the procedures of conrming that they can issue aPCAOB opinion. In particular, auditors will need to ensure that they were incompliance with the independence rules, which under PCAOB regulationscan differ from those in an AICPA audit.

As a company gains nancial sophistication, it should also begin preparingquarterly nancial statements. Though it is not required by legislation,investment bankers may want to include unaudited nancial informationfor the prior four or eight quarters in order to reect growth and trends.Preparing these statements in a timely manner can add to an investmentbankers positive evaluation of a company. If such quarterly nancial

information is presented, underwriters typically require that it be reviewed bythe companys independent auditors under the SAS 100 auditing standard.

As noted in Current regulatory and disclosure issues, (p. 26) thecompanys nancial statements included in an IPO registration statementwill have to conform to positions and practices prescribed by the SEC staffas well as US GAAP standards applicable to public companies, which maybe different than the nancial statements a company previously prepared. Inaddition, starting to prepare interim nancial statements can help expeditethe registration process, as they may be required, depending on when theIPO registration statement becomes effective.

Draft managements discussion and analysisA stumbling block that many companies face is their inability to describe theaffect of underlying factors on the companys performance. A registrationstatement and all future nancial statement lings with the SEC will requirethe inclusion of Managements Discussion and Analysis (MD&A) relatedto a companys nancial statements. This is a quantitative and qualitativediscussion of a companys performance. The company will need to describein-depth such items as changes in sales volumes and cost structures,liquidity and capital resources, sources and uses of cash ows, vendorrelationships, employee compensation, unusual nonrecurring charges,signicant environmental exposures, and other risks and uncertainties.

As a company completes its year-end and quarterly nancial statements, itshould take time to write its MD&A. It can be very difcult to remember whyinsurance costs went up or when a marketing campaign commenced threeyears after the fact. The practice of writing quality, comprehensive MD&Aswill expedite a companys registration process and be a major step towardoperating like a public company.


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Staff up early, as there willbe a lot of demands on thecompanys key resources atpeak times, at which pointit may be too late to bring intemporary assistance. Strike theright balance between internaland external resources toensure appropriate knowledgeretention after the registrationis complete, while enablingmanagement to focus on

running the business.

Identifying your going-public teamthe players

The decision to go public can be one of the most important ones in a

companys historyand one of the most challenging. A company needsexpert direction and assistance to stage a successful IPO. The companywill have the opportunity to select many of the participants in the IPOprocess, such as the auditors, lawyers, underwriters, and accountingadvisors. However, the SEC will also play a signicant part in the IPOprocess. Keeping in mind the impact that the SEC can have on thecompanys registration process is an important factor when choosingthe advisors that will assist in the IPO process.

The Securities and Exchange Commission

The SEC is charged with ensuring a fair and level playing eld for publiccompanies and their investors. It has the authority to pursue civil andcriminal prosecution against those who breach established procedures.

Liability may arise from material misstatements or omissions in a registrationstatement. If the SEC nds mistakes or requests clarication during theregistration process, it can delay an IPO.

It is a companys duty to potential shareholders to constantly monitor thedrafting of the registration statement. Companies should ensure that theycompletely understand all of its components and the assumptions behindthose components. The outside professionals companies hire to advise onyour IPO are experienced business advisors. They help companies makethe nal decisions; they do not make them for companies.

The SECs Division of Corporation Finance reviews the registrationstatement and ultimately allows or denies an issue to go effective, thatis, sell shares. Registrants generally are assigned to the SECs Division ofCorporation Finances review branches on the basis of standard industrialclassication codes. Teams of government attorneys and accountants and,in some cases, industry specialists or engineers, review each ling. Thechain of review leads up to the director of the division and the issuance ofa comment letter, as more fully described in The going-public process,(p. 38).

The SEC concerns itself with the thoroughness and clarity of the registrationstatement and the prospectus to ensure that these documents adequately

inform potential investors. Keep in mind that the SEC only regulates thevehicle used to offer a security. It evaluates neither the company nor thequality of the security.


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Company personnel

The level of a companys participation in the process of preparing the

registration document frequently depends on the expertise of the companyspersonnel, although outside counsel will typically play a large part in thedrafting process. In any case, company personnel will have to provide thenecessary information with which to prepare the document and be activelyinvolved in all aspects of the registration process.

A company should not underestimate the level of commitment a publicoffering will require of its staff. The process requires a great deal of acompanys attention and will likely distract staff from the day-to-dayoperations of the business. It is important to recognize that this is commonin an IPO and, in some instances, may necessitate hiring additional staff.

A teams commitment to the offering will be the difference between asuccessful IPO and a failed attempt.

Securities counsel

As with any selection of individuals to provide professional services,there must be the right chemistry between a management team and thecompanys securities counsel. A companys attorney will become thequarterback of its registration process.

A companys counsel must be professionally competent and have the abilityto put into plain English technically challenging concepts and descriptionsof complicated transactions. He or she must have the ability to evaluatelarge amounts of information and turn around documents quickly. It is

imperative companies nd attorneys who are experienced with the IPOprocess and with the industryone the company is comfortable with andis condent will protect its interests when dealing with the underwriters andthe SEC staff.

The investment banker

Companies can go to market without an underwriter, but the process isso complex and the know-how so specialized that it is rarely done. Thecomplicated market issues that are arcane to most people are the stock-in-trade of underwriters, and it is in the best interest of a companys offering totake advantage of their expertise. The value added by an underwriter shouldbe the assurance that an IPO will be properly managed and successfully

marketed and supported, both before and after going public.


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A principal, or managing underwriter, works with a company to developthe registration statement, coordinate the road show, underwrite certain

risks, and form a syndicate. This syndicate is composed of an underwritinggroup, which bears the risk of the underwriting, and the selling group. Theselling group solicits interest from its retail and institutional clients, sellsstock once an IPO goes effective, and provides after-market support. Theshare allotment each underwriter is committed to buy will be stipulated inthe prospectus.

Good managing underwriters and investment bankers have a highlydeveloped sense of what sells (or doesnt sell) and for how much. They alsohave an instinct for timing an issue, and they are able to anticipate pitfallsand calculate risks. Underwriters and investment bankers contribute otherskills and support, including:

Experience in marketing, structuring the deal, and facilitatingsyndications with co-underwriters and brokers to create support for thestock after it is issued

Knowledge of market conditions and various types of investors

Experience in pricing stock so it will be attractive to the company butalso reap a reasonable return for the investor

The ability to help client companies with future offerings

A research department with the scope to enable it to analyze the clientcompany, its competitors, the market, and the economy as a whole

Generally speaking, underwriters come in three sizes: major bracket

or wire-house rms with well-known names, a middle-tier companycomprising mostly regional rms, and local rms. Not surprisingly, the sizeand scope of a company and of its offering will, in part, determine the sizeof the underwriter it enlists for its IPO.

A good working relationship with an underwriter is critical, regardlessof the size of the rm a company selects. Companies should trust theirunderwriters to provide all of the information they will need to execute anIPO successfully.

Of course, the professional relationship between a company and itsunderwriter is mutually benecial. An underwriter earns money from anoffering in a variety of ways. They include:

The discount or commission. This averages around seven percentbut could be up to ten percent for more difcult or smaller offeringsand down to ve percent for larger or simpler offerings in acompetitive market.


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The right to underwrite future offerings of the companys securities

Non-accountable expense allowance. This standard practice allows

underwriters to bill a company an amount that may not exceed threepercent of gross proceeds.

Other compensation, such as warrants to purchase stock

Overallotments as discussed below

While these items may seem to allow quite a few charges by an underwriter,maximum underwriters compensation, both direct and indirect, areregulated and reviewed for fairness by the Financial Industry Regulatory

Authority (FINRA) before the offering may proceed. Blue Sky laws alsorequire a review of underwriters compensation by state examiners.

Generally, the underwriters agreement can come in two basic forms. Therst is a rm commitment, in which the underwriters pledge to buy all ofthe stock offered in the IPO and resell it to the public. This arrangementoffers the company the most security because the owners know they willreceive the full sales price of the issue. The second form is under a best-efforts commitment, in which the underwriter uses his or her best efforts tosell the stock but is under no obligation to purchase the stock should part ofthe issue remain unsold.

There are variations on these two basic agreements. They include an all-or-none commitment, which is a modication of the best-efforts agreement.In this commitment, all of the stock must be sold by the underwriter or theentire issue is canceled (at considerable cost to the company). In a partial

all-or-none agreement, the underwriter requires sale of a specied portionof the issue (typically two-thirds) for the best efforts to remain in effect onthe remainder of the issue.

The underwriters counsel

Also involved in the IPO process are the underwriters counsel, who aregenerally responsible for drafting the underwriting agreement. They alsoreview the entire registration statement and any related agreementsand contracts that are led as exhibits thereto. Their principal objectivein reviewing the registration statement is to ascertain on behalf of theunderwriter that the registration statement is complete and not misleading.In addition, the underwriters counsel usually prepares the Blue Sky ling,

which is necessary to have the registration approved by state regulators.Another task performed by the underwriters counsel is negotiating thecontent of comfort letters (the denition can be found in the Independent

Auditors section of this chapter).


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Independent auditors

As strategic and technical advisors, a companys independent auditors will

play a key role throughout the registration process. Therefore, at the start ofthe IPO process, a company will need to ensure that it has selected an auditrm that is registered with the Public Company Accounting Oversight Board(PCAOB). The selection of an auditing rm should also be based on its:

Experience with public company nancial reporting

Expertise in generally accepted accounting principles (GAAP)and the auditing standards of the PCAOB

Reputation and experience with IPOs and other capitalmarkets transactions

Ability to continue to service the company appropriately throughits growth and global expansion

Other factors to consider are the size of the rms local and global resourcesand its experience in the companys industry. Some of the specic servicesthe independent auditor will provide include:

Strategic advice in the planning stage of the process to establish arealistic plan to enter the capital markets

Requisite technical expertise in US GAAP and SEC requirements soit can advise a company on preparing the registration statement andobtaining SEC clearance

Guidance on the identication of potentially sensitive or problematicaccounting issues (e.g., cheap stock considerations), nancial disclosure

issues, and the overall transparency of nancial reporting

Audits of the nancial statements (The process of auditing multipleyears of nancial statements and related disclosure requirements forpublic offerings can be extensive. An established relationship with anauditor who knows a companys business well, coupled with thoroughpreparation on the companys part, should enable it to complete theprocess faster and more effectively, which can be crucial to the successof the offering.)

A comfort letter to assist the underwriter in its due diligence efforts(This letter details certain procedures that the companys externalauditor performed at the request of the underwriter, along with otherrepresentations the auditor made concerning the nancial statements orother information contained in the prospectus.)

A review of the prospectus and assistance in responding to theSEC comment letter process


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By appointing key advisorsearly, management is freedup to focus on the marketingphase of the IPO, wherethey can add the most value.Management will also be ableto anticipate issues and avoiduntimely delays, preserving thevalue of the IPO and enhancingthe markets condence inmanagement, while at the sametime protecting the companys

brand equity.

The importance of engaging qualied, independent auditors long beforethe IPO cannot be overstated, particularly if a company has never had its

nancial statements audited before. The rst audit of many young andexpanding companies often discloses accounting and nancial reportingproblems that must be resolved before the registration statement canbe led.

Typically, large accounting rms are structured as full-service professionalrms, offering services in various lines of business (e.g., audit, tax,consulting, and human resource advisory). A companys independentauditors, as well as individuals from these other lines of business, can playa valuable role as advisors in a variety of areas before, during, and afterthe going public process. Some of these roles include evaluating whethergoing public is the best alternative for a company, evaluating incentivecompensation plans, addressing a companys accounting system needs

and capabilities, reviewing the terms and conditions of acquisitions, and taxplanning. A company may also consider consulting an accounting rm thatcan provide IPO and nancial reporting advisory services as described inthe following section.

Advisory accountant

Companies often seek transaction support and advisory services from asecond accounting rm that is not restricted by independence standards.

An advisory accountant can offer advice and assistance to organizationswith limited experience in IPOs and executing capital markets transactionsby providing an objective view of the critical issues involved in accessing a

particular capital market. Some of the principal ways in which an advisoryaccountant can assist a company going through a capital-raising transactioninclude:

Advice on project managementCompanies must dene thetransaction requirements and the roles and responsibilities ofmanagement and their advisors at the outset. Failure to do so early can

jeopardize control and the effective management of the transaction.

Strategic adviceCompanies must evaluate alternative approaches andestablish a realistic plan to enter the capital markets.

Section 404Companies should obtain assistance from their advisoryaccountants regarding the design, documentation, and testing of internal

control over nancial reporting as management evaluates its compliancewith the requirements of Section 404 of Sarbanes-Oxley.

Issue resolutionThe advisory accountant can advise and assist withcomplex nancial reporting and deal execution matters.

Technical advisoryThe advisory accountant can and should haveextensive experience with complex capital markets transactions.


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Post-transaction servicesA knowledgeable advisory accountantcan provide advisory assistance with:

Implementing the new nancial reporting protocols necessary tomeet public company reporting requirements, along with ongoingtechnical advice on these requirements

Corporate governance

The adoption of new accounting, reporting, and disclosure standards

Training accounting and nance staff

Ongoing compliance with Section 404 of Sarbanes-Oxley

The nancial printer

Another important factor contributing to a successful IPO is the roleplayed by the nancial printer. The printer is responsible for printing theregistration statement and prospectuses according to the format andpresentation guidelines specied by the SEC. The major nancial printerscan also EDGARize documents and make the required ling with theSEC via EDGAR. (With respect to EDGAR, it is important that companiesle Form ID with the SEC well in advance of the offering to receive theiraccess and identication codes.) Because this is specialized printinginvolving rapid turnaround, only a few printers can adequately handleit. Underwriters, attorneys, and accountants will be able to recommendqualied nancial printers. Companies must also select a rm to design

and print the companys stock certicates.

Other professional advisors

A public relations rm experienced in SEC registrations can help guidecompanies through the restrictions of the quiet period and make themost of the opportunities that do exist, help prepare materials for analystpresentations, and coach management in their presentation skills. Inaddition, management teams are hiring speech consultants to help themprepare for the road show.

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Companies will also need to appoint a stock transfer agent to providethose administrative and operational services associated with trading

stock. The transfer agent issues, cancels, and transfers stock certicates,pays dividends, handles other corporate actions, and distributesshareholder reports.


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There are many regulatory and disclosure issues to address with an IPO, including mattersrelated to the Sarbanes-Oxley Act of 2002, current accounting disclosures, taxation matters,

and the actual preparation of the registration statement itself.

03 Current regulatory and disclosure issues


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Sarbanes-Oxley Act of 2002

While certain provisions of Sarbanes-Oxley currently apply to private

companies, including increased penalties and liabilities for certain crimes,public companies are also required to be compliant with each provisionof this legislation. It is important to note that there are numerous overlapsbetween the requirements of Sarbanes-Oxley and the listing requirementsof some exchanges. However, the timing of these overlapping provisionsmay differ. Management should start planning as early as possible to notonly understand the various compliance time frames, but also to takeadvantage of the timing to strategically plan implementation. Waiting untilthe registration statement is being prepared and marketed to addresscompliance with Sarbanes-Oxley can make for a very challenging process.

Many companies have found that they require signicant process changesto effectively implement a strong internal control framework, so waiting toolong to address Sarbanes-Oxley can create a huge burden on staff whoshould be focused on preparing the ling statements and coordinating withbanks and underwriters. Accordingly, private companies contemplating anIPO should consider the following:

Internal controlsSarbanes-Oxley requires a registrants management(CEO and CFO) to provide certain certications in periodic lings withthe SEC regarding the companys evaluation of the effectiveness of itsinternal control over nancial reporting (section 404). However, a newlypublic company (dened as one that was not required to le an annualreport pursuant to Section 13(a) or 15(d) of the Securities Exchange Actof 1934 [the 1934 Act] for the previous scal year and did not le an

annual report for the prior scal year) is not required to comply with eitherthe management or auditor reporting requirements relating to internalcontrol over nancial reporting until its second annual report. However,companies need to consider the discussion of their 404 plan and timelinein their marketing documents. Furthermore, sections 302 and 906 ofSarbanes-Oxley are required in the rst periodic ling (Form 10-K and 10-Q)subsequent to the IPO. Section 302 and 906 require that the CEO and theCFO of a public company certify that the companys nancial statementsare accurate, comply with the requirements of the exchange acts, andinformation reported is fairly presented.

Management should integrate consideration of internal controls into thenancial processes as early as possible to allow time to implement and

adequately assess the effectiveness of those controls.

Audit committeeSarbanes-Oxley requires public companies to havean independent audit committee with at least one member qualiedas a nancial expert. Accordingly, companies should understand therequirements and skills required and evaluate the composition of the auditcommittee to allow sufcient time to seek qualied individuals.


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Be sure to give yourself enoughtime to recruit proper outsidedirectors. In the post-Sarbanes-Oxley environment, you shouldallow four to six months forthis process.

Board of directorsSarbanes-Oxley requires that a majority of the membersof a board of directors be from outside the company. At least one board

member must have a nancial background either as a CPA or CFO. Onemember must chair the audit committee, and outside directors must meetin executive session. However, a company that qualies as a controlledcompany is exempt from the requirements of having an independent boardof directors. Attracting and retaining board members has become moredifcult and more expensive due to the perceived higher level of risk andshift from equity to cash compensation.

Auditor relationshipSarbanes-Oxley prohibits a companys externalauditor from providing certain non-audit services, including but not limitedto internal audit, legal, and valuation services. However, there are a numberof non-audit services that an auditor may provide, such as tax servicesand general advisory services. These permissible non-audit services

must be pre-approved by the audit committee. Accordingly, companiesshould evaluate their existing relationship with their outside audit rm toclarify permissible and non-permissible services and to establish clearindependence related to existing or future services.

Code of ethicsSarbanes-Oxley requires a code of ethics for seniornancial ofcers or clarication on why one has not been implemented. Thecorporate governance listing requirements of many exchanges also requirea code of ethics. It is important to understand the overlapping nature ofthese requirements so appropriate processes can be developed and putin place.

Loans to company executivesSarbanes-Oxley prohibits public companies

from extending or maintaining credit in the form of a personal loan to or forany director or executive ofcer. Accordingly, appropriate actions shouldbe taken to ensure these types of arrangements can be extinguished priorto the initial public offering.

Common Accounting and Reporting Issues

Below are some of the most common accounting and reporting issues thata company will face as part of the IPO process as well as related areas thatare often the focus of SEC reviews.

Stock-based compensation

Cheap stock continues to be a focus area for the SEC. Generally, theSEC challenges the fair value of stock options granted in the periodpreceding the IPO, while a company is private, with the presumption thatthe exercise prices were below the market value of the stock at the time ofthe grant. The difference between the exercise price and the market value


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must be considered when computing stock-based compensation and therelated expense should be amortized to income over the vesting periods

of the options. Since stock options are one of the major components ofcompensation for many start-up companies, this compensation expensecan be signicant, thus having a material effect on reported nancial results.Whether this will negatively impact the IPO valuation is dependent on thecurrent market view of this expense.

Companies preparing for an IPO need to carefully review their option pricinghistory. Where option exercise prices are signicantly less than the price ofany other equity instruments sold near the dates of option grants, there willbe close scrutiny by the SEC, and the closer the grant dates are to the IPO,the more intense the review.

Typical SEC focus

Regarding stock-based compensation, the SEC also focuses on:

The signicant factors, assumptions, and methodologies used todetermine the fair value of the underlying common stock

Whether a contemporaneous valuation by an unrelated valuationspecialist was performed

The valuation range determined by various methodologies and thecombination or weighting of those methods

The signicant factors contributing to the difference between the fairvalue as of the date of each grant and the estimated IPO price range

Explanations of why or whether marketability discounts, illiquiditydiscounts, and common stock discounts (due to preferential rights ofpreferred stock) were used

Determination of comparable companies used

Liability versus equity classication

The SEC has a history of scrutinizing the classication of liabilities andequity in nancial statements. This has resulted in the issuance of astandard that claries this classication. Certain nancial instruments thatwere previously classied as mezzanine in the balance sheet may nowbe required to be classied as a liability. Particular attention should be paidto warrants and preferred stock. One area that could provide for complextransition issues between private and public companies is in the area ofmandatorily redeemable shares.

The denition of mandatorily redeemable securities has historically beenfound only in SEC rules. However, recent guidance issued by the Financial


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Accounting Standards Board (FASB) provided a new denition of the termmandatorily redeemable and requires that any securities meeting that

denition be reported as liabilities in nancial statements. FASBs denitionof mandatorily redeemable differs from that of the SECs. Accordingly, amandatorily redeemable security that does not require liability classicationunder FASBs rules guidance may require separate classication andaccounting under the SECs rules. The rules can be complex and the rulescan vary signicantly based on the preferred stock redemption provisions.

Typical SEC focus

Regarding liability versus equity classication, the SEC also focuses on:

For any awards that must be classied as liabilities, the focus is onthe assumptions used to determine the fair value of the instrument,including the underlying of the instrument (e.g., the fair value calculationof a preferred stock warrant and the underlying price of the preferredstock itself)

The changes in the valuation of the instruments over time

The variation of the valuation of the instrument from the valuation ofthe common stock valuation

Benecial conversion features of preferred stock and debt

Similar to cheap stock issues, the SEC continues to focus on theconversion price embedded in convertible preferred stock and debtsecurities issued within one year of an IPO. Occasionally, a company will

issue convertible securities within a short period before an IPO with aconversion price below the expected IPO price. The SEC staff believes thisissue to be a valuation issue similar to the issue of cheap stock, and it hasapproached it in a similar manner.

In some cases, the SEC staff has required the IPO price be used as themarket price of its common stock in measuring the benecial conversionfeature (BCF). Convertible securities issued within one year prior to the lingof an initial registration statement with a conversion price below the initialoffering price are presumed to contain an embedded BCF. To overcomethis presumption, a registrant should provide sufcient, objective, andveriable evidence to support its assertion that the accounting conversionprice represented fair value at the issuance (commitment) date. If the

SEC determines that there is a BCF, the in the money portion would bereduced from the net income available to common shareholders, loweringearnings per share.


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With the introduction of guidance on determining fair values, signicantfocus has been placed on the appropriateness of the fair value assigned

to the underlying stock in connection with such transactions. Judgment isrequired when determining the fair values for securities that are not activelytraded. As a result, third-party valuation specialists are often employed todetermine the fair values of such securities.

Typical SEC focus

See the factors described in the introduction to the chapter, Stock-based compensation.

Employee notes receivable

Historically, private companies have issued shares to employees in

exchange for notes receivable, primarily to start holding periods for taxpurposes. Employee notes have also been issued for other reasons, suchas relocations and house purchases. There are some key factors thatcompanies need to consider regarding employee notes.

For notes issued for stock, the recourse or nonrecourse nature of the notes,both in legal substance and in form, needs to be evaluated to determinewhether the transaction is substantive. Companies also need to considerSection 402 of Sarbanes-Oxley, which prohibits publicly traded companiesfrom providing personal loans to directors and executive ofcers. Thisprohibition on executive loans at public companies has also led to anoverall decrease in the frequency of loans being issued to employees inprivate companies.

Companies with existing loans or considering entering into new loans toemployees should work with appropriate legal counsel to determine whichloan arrangements are prohibited and take appropriate corrective actionsprior to the public offering. This corrective action may require executivesto repay loans prior to the IPO and the original contractual maturity, soadvance planning is essential.

Typical SEC focus

For employee notes receivable, SEC staff will question the classication ofthe receivable if it is not presented as contra equity (as discussed in SABTopic 4E) if the receivable was the result of a stock transaction, unless suchreceivable was repaid prior to the issuance of the nancial statements.


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Revenue recognition

Revenue recognition continues to receive a great deal of attention from the

standard-setting bodies and the SEC as companies create many new andcomplex transactions. Some areas that can be particularly complicated are:

Software revenue recognition

Revenue arrangements with multiple deliverables

Barter transactions

Bill and hold

Sales to resellers

Consignment sales

Up-front fees

Typical SEC focus

Regarding revenue recognition, the SEC specically focuses on:

Proper disclosure of the process used to evaluate the various factorsthat affect the Vendor Specic Objective Evidence (VSOE) rates used inconnection with software revenue transactions and accepted Third-PartyEvidence (TPE) rates for arrangements with multiple deliverables

Disclosure of signicant components of deferred revenue and theassociated periods over which such balances will be recognized

Accounting for milestone arrangements

Business combinations

Recently issued guidance on business combinations require that thepurchase price allocation in a purchase business combination begin withan analysis to identify all of the tangible and intangible assets acquired.Intangible assets, such as patents, copyrights, brand names, customer lists,and above/below market contracts may be identied, and the fair value ofeach asset must be estimated. The total purchase cost is allocated basedon the relative fair values of the individual assets.

Underlying assumptions and data used to develop the valuations should beadequately tested and challenged by companies and their auditors.


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Typical SEC focus

Regarding business combinations, the SEC specically focuses on:

Appropriateness of the fair values utilized to record assets andliabilities acquired

Accounting for changes in a valuation allowance for acquired deferredtax assets and the resolution of uncertain tax positions

Disclosures associated with contingent consideration and the relatedaccounting after the adoption of the recently issued guidance onbusiness combinations

Consolidation issues

New guidance on consolidation signicantly changes the consolidation rules

for variable interest entities and establishes consolidation principles closerto the traditional control-based approach rather than previous guidancethat focused more on the quantitative assessment of economic risks andrewards. Affected arrangements include the consolidation of commonstructures, such as joint ventures, equity method investments, collaborationarrangements, co-manufacturing, and power purchase arrangements.The adoption of this new guidance may require signicant changes toa companys accounting policies, nancial statement disclosures, datagathering processes, and internal controls. However, the impact of theguidance is not limited to the nancial reporting process and is expected toaffect other areas, including debt covenant compliance, nancial metrics,compensation, controls and systems, and stakeholder communications, toname a few.

Typical SEC focus

Regarding consolidation issues, the SEC specically focuses on:

The considerations of whether a variable interest entity exists,including factors considered in determining the primary beneciary andconsideration of whether a service provider has a variable interest

Extensive disclosure requirements considering a companys involvementwith variable interest entities and any signicant changes in risk exposuredue to that involvement as well as the impact of such entities on thecompanys nancial statements


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Segmental reporting

The SEC has questioned registrants on the determination of business

segments and adequacy of segment reporting disclosure. Their concernis frequently whether there is an inappropriate aggregation of multiplesegments or if there is an inadequate explanation of the basis foraggregating information.

Typical SEC focus

Regarding segmental reporting, the SEC specically focuses on:

Consideration of the proper identication of the chief operating decisionmaker (CODM), which may not always be a single individual

Exclusion of components of a business as a segment when the CODMreceives reports of that components operating results on a regular basis

The appropriateness of the aggregation of segments (The SEC has notedthat aggregation represents a high hurdle that is only suitable in certainlimited situations.)

Identication of the products or services driving revenue for eachreportable segment

Disclosure of total revenues attributable to external customers

Disclosures for each country in which the registrant generatesmaterial revenues

Adequate disclosures regarding material reconciling items betweensegment results and the consolidated results of operations

Consistency with the manner in which the business section and MD&Aare written

Compensation disclosure and analysis (CD&A)

The CD&A addresses the objectives and implementation of executivecompensation programs, focusing on the most important factors underlyingthe companys compensation policies and decisions. It addresses whyeach compensation program element was chosen, how award levelswere determined, and how each element ts into the companys overallcompensation objectives.

Recent changes to proxy requirements also include a new disclosure of howrisk is related to compensation and whether or not these risks may havea material effect on the company. The focus is on how the corporationscompensation structures and practices drive an executives risk-takingand the compensation committees management of risk regarding itscompensation program.


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The changes are meant to increase disclosure of the relationship betweena companys overall compensation policies and how these policies create

incentives that can affect its risk and the management of that risk. Publiccompanies are required to discuss and analyze in the CD&A the riskattributes of its broader compensation policies for employees (includingnon-executive ofcers). This new disclosure will only be required if therisks from a companys compensation policies have a material impact onthe company.

Typical SEC focus

Regarding CD&A, there are a few things that companies going public shouldkeep in mind:

If registrants have an adequate basis for omitting incentive planperformance targets (this is a high hurdle), they should providethe alternate disclosure regarding the relative likelihood that thoseperformance targets will be met.

Descriptions of incentive plan performance targets should be specic.

Regardless of the terminology used, benchmarking executivecompensation should be accompanied by an identication of the othercompanies that were used for benchmarking purposes.

In disclosing executive compensation decisions, registrants shouldprovide a clear description of the respective roles and responsibilities ofthe CEO, compensation consultants, and the compensation committee inthe decision-making process.

Separate nancial information

In addition to a registrants annual and interim consolidated nancialstatements, the SEC may require separate, audited nancial statements forcertain specied entities, such as signicant businesses acquired or to beacquired (Rule 3-05), certain equity method investments (Rule 3-09), andguarantors of public debt securities (Rule 3-10). Obtaining audited nancialstatements of these companies can be a difcult and costly task andcould potentially delay an IPO timetable. Furthermore, separate nancialstatements for any non-US entities may require a US GAAP reconciliation ifthe nancial statements are not prepared in accordance with IFRS as issuedby the IASB.

Typical SEC focus

The separate nancial statements must comply with Regulation S-X,although a non-public entity would not need to include public companydisclosures, such as segment information, pensions, earnings pershare, etc.


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IPO of subsidiary businesses (carve out)

Frequently a company may choose to divest of a portion of a subsidiary,

or legal entity, through an IPO, or 100 percent of a subsidiary businessthrough a public sale of the business. This requires separate carve-outnancial statements of the subsidiary business, as if it were a stand-aloneseparate entity.

This nancial information can be challenging to produce due to the need tocarve out the subsidiarys nancial statements from the larger, consolidatedaccounts of the parent company. Companies should give specialconsideration when deciding which assets and liabilities are to be includedas part of the business and how to allocate certain shared corporate costs.Each carve-out situation is unique and requires separate consideration anda signicant amount of judgment. There are limited specic accountingrules or guidance that govern the composition of the carve-out entity.

A spin-off is the non-sale divestiture of a carve-out entity to the parentcompanys shareholders in which the carve-out entity generally becomes anindependent company.

Typical SEC focus

Regarding carve outs, the SEC specically focuses on:

Expense allocations and pushdown of corporate headquarters accounts

Debt and capital presentation

Interest on capital structure, if appropriate

Presentation of income taxes Pro forma future stand-alone costs

Intercompany balances and activity

Non-GAAP nancial measures

These are a measure of a registrants historic or future nancialperformance, nancial position, or cash ows that exclude amounts ormake adjustments that have the effect of excluding amounts that areincluded in comparable calculations presented in accordance with GAAP.Examples of common non-GAAP measures can include adjusted EBITDA,free cash ows, or quality of earning adjustments.

Typical SEC focus

Regarding non-GAAP nancial measures, the SEC specically focuses on:

Disclosure of the most directly comparable GAAP nancial measurealong with reconciliation between the non-GAAP measure and thecomparable GAAP measure


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Presentation of the GAAP measure with equal or greater prominencethan the non-GAAP measure and the disclosure of why the non-GAAP

measure is useful to investors The demonstration of the usefulness of the non-GAAP measure

to investors

Stock-splits

During an IPO, a company will often declare a stock-split that does notbecome effective until just prior to the effectiveness of a registrationstatement. In many cases, the intent of the stock-split is to establish anoffering price that is within a preferred range. In such cases, it is appropriateto give retrospective effect to the stock-split in the historical nancialstatements. The auditors will then issue a preamble report on the nancialstatements. A preamble report is comprised of the standard report precededby a preamble indicating that the split has not occurred, but that when itdoes, the auditor would be in a position to furnish the report presented. Inthe subsequently amended registration statement after the split has beenconsummated, the preamble is deleted and the auditors report is dualdated with respect to the split.

Earnings per share

For each period that an income statement is presented, a companygenerally will disclose earnings per share (EPS). This disclosure mayinclude a reconciliation of the basic and diluted per-share computationsfor income from continuing operations and the impact of all securities that

affect EPS. This calculation can become burdensome for companies withcomplex capital structures, as they are required to disclose the effect ofpreferred dividends and dividends in arrears, as well as securities that couldpotentially dilute EPS.

Typical SEC focus

Regarding EPS, the SEC specically focuses on:

Nominal issuance/penny warrants

Pro forma EPS on face of historical nancial statements due to automaticconversion of preferred stock upon IPO


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The most successful IPOs are launched by those businesses that operate as

public companies well in advance of the actual IPO. These businesses have arelatively smooth process of going public, and they quickly transition to life aspublic companies.

04 The going-public process


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Typical execution timeline

Businesses often begin their preparations for becoming public companies well before they launch the IPO process

A typical IPO execution process can take about 6-12 months. Advance preparation is a key success factor thatallows for a smooth and efcient execution process.

The following graph outlines a typical execution timeline involving key participants in an IPO for the period leadingup to and after an offering.

6-12 Months

Before

Before Effective

Date 20 Days

Before Effective

Date 1-10 Days

Offering Day After Effective

Date 5-7 Days

0-30 Days

(optional)

Company Quiet periodbegins; Holdand all handsmeeting; Execute

a letter of intent;Select printerand transferagent; Cleanup nancialstatements andensure theircompliance withRegulation S-X

Cooling offperiod begins;Executivesperform road

show

Executeunderwritingagreement; Issuepress release

Providecerticates;Collect proceeds

Provideadditionalcerticates;Collect addition

proceeds

Company

counsel

Performhousekeepingof companyrecords; DraftS-1; File w/

the SEC; FileFINRA listingapplication

Clear SECcomments

Pricingamendment led;

Accelerationrequested; Filenal registration

statement

Deliverdocuments/opinions

Update closingdocuments

Independent

auditor

Completeaudit of annualnancialstatementsand review ofinterim nancialstatements;Reviewregistrationstatement

Audit/reviewupdated nancialstatements,if necessary;Respond to SECcomment letter

Deliver draftcomfort letter

Deliver nalcomfort letter

Deliver bringdown comfortletter

Second bringdown comfortletter

AdvisoryAccountant

Advise theCompany ofthe nancialstatements,technicalaccountingissues andregistrationstatementincluding any proforma nancialinformation

Advise theCompany onthe updatedregistrationstatement

Advise theCompany ontheir ongoingreporting andcompliancerequirements asa public entity


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6-12 Months

Before

Before Effective

Date 20 Days

Before Effective

Date 1-10 DaysOffering Day After Effective

Date 5-7 Days

0-30 Days

(optional)

InvestmentBanker

Assessmarket; Makepresentation toboard; Continuedue diligence

Distributered herringOrchestrate roadshow; Solicitexpressions ofinterest

Form syndicate;Place tombstonead

Executeunderwritingagreement; Runtombstone ad

Provide netproceeds

Exerciseoverallotmentoption; Makedeterminationabout issuingresearch report

Investment

bankers

counsel

Begin duediligence;Prepare FINRARegulation ling;Undertake BlueSky lings

Clear FINRARegulationcomments

Continue duediligence

Assist in closing Assist in secondclosing

Financial printer Print preliminary

registrationstatement/prospectus (redherring); ProduceSEC & FINRARegulation lingpackages

Print nal

registrationstatement/prospectus

SEC Reviewpreliminaryregistrationstatement; Issuecomment letter

Declare offeringeffective

FINRA

regulation

Review

preliminaryregistrationstatement; Issuecomment letter

Resolve

comments

Declare no

objections

Once a company reaches a preliminary understanding with its underwriters,the IPO process starts in full force, and a quiet period begins duringwhich a company is subject to SEC guidelines regarding the publication ofinformation outside the prospectus. The opportunity to enhance awarenessof a company, its name, products, and geographic markets will be limited,since any publicity that creates a favorable attitude toward the companyssecurities could be considered illegal. However, the continuation ofestablished, normal advertising and publicizing of information is acceptable.

This phase of the offering should start with a sense of urgency, because theclock is ticking. Companies will need to juggle four tasks in parallel timelines and keep business running as usual. These four tasks are:

The preparation of the preliminary prospectus

The investigation of the companys affairs for underwriter due diligence

The monitoring of market conditions for pricing purposes

The preparation of marketing materials for the road show

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As excited as you may be aboutyour IPO, do not promote duringthe quiet period. Allow the quietperiod to be just thatquiet.Loud noises attract attention

you might not want, particularlyfrom the SEC. Keep condentialcompany informationcondential. Spreading newsabout the company to friends,family, and even in casualconversation to the person nextto you on an airplane can be areal temptationand can spellreal trouble.


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Of course, you are not the onlysource of information. Keep inmind that the press, which isby denition independent, willtime its articles according to itsinterests, which may not be inthe best interest of your offering.Excessive attention duringthe quiet period can only hurt,and managing press interestshould not be left to chance.Work with your experienced

public relations rm and SECcounsel to properly maintain thequiet period.

As previously mentioned, a company can generally expect it to takeanywhere from three to ve months from the time the company decides

to go public until the time it receives the proceeds from an offering. Theactual length of this period depends on, among other things, the readinessof the company to go public, the availability of the information that must bedisclosed in the registration statement, and market conditions.

Days 1-60

Holding the all-hands meeting

The rst step in the IPO process is arranging an all-hands meeting. Thismeeting should be attended by all members of the registration teamcompany management, independent auditors, accounting advisors,underwriters, the companys attorneys, and the underwriters attorneys.

The purpose of this initial organizational meeting is to discuss the natureof the offering and the appropriate SEC registration form, coordinateresponsibilities for sections of the registration statement, establish atimetable for the anticipated ling date, and share information regardingthe working groups availability.

Throughout the IPO process, additional all-hands meetings should takeplace to discuss any problems, review drafts of the registration statement,and determine whether the registration process is on schedule.


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As distracting as your IPOmay be, keep a keen eyeon your business. IPOs areeasily so absorbing that youcan lose track of your day-to-day business concerns. Becognizant of this distractionpotential, and plan for it toensure your business doesntcome out of the IPO processweaker than it went into it.Good project management

will be essential to effectivelymanaging the project andoutcome with minimumdistraction from day-to-daybusiness. For example, itmay be useful to use projectmanagement tools and appointan IPO team captain to managethe process.

Registration statement form

The choice of which SEC form to be used for registration purposes is a legal

determination that should be made by a company in consultation with itscounsel and underwriter.

Form S-1 is the basic registration form for IPOs. In 2008, the SECintroduced new rules that eliminated the ability of smaller business lers touse Forms SB-1 and SB-2. Instead, smaller reporting companies now mustle using Form S-1, in which the nancial and information requirements areless stringent. The basic nancial statement requirements of Form S-1 forsmaller reporting companies and all other companies are:

Requirements Form S-1 Form S-1

(smaller reporting

companies only)

Income statement 3 years 2 years

Balance sheet 2 years 2 years

Statement of shareholdersequity

3 years 2 years

Earnings per share 3 years (corresponding toincome statement)

2 years (corresponding toincome statement only),except for 5-year datesand quarters

Managements discussionand analysis

Required Required

Selected nancial data Required - 5 years of

historical selected nancialdata

Not required

Separate nancialstatements fo

Roadmap for an Ipo a Guide to Going Public

Documents

Transcript of Roadmap for an Ipo a Guide to Going Public