Fueling your IPO launch

When companies make the decision to go public, they are committing to certain obligations and regulatory requirements that require the right type of operating procedures and infrastructure to handle governance and compliance mandates. When Congress passed the JOBS Act in 2012, it eased some of those requirements on firms planning to go public. 

Under the new law, emerging growth companies with annual revenues under $1 billion are required to submit only two years of audited financial documents (compared with three years previously) and, for the first time, could file confidentially until 21 days before the IPO roadshow. Recently, the New York Times reported an Ernst & Young study, which notes that 63 percent of companies in 2012 opted for confidential review, primarily because confidentiality protects the company from embarrassment should it decide not to proceed with the IPO prior to the roadshow.

The impetus for the easing of requirements stemmed mostly from the fact that ‘IPOs had dried up during the economic crisis,’ says Catherine Bromilow, a PwC partner and contributor to ‘Governance for companies going public: what works best?’, a PwC report. ‘There was also concern about the cost of regulation and whether the cost of going public was so exorbitant that firms needing the capital market influx to grow and add to their businesses were unable to raise capital.’

The PwC report offers several recommendations for companies preparing to go public, including concentrating on governance issues required by the SEC, making necessary changes in board structure to ensure directors’ independence, and understanding the influence of shareholders on corporate decision making. If the JOBS Act works the way some want it to, there will be more small companies dealing with the challenges of governance and compliance even as pressure to increase disclosures and transparency intensifies.

Easing restrictions

David Westenberg, an attorney at WilmerHale in Boston, Massachusetts who specializes in IPOs and capital markets, says the JOBS Act has ‘relaxed financial disclosure requirements and financial requirements in some areas’, which has been helpful. 

Enabling companies to file confidentially for an extended period has enticed more companies to consider entering the stock market. ‘Some companies that start down that path decide not to [go public] because market conditions are bad or the company’s performance isn’t strong enough,’ Westenberg notes. Under the old requirements, firms were compelled to divulge their revenue figures to competitors and the compensation packages of their CEO and senior management to their employees. ‘All things considered, you don’t want to show that to the world,’ he adds.

Westenberg believes about 90 percent of companies considering going public are emerging growth companies and thus eligible under the JOBS Act. Companies still need to supply ample financial data and ensure board members are independent within a year after listing (rather than at the time of the IPO) and weren’t previously insiders or part of the company.

Still, many companies prefer to stay private and opt to raise capital through private equity. The major stimulus to go public involves liquidity, according to Westenberg. Some advantages of going public include enabling firms to raise $100 million to $150 million and issue options to valued employees to help retain and reward them. But it’s hard to raise $100 million in a private offering, Westenberg adds.

Even in this welcoming IPO climate, however, Bromilow says boards of private firms play an increasing role in helping decide the strategic issue: to go public or stay private. Choosing whether to stay private or invest the time to enter the market – often taking as long as a year preparing due diligence – is a complicated decision. It’s also costly and time-consuming to hire underwriters and ramp up providing financial data.

Challenges to going public 

If a company opts to enter the capital markets, one major area that needs to be addressed involves the composition of the board. For example, before it went public, childcare provider Bright Horizons Family Solutions had eight insiders out of 10 members on its board, including its two co-founders, three current and former executives and three seats held by the private equity firm that funded the company. To meet SEC requirements, the insiders needed to be replaced by independent members within a year of going public, and the company had to establish independent audit and compensation committees.

Another major challenge is identifying board members who have ‘good insight into the company’s industry, know the competitors and understand the state of technology and key risks to the industry,’ Bromilow asserts. Although vital, it’s often difficult to find board members with this level of industry insight as anti-trust rules prevent hiring anyone who is a direct competitor. Moreover, as social media’s clout proliferates, technological know-how is increasingly critical to a board’s expertise, as is experience with executive pay.

Even though some requirements were eased for firms going public, many traps still exist. Bromilow says too often companies don’t devote enough time to the planning that’s required, understanding the complicated rules, the need to respond to shareholders and the scope of decisions that must be made. Too many strategic choices ‘get made late or are rushed and end up being not the best decisions in the long run,’ she adds.  

For smaller companies, hiring additional resources, such as attorneys with IPO experience and investor relations specialists, can help the transition to becoming a public company. But leaning excessively on consultants is not in a company’s best interests, says Kathleen Smith, a partner at Renaissance Capital, a Greenwich, Connecticut-based firm that analyzes IPOs for institutional investors. Smith urges companies not to yield all major decisions to consultants. ‘The best thing a firm can do is to rely on itself and a team to get the process going, rather than just counting on the underwriter or attorney,’ she suggests.

Preparing to go public

Readiness is critical to going public, explains Mike Gould, the Chicago, Illinois-based PwC leader of IPO services in the US. He says firms need to anticipate the critical questions that arise during the due diligence process, including auditors’ questions, SEC queries and issues raised by potential investors during the roadshow. To meet SEC guidelines, firms must prepare the documentation, review annual financial returns and upgrade investor relations, treasury, risk management, tax, HR and technology functions. They also need to strengthen their corporate governance and legal requirements when going public. ‘They need to have their arms fully around the IPO process,’ Gould says.

When Demandware, a Burlington, Massachusetts-based digital commerce company with 330 employees and $80 million in revenue in 2012, issued its IPO on March 15 last year, it had several reasons to go public. CFO Scott Dussault lists them as follows:  

1. The firm had raised $60 million previously, but its IPO aimed to raise $103 million to avoid the company becoming ‘cash-constrained’

2. Because the company sells cloud computing services to larger firms, going public would raise Demandware’s visibility and credibility

3. Long term, it could employ capital raised in the IPO to consider mergers or acquisitions even though it’s only spent $2 million so far.

Before Demandware went public, it strengthened its internal executive team and board, hiring a general counsel and investor relations director with IPO expertise and strengthening its finance, accounting and IT systems teams. It added Jit Saxena, the chief executive and founder of Netezza, a data warehousing company, to its board, based on his experience with IPOs and public companies. ‘He helped us navigate going public in terms of sending out business messages and dealing with investments and quarterly profits,’ explains Dussault.  

Prior to filing, Demandware ensured its compensation disclosures and accounting policies were aligned with SEC requirements. It also hired Goldman Sachs as its underwriter, which helped compare it with other companies and determine its valuation at $16 a share. Goldman prepared Demandware’s senior executive team for the roadshow, anticipating the questions institutional investors would likely ask. Fifteen months after going public, Demandware’s stock price had doubled.

Dussault says raising $103 million by going public has both benefits and risks. Demandware has invested in hiring more engineers and ramped up its R&D, but as a public company it invests the money more carefully and judiciously. ‘As a private company, you can take more risks,’ he points out. Being a public company now helps Demandware recruit staffers who are attracted to a company with a strong balance sheet and a rising stock price, he adds.

Ultimately, going public is all about readiness, Dussault observes. ‘Too many companies view an IPO as an end-game,’ he says. ‘But the IPO is an evolution in a company’s history, a transition to growth and achieving long-term objectives.’ 

Practice makes perfect

Despite performing all the necessary due diligence required in an IPO, some companies have encountered problems. Both Groupon and Facebook fell into several traps, damaged their reputations and befuddled investors. During its quiet period, Groupon’s then CEO, Andrew Mason, disseminated a nearly 2,500-word email about the firm’s stock issuance. A month later, it revoked its IPO and decided to wait until economic upheavals in the stock market had faded. And more than a year after going public, Facebook’s valuation has only recently recovered to its initial pricing, having dipped 40 percent in the interim.

When Brightcove, a Boston-based software company that specializes in distributing digital media, explored going public, it started putting the pieces together to issue the IPO a full year before launching, explains Chris Menard, its CFO. It started doing quarterly reviews with its accountants while still private; and it started working on Sarbanes-Oxley regulations and upgraded its financial systems in anticipation of the IPO. Moreover, its underwriter Morgan Stanley introduced Menard to 10 leading industry analysts whom he met with prior to the IPO to enable them to better understand Brightcove’s business model.

To ease the transition, ‘we practiced being a public company even when we were private,’ Menard points out. By the time Brightcove issued its IPO in February 2012, the company was already operating smoothly. In fact, in 2012 it generated $88 million in revenue and now employs 345 workers.

Menard came away with an important lesson after the IPO: venture capital firms owned 50 percent of the company stock before the IPO and 40 percent after, and he wishes he had collaborated with them to develop ‘a more organized system for selling those shares to the public markets, such as a secondary offering or block trades.’ Because the venture capital firms owned such a large percentage of stock, investors thought their ability to unload large chunks of stock on the open market could tilt and cause the stock price to fluctuate.

Since going public, Brightcove acquired Zencoder, a cloud-based video system, for $27 million in summer 2012, using equity gained from its IPO. Being a public company has heightened its credibility and opened doors to the C-suites of larger companies such as Walmart, Nike and Viacom. The readiness and preparation eased the path to going public.

Bromilow says companies intending to go public need to intensify their emphasis on governance as well. Too many companies going public ‘don’t understand how much information must be provided on an ongoing basis in proxy statements and on their website,’ she says. Having a strong investor relations team to deal with institutional investors and other shareholders is also critical to meeting the demands of shareholders.

Upon becoming a public company, the CEO and management team must make adjustments such as becoming more responsive to the independent board, keeping it informed and becoming more tuned in to shareholder concerns. Assembling a team of independent directors with public company know-how ‘can help management avoid pitfalls, get better answers and build greater shareholder value,’ says Bromilow. It’s what going public is all about.

PRE AND POST IPO CHECKLIST

Demandware senior vice president and general counsel Sheila Flaherty is a very important member of the team that helped make the company’s $103 million IPO a success. Her extensive knowledge managing the legal affairs at public and private corporations was invaluable both before and after the company’s public offering.  

Flaherty’s previous experience with M&A and public equity and debt offerings gives her a keen insight into the role of the general counsel and the legal team leading up to an IPO – and well beyond it. 

Prior to an IPO, she says it’s vitally important to take care of all corporate governance housekeeping. ‘Ensure all minute books, board and shareholder approvals, and appointments of officers and directors are up to date and accurate,’ she says, noting that corrective actions should be taken if even the slightest detail is out of order.

Given the scrutiny over executive pay, Flaherty suggests a stock, option and warrant recordkeeping audit should be conducted. Also, before the audit, she says it is important to ‘set up a data site and get a handle on all contracts and other relevant due diligence documentation.’

Once the IPO has been completed, the legal team still has work to do. For Flaherty the most important of these is to establish ‘communication and training for all employees and board members to educate them on their obligations and responsibilities once the company is public.’ 

Training on insider trading rules, disclosure obligations and compliance reporting requirements are all critical, and the importance of adhering to these obligations and standards must be clearly communicated to all employees. ‘This communication and training should be ongoing, too,’ Flaherty adds.

Finally, she advises general counsel to ‘hire or retain SEC expertise – either in-house or externally – to ensure support for all required reporting and filing obligations.’ The last thing any company wants to do is spend the time, energy and money to go public only then to find itself non-compliant with regulators and lax on governance.