Gaining maximum value from each IPO requires confidence, decisiveness, and the right foundation. If your company is contemplating an IPO, its board can play an important role in guiding management to assess the risks and rewards.
Taking a company public is a big deal. But market volatility, geopolitical uncertainty, and the increase of Special Purpose Acquisition Company (“SPAC”) activity continue to impact the IPO landscape. So yesterday’s experience doesn’t always help you address today’s challenges. Here are the critical questions boards should ask before taking a company public.
Investors who understand industry dynamics and know the companies in your sector will wonder what makes your company special. And they’ll be skeptical of claims that your business model is so innovative you don’t have real competition. This makes it especially important for management to be able to explain the company’s competitive advantages and how it plans to grow after the IPO. In other words, management has to work on continually refining its equity story.
Directors can help management improve both the story and how it’s delivered. But directors can also help management stay true to the story and guard against the temptation to revise it each time you hear from potential investors who are looking for something else.
Designing a process that allows management to reliably forecast business results requires a great deal of sophistication. Public company executives are expected to accurately forecast financial results down to a tight range of pennies per share. Private companies that haven’t had much need to forecast accurately will have to figure it out. This may necessitate both organizational and system changes. Since these take time, it means getting the discipline in place well before going public. Getting forecasts wrong in the first few quarters as a public company can severely damage investor confidence—and may get punished by the market, driving stock prices down.
Boards should be asking to see the forecasts. And they should understand whether management is able to obtain accurate financial information quickly and to forecast accurately.
Private companies rarely have all of the capabilities and support functions they’ll need as public companies. Worse, many don’t realize how long it takes to build them. We’re talking about some fundamental processes and capabilities: financial planning and accounting, internal controls, financial reporting, tax, risk management, human resources, legal, and communications. Today’s better-prepared companies take a thoughtful approach to assessing their weaknesses and remediating them before going public.
Directors should ensure management has identified any gaps and is taking the appropriate steps to build the teams and processes needed.
Private companies often rely on measures that deviate from generally accepted accounting principles (GAAP). Most typically, company’s use their own version of adjusted EBITDA, and/ or adjusted net income to measure management performance. However, once public, investors will expect management to report the same measures as comparable companies. Companies using KPIs and non-GAAP measures that deviate from industry norms and GAAP can expect research analysts and investors to ask for those custom metrics to be reported and explained every quarter.
Directors should ensure management understands which metrics are the most important in the sector and how they align with what the company plans to report. The board will also want to understand management’s plans to set targets for and track those metrics and to ensure the accuracy of these metrics.
It’s important to understand that the metrics public companies use will also be under the regulatory microscope. The SEC is scrutinizing the use of non-GAAP measures, expressing concerns about the proliferation of their use and the fact that they usually report better results than the related measures under GAAP.
The board should understand how management plans to adjust GAAP results and discuss whether those adjustments provide better insight into the company’s business, past performance, and prospects. The board should also ask management whether they’re calculated consistently.
Risk factors include information about the most significant risks that apply to the company or to its securities. These may be company-specific or market- or sector-wide. A classic approach to developing the risk factor section of the IPO prospectus is to start with a listing of risks in the industry. But those aren’t necessarily the risks that truly worry management.
Directors should understand what the biggest risks are to the company and encourage management to prioritize them at the beginning of the list. As COVID-19 continues to change the economic landscape, the board should consider management’s ability to navigate economic downturns, supply chain and manufacturing delays and disruption, and the challenges of a remote workforce. But just as important, the board should be discussing how management is addressing those risks to manage or minimize their impact. This is part of the board’s responsibility to oversee how management identifies and addresses the biggest risks to the company.
A security breach can damage a company’s reputation and may prompt lawsuits and fines. Plus, it can be expensive to remediate IT system weaknesses and help victims recover. So it’s not surprising that when boards and management talk about key risks, cybersecurity is high on the list.
While both private and public companies are under constant threat from cyberattacks, the stakes are higher for public companies. After an incident, they also have to consider what needs to be disclosed, when, and how—as well as anticipating what impact the disclosures might have on share price. Management should have security controls in place to protect customers, employees, confidential data, and intellectual property. There also needs to be a plan to address breaches, including how related communications will be handled.
For their part, few boards have specific expertise and experience in IT or cybersecurity. Even though it’s difficult for directors to know what to ask, it’s an important subject cover with management to ensure the company is getting access to the expertise and support it needs.
Private companies are used to engaging with customers and employees, as well as partners from the private equity or venture capital firms that provided funding. Although those shareholders may ask challenging questions, management typically has some relationship with them. But public companies have a much wider group of shareholders with different time horizons, goals, and priorities. And they also face additional scrutiny from the media, securities regulators, proxy advisory firms, and research analysts. Plus, executives need to weigh how much information on strategy and operating challenges they should share. Shareholders and others may want such details, but so do competitors.
These more complex communication demands need careful attention. Publicly traded companies must comply with Regulation Fair Disclosure (Reg FD), which mandates that companies disclose material information to all investors at the same time. On the investor relations front, it’s very common for companies to have an external advisor as well as internal professionals with direct industry experience to help manage these communications.
The board will want to ensure management is ready to handle the new communications demands. That includes developing a communications policy and appointing a spokesperson. It also means deciding which directors (if any) will participate and how.
This is different from whether the company is ready. This is about the executives and their prior experience. Executives will face higher levels of personal scrutiny and greater demands on their time after the company goes public. New stakeholders will divert management’s attention away from operating business issues, and although it may feel like it, this isn’t time spent away from the business. It just happens that there’s a new definition of what constitutes “the business.” Not every company founder or leader is suited for this change in role—and some won’t see value in spending time on such matters.
The board should assess whether the current executive team has the talent and aptitude to handle these more subtle public company requirements. If not, the board has a vital role to ensure the right talent is recruited.
Under NYSE and NASDAQ listing requirements, boards must have a majority of independent directors within a year after listing. Plus, audit committees must be composed entirely of independent directors within one year after registration, and compensation committees must be entirely independent within one year after listing. That means a board will likely need to replace at least some directors.
But board composition questions don’t end with independence. Having directors with the appropriate mix of skills, experience, and diversity is critical to effective board oversight. Companies have to disclose in proxy statements the background and qualifications of directors and nominees and whether diversity is considered in the director nomination process. For many institutional investors, as well as investment banks and even state legislatures, diversity has been an area of significant focus. Public companies headquartered in California, for example, are now required to have a minimum number of female directors on their boards, and starting at the end of 2021, will also be required to have directors from “underrepresented communities.” So going public means the board needs to consider thoughtfully what its composition should look like.
Boards also have important governance decisions to make: voting standards, whether to have a classified board (where not all directors are up for election every year), and whether the CEO will also be the board chair, for example. Investors have strong preferences for certain governance structures, and it’s helpful to understand their views when deciding. That said, boards need to balance those preferences with what structures will protect a young company, while recognizing that investors may press for changes down the road, once the company matures.
Today’s increasingly volatile, complex, highly regulated, and litigious environment does put public companies and directors right in the cross hairs of regulators. They face the risk of reputational damage, criticism from the media, and even the threat of lawsuits for decisions they make. Furthermore, D&O insurance policies have significantly increased in price in recent years, and the timeline for negotiation and execution of such policies has extended and become more burdensome for companies. In 2017, there were 26 IPO-related federal securities class-action lawsuits filed.
Not everyone is comfortable taking on the liability involved in signing a registration statement. Since this environment can be daunting, carefully consider the challenges and risks of being involved in a company that’s about to go public.