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Listed below are certain matters companies planning initial public offerings should address prior to initiating the offering. Failure to plan effectively can result in substantial delay in the offering, operating problems for the company and frustration by management. Some of the issues discussed below should be incorporated into the operations of the company from its inception. Other items can be addressed during the year to six months preceding the anticipated date of the initial public offering. (1) Identification of Investment Banker. The process of finding an investment banker to underwrite the offering should begin well in advance of the proposed offering date. Six months to one year should be allocated to this process to ensure the offering is commenced on schedule. Management should also understand that more than one investment banking firm is often required. For example, some investment banking firms specialize in underwriting young technology companies and marketing their stock to institutional investors (E. g. Alex. Brown). Other investment bankers offer a large retail marketing effort to individuals (E. g. Merrill Lynch, Prudential and Shearson). Other investment bankers are particularly strong in the Southeast region (E. g. Wheat First and Interstate). Management must not only find an investment banker willing to underwrite the offering. It must also find the right combination of investment bankers who can provide both the best valuation and the mix of investors management desires. (2) Back-up Financing Plans. Initial public offerings are notoriously unreliable vehicles for raising essential capital. The success of a public offering often depends on the general state of financial markets, which is beyond the control of the company. Predicting the future state of financial markets is extremely difficult as it depends upon many factors, including the overall state of the economy, politics and national and world events. Therefore, companies need to plans their offerings well in advance of the time the proceeds are required. Plans for alternate ways to obtain all or part of the required funds are prudent in case there is an extended time in which market conditions are not favorable for an initial public offering. (3) Directors and Officers Insurance. Because of the high exposure to securities law liability incurred in connection with initial public offerings, officers and directors, who have personal liability for securities law violations, are prudent to cause the company to obtain insurance to defend against shareholder actions arising out of the offering. Because of the potential exposure, insurance companies and reinsurers can take a substantial time to evaluate the company's application for insurance. Consequently, it is advisable to begin the process of obtaining insurance coverage three to six months prior to the offering. (4) Gun Jumping. SEC rules prohibit a company from priming the market for sales of stock in the IPO by means other than the prospectus and certain press releases and tombstone advertisements, the contents of which are restricted by SEC rules. Press releases about new products, television and radio interviews with officers and under certain circumstances even product advertising can be construed by the SEC to be priming the market for the sale of stock in the IPO. As public offerings can last six months or more, a company's sales can be adversely affected if it restricts all such activities for the duration of the offering. Good planning by a company can enable it to conduct most types of marketing activities and comply with SEC rules because SEC rules generally permit companies to continue the same sales efforts it pursued before the offering commenced. Therefore, a company should not wait until immediately before an IPO to launch new advertising or public relations campaigns. It should conduct its advertising and public relations before the offering with a view toward creating a record that permits it to pursue legitimate sales activities throughout the offering period. (5) Build Support for Positive Statements about the Company. Management should be aware that any positive statement about the company or its products or industry that is contained in the prospectus filed with the SEC for the IPO and distributed to investors must be supported by something other than management's opinion. This is because unsupported statements can cause substantial liability for the underwriters, the company, management and the attorneys. This risk of liability is eliminated or reduced if the statement is supported by credible independent third party sources. Therefore, management should identify positive statements it would like to include in the prospectus and begin seeking independent support for such statements well in advance of the offering. One of the most troublesome disclosure issues is that management often desires to compare its products favorably with the products of competitors. These favorable comparisons require independent support. Other common statements that require independent support include the size of the market, annual growth of the market and market trends. Newspapers, industry journals, customer comments about the product and reports by independent consultants generally recognized as industry experts are among the most common methods of supporting statements in the prospectus. (6) Build Support for Excluding Negative Statements. Management should review at least several prospectuses (preferably for initial public offerings by companies in the same industry as the company). These prospectuses will contain many negative statements about the company making the offering. If management desires to exclude such statements from the company's prospectus, it should seek to build support from independent sources (as discussed in item (4) above) showing that such negative statements do not apply to the company. (7) Heading Off Disclosure Problems. Many companies create anxiety on the part of underwriters over problems that are not really issues, but which appear to be issues because of a paper trail. Examples of this include letters from customers complaining about the performance of products or services provided by the company or an annual review letter from the company's accountants that the company's computer accounting systems are not sufficient or are not being used properly. The solution is not to destroy damaging documents. The solution is to address problems before they arise or to document that problems have been fixed. In the case of the customer complaint, the company should try to obtain a letter from the customer indicating that the problem has been resolved to the satisfaction of the customer. In the case of a damaging review letter from the company's accountants, the company should try to obtain informal advice from the accountants throughout the year and address problems before the annual review by the accountants so that their review letter is clean. (8) Embarrassing Disclosures for Employee and Shareholder Relations. The sections of prospectuses entitled "Management" and "Principal Shareholders" generally contain between four to ten pages which describe in detail the business backgrounds of the officers and directors of the company, compensation arrangements for officers and directors, transactions between the company and its officers, directors and principal shareholders and the numbers of shares and options owned by officers, directors and principal shareholders. Management should understand that every employee in the company will see this information soon after it is filed with the SEC. Therefore, management should avoid making statements to employees about compensation policies of the company that will not bear up to scrutiny in the prospectus. This has caused considerable dissension among employees at some companies. Another common problem is that the compensation policies of privately-owned companies are often oriented toward achieving the best tax result for the owners of the company. Numerous expenses that might otherwise be personal in nature are paid by the company so that pre-tax dollars can be used, rather than after-tax dollars. Such items often include automobiles, country club memberships and other perks. If such perks are extensive, they can place management in an unfavorable light with investors. Another potentially embarrassing disclosure is that if any of the officers, directors or principal shareholders of the company have been involved with a bankruptcy, either personally or of a company in which they held office, that fact must be reported in the prospectus. Likewise, if such persons have committed any crime, it must be reported. Therefore, companies should determine well in advance of the offering whether there are any potentially troubling aspects of their team's backgrounds. New additions to the team should be screened for these factors prior to their joining the team. (9) Industry Disclosure Documents. Management should obtain copies of prospectuses and Form 10-Ks of other companies in their industry to familiarize themselves with the types of disclosures that are appropriate for the industry. Copies of such documents can be obtained from the SEC. (10) Facilitation of Due Diligence. The underwriters, their counsel and company counsel will seek to review numerous documents, including all substantial agreements, minutes of board of directors and stockholders meetings, written consents, stock transfer records and other documents. This review will be substantive in nature so that they can identify risks and problems, but the review will also focus on whether all the parties have executed the agreement or consent, whether a quorum was present at all meeting of the Board and shareholders and whether notice of meetings were either duly given or waived. As it is in the interest of the company to facilitate the due diligence process so that it does not delay the offering, it is useful for companies to: (i) have their minute books and related documents reviewed prior to the offering so that any signatures or documents that may be missing can be obtained, and (ii) review all the files of the company and copy all documents that are likely to be requested so that they can be delivered for review at the beginning of the offering process rather than several weeks into the process. Standard due diligence document lists are available that will cover 90% of the documents actually requested for the offering. Having this done in advance of the offering has the beneficial effect of (i) eliminating one burdensome task that the company's administrative personnel would have to do at a time when the other demands of the offering will require their attention, (ii) allowing the company to correct any problems that might surface when it reviews the documents, (iii) allowing the underwriters and their attorneys time to identify potential problems in time for them to be remedied prior to their delaying the offering and (iv) making it more likely that the registration statement will include all required disclosures. (11) Material Contracts. SEC rules require that all "material contracts" be filed as exhibits to the registration statement. The term "material contracts" is very broadly defined by the SEC. It should be noted that small companies are at a disadvantage compared to large companies because the same contract that would not be material for a large company may be material for a small company. These contracts are not a part of the prospectus that is sent to investors, but they are public documents that can be reviewed and copied by anyone (including a competitor, customer or supplier) without much effort. The SEC has a procedure for granting confidential treatment of all or part of a material contract, but the SEC does not broadly grant confidential treatment for contracts it believes are important to investors making decisions about whether to invest in the company. Therefore, the SEC is likely to grant confidential treatment only to select portions of a small number of contracts. Even this limited confidential treatment is granted only after an application is made by the company which describes the anticipated adverse effects on the company if confidential treatment is denied. Management should seek to minimize the amount of sensitive information the company's agreements contain. It is also important that the company not agree to language in agreements that requires the agreement and its terms to be kept secret without including an exception for matters required to be disclosed pursuant to securities laws. The SEC does not generally grant confidentiality requests merely because the company would breach its agreement by filing the contract as an exhibit. The SEC believes that this would merely have the effect of encouraging companies to include in all their contracts the requirement that the contract be kept secret, which would undermine the SEC's goal of full disclosure. Since the SEC will not permit a registration statement to become effective unless all required exhibits are filed with the registration statement, confidentiality language in agreements can either slow down the offering while the company waits for the other party to the agreement to approve disclosure or can prevent the offering if the other party refuses to approve disclosure. (12) Acquisitions. SEC rules require that the registration statement contain audited financial statements that include balance sheets for the two years preceding the offering and operating statements for the three years preceding the offering. If the company has acquired another company or a product line or division of another company during the period covered by the financial statements, the financial information of the acquired company or division prior to acquisition must be included in the financial statements of the company used for the offering. Therefore, the company and its accountants must have access to the financial records of the acquired company, product line or division. This may be particularly difficult if the business acquired was not operated by the seller as a separate business. In that case, substantial work will be required to separate the financial records of the acquired business from the other business of the seller. There are two basic approaches to handling this issue. The first and safest is for the purchaser to obtain possession of the necessary records at the closing of the acquisition. The buyer's accountants should be consulted to determine the records acquired are sufficient for an audit. However, this may be expensive if the business being acquired was not operated as a separate business by the seller. An alternative is to have the purchase agreement provide that the buyer and its accountants will be given access to the records needed to create audited financial statements if it becomes necessary to create such financial statements. However, this contractual approach is no guaranty that the purchaser will be provided the necessary records when they are needed. The seller may refuse to cooperate in a timely manner or may not have maintained the records properly. The seller may even be out of business at the time the buyer needs access to the records. As failure by the buyer to obtain access to the necessary financial record may result in the inability to conduct an IPO for three years after the acquisition, buyers with plans to do a public offering should be careful to obtain the necessary financial records of any business they acquire. (13) Accounting Personnel. Not all accountants (even in big six firms) are familiar with the process of public offerings. Management should inquire about the public offering experience of the particular individuals assigned to their work by their accounting firm. If the accounting team lacks experience with at least several prior public offerings, management should request than an individual experienced with public offerings be assigned to their company's work well in advance of the offering. Switching accounting personnel immediately before the IPO, even if it is the same firm, is likely to result in delays in the IPO. The company needs individuals who are both experienced in public offering work and who know the company well through prior work for the company. (14) Differences in SEC Accounting Rules. In some cases, the SEC imposes different accounting rules than accountants are required to use under generally accepted accounting principles. Therefore, even though a company has audited financial statements, the financial statements used for the IPO may differ from the company's current financial statements for the same years. Generally, the SEC rules are not so different that they cause substantial changes in the financial statements, but the effect of the SEC rules varies from one company and industry to another. Management should discuss with their accountants what the differences are with SEC accounting rules and how they will affect the financial statements of the company so that management will not be unpleasantly surprised by the financial statements used for the IPO. (15) Expending of Options and Stock.
SEC accounting rules require companies to treat as compensation
expense discounts from market price given to employees holding options
or stock. If large amounts of stock or options are involved, this
can make the earnings performance of the company as shown of its
financial statements substantially less attractive than it otherwise
would be. Every company conducting an IPO has issued stock or granted
options to officers, directors and employees at prices that are
less than the IPO price, but the timing of such issuances of stock
or options can result in very different accounting treatment being
required by the SEC. It is easier for companies to take the position
that stock issued for $5 less than the IPO price one year prior
to the IPO was issued at the market price at the time of issuance
than for stock issued at the same price a month before the IPO.
It is much more plausible that intervening events have caused the
market price to increase substantially over a one-year period prior
to the IPO than during a one-month period. Companies should coordinate
option and stock timing and pricing with their accountants and their
attorneys to avoid an adverse impact on their earnings. (17) Stock Options. Some states limit the number of options that can be outstanding after the offering. For example, Virginia does not permit registration of securities if the number of shares issuable pursuant to outstanding options exceeds 15% of the shares outstanding after the IPO. (18) Preparing the Management Team. Initial public offerings usually subject members of the management team to significant stress and often cause the company to perform poorly because senior management is spending most of its time on matters related to the offering. Management should anticipate these problems and prepare for them. Preparations could include (i) scheduling vacation time before the offering process begins so that the team is rested for the upcoming crunch, (ii) allocating responsibility for different tasks related to the offering, (iii) temporarily shifting some responsibilities for daily operations of the company away from members of the team who will be heavily involved in the offering to those members of the management team whose participation in the offering process is likely to be minimal and (iv) assessing whether additional management personnel or administrative support staff should be hired to handle the extra workload required by the offering. |
