Building on the momentum from 2013, the 2014 IPO market produced 244 IPOs, the highest annual figure since 2000 and almost one-third higher than the annual average of 186 IPOs recorded between 2004 and 2007—the last period of sustained offering activity. Many companies these days, including some of our clients, are entertaining the idea of going public. In this post, we focus on the Sarbanes–Oxley Act of 2002 (SOX), one of the regulatory hurdles a company must overcome during the IPO process, and just one of many considerations a company’s leadership must make when deciding if being public is the right course for their growing business.
Finding Success in a Sound, But Imperfect Regulatory Platform
Most would agree that the IPO is an aspirational event, and in a recovering economy, creates its own initial demand. On paper and in theory, the reasons for an IPO can be quite appealing:
• To raise capital for expansion and growth
• To develop a currency to be used to acquire other companies
• To attract quality employees with a long-term horizon
• To provide liquidity for owners, management and employees
• To enhance branding
• To improve the company’s valuation (which tends to be greater in the public markets than in the private markets)
• To provide daily valuation of the company
• To generate credibility among clients, prospects and investors through its financial compliance
The markets have been increasingly welcoming to IPOs, but there have been a few inhibitors to the IPO markets, and some believe SOX is one of them. SOX, while effective in its focus on controls and transparency, has become a financial burden for companies, so much so that it has dampened the aspirations of would-be small-cap IPOs.
This bill, which contains eleven sections, was enacted as a reaction to a number of major corporate and accounting scandals, including those affecting Enron, Tyco International, and WorldCom. These tragedies cost investors billions of dollars when the share prices of the affected companies collapsed and shook public confidence in the US securities markets. The main edict of SOX is the individual certification of the accuracy of financial information by the top management of each public company. In conjunction with the certification, penalties for fraudulent financial activity are much more severe. SOX also increased the oversight role of boards of directors and mandated the independence of the outside auditors who review the accuracy of public companies’ financial statements.
Beyond the goal of increasing the accuracy of public financials, the intention of these directives was to restore investor confidence in the markets, which most would agree, it did achieve.
However, for the CEO of a growth company, who wants to spend every available dollar for organic investment or in acquiring other businesses, every dollar spent on the personnel and systems required to meet the requirements of SOX is a financial burden.
Enter private equity. In lieu of an IPO, venture capital and private equity investors, as well as acquisitions by other companies, have become a rewarding substitute, taking the place of the public markets for the aspirational growth company.
To provide an alternative to private equity and to promote growth of the public markets, the Securities and Exchange Commission (SEC) is contemplating repeal or modification of SOX to make it less financially burdensome to public companies.
In the meantime, Congress passed a new initiative called the JOBS Act. More on that in our next post.