Last week, the Public Company Accounting Oversight Board (PCAOB) released its semi-annual white paper providing general information about certain characteristics of emerging growth companies (EGCs). The PCAOB’s white paper provides a number of observations regarding EGCs, which we summarize in a just-released Flash Report published on Protiviti’s website. In our Flash Report, we also review the implications for EGCs that report material weaknesses in their internal control over financial reporting and offer guidance to affected organizations to help them avoid or overcome such findings.
By Charles Soranno, Managing Director
Financial Reporting Compliance and Internal Audit
Early in December 2016, I had the pleasure of leading an in-depth webinar exploring how fast-growing companies can prepare for challenges related to changes in their culture and talent requirements, particularly when ramping up for an IPO or following one.
I was joined by Carmela Krantz, Vice President of Human Resource at WideOrbit; Danielle Soucek, Director of Insight Product at Equilar; and Michael Waxman-Lenz, CFO at Undertone. Together, we provided analysis and guidance on how to create the right team, scale for growth, benchmark against peers and competitors, and develop a public company mindset.
As companies implement their growth plans in the new year, it’s worth revisiting a few of the big ideas that emerged from the event.
Building the Right Team – Recognize the Influences
An organization’s ownership structure, its industry dynamics, and whether it has a domestic or global presence shape its culture and need for certain skillsets. Challenges typically emerge when companies bring in new investors, prepare to launch an IPO, add locations, or significantly expand their employee base.
Ownership has a tremendous impact on what the right team looks like, for example. A closely held startup may not have formal financial reporting requirements, but as it attracts institutional capital or registers for a public offering, more specialization and structure is required as expectations and demands change. Institutional investors likely will be less forgiving of reporting errors than founders working in a close-knit setting, and companies that execute their IPOs have to meet strict Securities and Exchange Commission (SEC) regulatory, compliance and reporting requirements. Will free-thinking, entrepreneurial-oriented individuals who were involved in virtually all aspects of a startup’s early development be able to not just perform, but thrive, in this more regimented operating environment?
Scale for Growth
Maintaining robust and consistent communications and formal communication protocols (especially for public companies) between an organization’s leaders and its workforce – even to the point of “over communicating” – is perhaps the most important strategy human resources (HR) can promote when employment rosters are expanding by the dozens each month. Letting employees know how they fulfill a company’s mission during times of rapid change keeps them plugged-in, motivated and contributing to desired business outcomes.
Staying ahead of the recruiting battle is another critical step HR can take. Human resource managers and recruiters must work closely with the C-suite to better understand the dynamics of the growing company and the mindset – not just skillset – required to make new hires successful. Also, by keeping employees informed of open positions and using referral incentives, HR can make all employees recruiters. This strategy can help fill jobs more quickly and often nets candidates of a certain caliber that have a higher chance for success.
Compensation practices change dramatically after a company prepares for and ultimately completes an IPO, typically moving from less structured to more formal, documented programs designed to secure and retain talent. The scrutiny, by the SEC and others, of publicly available post-IPO executive compensation data requires organizations to balance shareholder interests with rewarding executives fairly.
One of the best ways to strike that balance begins with defining the talent market by selecting a peer group survey or collecting proxy data, or by combining both methods. Many companies utilize compensation consultants that can provide the data. Often, the advisors also understand how less tangible factors, such as management philosophy and individual performance, may influence pay packages.
Get a Head Start
While an IPO may be the last thought on the minds of executives running rapidly growing companies, especially early-stage companies, operating as if an transaction is imminent can make organizations more attractive and valuable when investors begin to take interest. Steps companies can take in that direction include developing a solid IT and finance infrastructure, assembling superb finance and operations teams, establishing excellent corporate governance, and developing a public company mindset among employees.
Of these initiatives, developing sustainable and scalable IT infrastructure and strong finance and accounting teams are among the most critical. However, infrastructure also encompasses making sure a company’s organizational chart is balanced and determining whether special technical or general needs should be outsourced. Organizations also need to be aware of pitfalls that could derail the development of a transaction-ready public company mentality. Underestimating the effort required not just before, but also after the IPO, is chief among them.
Rapidly growing companies face a number of challenges as they transition from freewheeling entrepreneurial startups to more structured, efficient and mature operations. By preparing for headwinds associated with changing cultures, they can put themselves in a better position for success. Listen to the recorded webinar for a deeper dive into the ideas discussed here.
Good news for small companies considering an IPO. On December 4, 2015, President Obama signed the Fixing America’s Surface Transportation Act (the FAST Act). Aside from directing transportation spending, this act includes provisions relevant to startup companies and companies seeking to pursue the IPO path. Below, I’ve outlined the major ways in which this act affects so-called “emerging growth companies,” or EGCs – defined as companies with revenues of less than $1 billion in their most recent fiscal year – by potentially reducing the costs related to initial filings and allowing them to keep their information confidential longer.
- Longer confidentiality period. Under the JOBS Act, which created the EGC category, a company that meets that definition needs to publicly file a registration statement for its IPO no fewer than 21 days before the start of its roadshow. Under the FAST Act, this time period has been reduced to 15 calendar days.
- Maintaining EGC status longer. In some cases, companies that have started the IPO process as EGCs have lost that status – for example, if the SEC review process continued past the end of the fiscal year in which the issuer crossed over the $1 billion revenue threshold. Under the FAST Act, such a company would remain an EGC through the earlier of either its IPO date or the 1-year anniversary of it otherwise losing EGC status. By retaining this status, the company is entitled to reduced regulatory and reporting requirements under the Securities Act and the Exchange Act.
- Reduced disclosure requirements. The FAST Act permits EGCs to omit historical financial information from their initial confidential submission or public filing of the IPO registration statement if this historical financial information would not be required in a registration statement (S-1 or F-1) at the time of the road show.For example, EGCs are currently required to include 2 years of audited financial statements in their public IPO filings. For some issuers, the timing of the IPO process may be such that the fiscal year would complete while the review process is still going on, and therefore the company would need to add audited financial statements for that most recent year. Under the FAST act, in a situation like that, financial statements for the earlier year would not be required in the registration statement. Instead of going through the expense and effort to audit and include financial statements from that prior year, the issuer could simply omit that year from the initial and subsequent filings.
These provisions do not free small companies of the onerous task of preparing and filing their IPO-related financial statements but they do provide some relief, including a longer confidentiality period.