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The cost of being public in the era of Sarbanes-Oxley20/02/2006. Source: Israel Venture Capital Journal (IVCJ). Thomas Hartman, Partner, Foley & Lardner LLP
 Many private Israeli firms, including those that are venture-backed, see an initial public offering as their ultimate goal. Yet the costs of being public in the US can be substantial and sharply impact operations, says Foley & Lardner, in this Israel Venture Capital Journal article.
Many private Israeli firms, including those that are venture-backed, see an initial public offering as their ultimate goal. Yet the costs of being public in the US can be substantial and sharply impact operations. The US-based law firm of Foley & Lardner LLP, conducted studies in 2004 and 2005 on the cost of being public. The studies were prepared under the direction of Foley & Lardner’s Detroit-based partner, Thomas Hartman. In this IVCJ article, they present a shortened version, highlighting the firm’s findings, which should give food for thought to Israeli companies considering the going public route.
Principal findings
• The average cost of being public in FY 2004 for a company with annual revenue under $1 billion increased $851,000 (33 percent) from FY 2003.
• Average costs increased $2.4 million (223 percent) from the enactment of the Sarbanes-Oxley Act through FY 2004.
• In FY 2004, the average cost of being a public company with more than $1 billion in annual revenue was $14.3 million, an increase of $4.4 million (45 percent) from FY 2003.
• Lost productivity continued to represent a major cost for all companies responding to Foley & Lardner’s 2005 survey, particularly for smaller public companies. Average costs associated with lost productivity increased more than 556 percent to $1 million in FY 2004 for companies with annual revenue under $1 billion, compared to an 18 percent increase to $2.9 million in FY 2004 for companies with annual revenue of over $1 billion.
• Fees paid to outside auditors continued to increase by double digit percentages year-to-year since the enactment of the Sarbanes-Oxley Act in 2002. This increase accelerated dramatically in FY 2004. Foley & Lardner attributes this increase to the substantial costs associated with the financial control audits required under Section 404 of the Sarbanes-Oxley Act, which phased-in for most domestic public companies at the end of 2004.
- Of all companies analyzed, audit fees increased an average of 61 percent between FY 2003 and FY 2004.
- Audit fees increased an average of 84 percent for S&P Small-Cap companies, 92 percent for S&P Mid-Cap companies and 55 percent for S&P 500 companies.
• It continues to be increasingly expensive for companies of all sizes to attract and retain qualified directors. In FY 2004, S&P Small- Cap, S&P Mid-Cap and S&P 500 companies witnessed double digit increases in average annual director fees with increases of 17 percent, 14 percent and 13 percent, respectively.
Over the past four years, the impact of corporate governance reform on director fees has been significant, with increases of 46 percent for S&P Small-Cap, 45 percent for S&P Mid-Cap and 43 percent for S&P 500 companies between FY 2001 and FY 2004.
• Consistent with results from previous years, a significant number of survey respondents (20 percent) are considering going-private transactions as a result of corporate governance and public disclosure reforms. Additionally, respondents to the 2005 survey are increasingly considering other options, including a sale of the company (10 percent) and merger (14 percent).
• There was a significant increase in the number of survey respondents who felt that corporate governance and public disclosure reforms have impacted administrative expenses "a great deal," rising from 54 percent in the 2004 survey to 70 percent in the 2005 survey. This increase is attributed to the financial impact of the FY 2004 phase-in of Section 404.
• A vast majority (82 percent) of respondents felt that corporate governance and public disclosure reforms were too strict, an increase of 15 percent, compared to the 2004 survey.
Sample responses by executives
Responses regarding the impact of Section 404 on company relationships with outside auditing firms:
• ...we used to work together, now the auditors are the policemen/adversaries not consultants/advisors.
• … the relationship is much less client-service oriented and collaborative. Consultations with our external auditors are much more formal and less frequent.
• … it has created an adverse relationship with the auditors. They are no longer an adviser the company can count on during the normal course of business. Public company auditors are now privatized regulators for the SEC.
• We rely less on them for advice. We are more cautious about what is discussed with them, when and by whom.
• We don’t share strategies, ideas or proposals with them any more than we would share them with the IRS.
Responses on how the Audit Committee reforms implemented by Sarbanes-Oxley have changed the relationship between a board’s audit committee and senior management:
• We now have a "Lead Audit Director" and overall our Audit Committee is involved in more decisions made throughout the year.
• The relationship between management and the audit committee has become much more formal as the scope of the audit committee has expanded and their requests for information from management have increased.
• More meetings and more costs.
• The Audit Committee takes their responsibility much more seriously now. They are more involved with related-party transactions, the whistle blower hotline and critical accounting transactions.
• It has caused a much more intense relationship and deeper questioning of company practices.
Suggestions for modifying corporate governance and public disclosure reform:
• Get a panel of CEOs to work with government to amend SOX.
• While stock exchange rule changes have generally been fair, section 404 of SOX is unduly costly and burdensome with limited benefit. This section should be repealed or drastically modified to a more moderate position.
• The reforms are driving small companies out of the public markets. It is virtually impossible for a small company to comply with the requirements and stay in business.
• SOX 404 is a political over-reaction. The provisions of SOX 404 need to be focused more on accountability, not documentation and meaningless bureaucracy.
• Overall, the governance and disclosure reforms are a positive step forward to increase reliance on our country’s economic society, but we have somewhat decreased our abilities to continue growing and attracting new companies to set up shop here because of the strenuous requirements placed on public companies in America.
• The legislation has increased costs and increased internal awareness of the "rules of the game," but was needed.
This article appeared in the Israel Venture Capital & Private Equity Journal (IVCJ). IVC Research Center publishes the Israel Venture Capital & Private Equity Journal, a quarterly review of trends and developments in the Israeli-related venture capital industry. IVCJ, distributed worldwide, is dedicated to provide wide-range coverage of Israel's venture capital industry. For more information please visit www.ivc-online.com
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