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Getting in position to be in position

Achieving liquidity through the US public equity markets has become more time consuming and more expensive in the wake of the Sarbanes-Oxley Act of 2002 and other related regulations. Portfolio companies that understand the increased effort required to complete an initial public offering and prepare in advance to be a public company will significantly reduce the number of obstacles to liquidity confronting them and their private equity investors, according to Mark Bettencourt of Testa, Hurwitz & Thibeault.

Signs of life in the IPO market have awakened interest among private equity investors and their portfolio companies in achieving liquidity through the public equity markets. The public offering landscape has changed dramatically, however, since the IPO boom of the late 1990s. The Sarbanes-Oxley Act of 2002 and related regulations make the IPO process more time consuming and advance preparation more critical. What, then, should portfolio companies do in preparation for an IPO?

In the current environment, IPO preparations include traditional matters such as managing public communications and putting corporate records in good order. Portfolio companies with IPO aspirations must be conscious of media interviews, press coverage and website postings. Moreover, in addition to traditional IPO preparations, portfolio companies should also be focusing resources on three areas - accounting and controls, corporate governance and executive employee arrangements. Given the requirements imposed by Sarbanes-Oxley, portfolio companies should expect to spend a significant amount of time preparing to begin the IPO process, and should consider the following well in advance of an intended IPO in order to get in position to be in position.

Accounting and Controls. The Sarbanes-Oxley requirements relating to internal controls, disclosure controls and procedures, and auditor independence will likely prove to be the source of much additional expense and difficulty. At the time of its IPO, a portfolio company will need to have in place compliant controls and procedures. The design and implementation of these controls and procedures will take significant time and require close coordination with outside advisors.
In addition, a portfolio company should, as much as practical, act like a public company when obtaining services from its outside auditor. To preserve the independence of its outside auditor, a portfolio company should not obtain any non-audit services specifically prohibited by Sarbanes-Oxley. Moreover, a portfolio company should pre-approve, ideally through an independent audit committee, all audit and permitted non-audit services provided by its outside auditor.

Corporate Governance. Sarbanes-Oxley has significantly expanded the responsibilities of independent directors and board committees. Portfolio companies need to understand the criteria for director independence and the general requirements regarding board of director and committee composition. In addition to general independence requirements, audit committee members must be able to understand financial statements and at least one audit committee member must have a certain level of financial sophistication. Although a newly-public company has in some cases up to one year after its IPO to comply fully with these composition requirements, the time needed to identify and attract new independent directors may prove to be longer than expected.

As the launch of the IPO process draws nearer, a portfolio company should govern itself as much like a public company as possible. Additionally, many of the company's affairs should be under the direction of an audit committee and a compensation committee. For example, an audit committee should have responsibility for directly overseeing the outside auditor, and should identify the portfolio company's critical accounting policies and discuss them with the outside auditor.

Executive Employee Arrangements. Sarbanes-Oxley prohibits any public company from extending, maintaining or arranging personal loans to its directors or executive officers. For portfolio companies, this prohibition on personal loans is a potential minefield. Prohibited personal loans include arrangements not universally understood to be loans, such as use of corporate credit cards for non-business purposes, bonuses that must be reimbursed if not fully earned, certain credit arrangements to fund stock purchases, and certain split-dollar life insurance policies. It is also important to note that a portfolio company will become subject to the prohibition on personal loans upon filing its IPO registration statement with the SEC, not upon the commencement of trading as a public company. Thus, portfolio
Achieving liquidity through the public equity markets has become more time consuming and more expensive. Portfolio companies that understand the increased effort required to complete an IPO and prepare in advance to be a public company will significantly reduce the number of obstacles to liquidity confronting them and their private equity investors. So, prepare wisely and early.

This article is reproduced with permission of Testa, Hurwitz & Thibeault, LLP. For more information about Testa, Hurwitz & Thibeault, LLP, please contact www.tht.com
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