Being Public: Life After the IPO

by Boris Feldman


You think that the hard part is over. No more all-night drafting sessions at the printer. No more binges on the road-show. The registration statement has gone effective. You can watch your ticker symbol scroll across the TV screen in the morning. You're public! But ask anyone who's been an officer of a public company which is harder: getting through the IPO, or adjusting to the responsibilities of being public. Most will say that complying with the obligations of a public company makes the IPO itself look easy.

Here are some tips on making the transition easier. Obviously, there are many additional issues that a public company must address. This article focuses on the disclosure and accounting decisions that most often result in shareholder litigation or SEC enforcement proceedings.

Disclosure issues

Enhance shareholder value with performance, not hype. Some executives try to boost their company's stock by overplaying every development at the company and by over-promising future results. There is a price to that approach. The company's credibility with Wall Street will be diminished when actual results fall short of management's prior guidance.

The company will also be at increased risk of a shareholder class action lawsuit following a disappointing quarter or an unsuccessful product launch. One of the factors that plaintiffs' lawyers evaluate is management's statements during the period leading up to the disappointment. Executives who hype the company at every opportunity are more likely to get sued.

This is not to suggest that executives should ignore their companies' stock performance. On the contrary, one of their responsibilities is to enhance shareholder value. But the most respected public companies have learned that the best way to do that is by delivering solid results, not by promising rosier times around the corner.

Control Wall Street's expectations – don't let them control you. Some executives, particularly of younger public companies, take sell-side analysts' projections as gospel. They believe they cannot challenge those projections and must drive the company to achieve them. Sometimes, such executives set their internal targets based on what the Street says the company should achieve – even when that happens to be dramatically higher than the internal team says it can deliver.

This is a dangerous path. In the most egregious financial frauds in the technology industry, a key part of the problem was a CEO (often, the founder) who viewed himself as a slave to Street expectations. That mind set – 'We've got to deliver x percent growth at any price' – can pressure the sales force and finance team into cooking the books.

Wall Street analysts hate surprises. Public companies are therefore punished more severely for surprises than they are for weak, but anticipated, results. The key is to shape Wall Street's expectations at the earliest possible time. If the analysts are predicting 40 percent year-over-year revenue growth, but your sales team is unlikely to deliver more than 20 percent, warn the market early. Similarly, if Wall Street expectations previously seemed reasonable, but now look unachievable, let the market know that prospects have changed. That way you avoid a legion of analysts saying, after a disappointing announcement, 'Why didn't you tell us before?'

The US Congress has created a safe harbor for forward-looking information accompanied by appropriate risk disclosures. If a company follows the safe harbor requirements in shaping Wall Street expectations, it should win early dismissal of lawsuits by disappointed investors.

Focus on the real risks to your business, not on boilerplate. Cautionary disclosures are at the core of being a publicly traded company. To discharge your obligations under the federal securities laws – and to protect yourself against shareholder class actions – you must include in your SEC filings a meaningful discussion of factors likely to affect future performance.

Most public companies do that well – initially. IPO prospectuses usually lay out in detail the risks to investors. For many companies, however, the effort devoted to risk assessment declines substantially post-IPO. Some companies are slow to update their risk disclosures to reflect new challenges to the business.

Consider adopting the following protocol: As a company finishes a quarter and closes its books, senior management typically meets to prepare for the quarterly conference call with securities analysts. Someone should assume responsibility for asking, 'If we miss our target for the coming quarter, what is likely to be the cause?' Public companies are usually surprised when they have a quarterly shortfall; but they are rarely surprised about the factors that led to the disappointment. During these pre-conference call sessions, explore whether the risk profile has changed. Take those risks and make sure that analysts on the call understand and appreciate them. Add those factors to your next quarterly report on form 10Q, if they were not previously addressed.

Accounting Issues

Set high ethical standards early and enforce them. The way to avoid restatements, SEC investigations and the other horrors that flow from accounting irregularities, is to set high ethical standards early in the life of the public company. There is no substitute for a model of high integrity set by the CEO, CFO, VP of sales, and controller. You must let every employee know that you will not tolerate improper sales, even if they seem to be needed to hit the quarterly target and avoid disappointing the Street.

For standards to be meaningful, they must be enforced. If a salesperson closes a deal by signing a secret side-letter with a customer, which is not disclosed to accounting personnel, you must respond in a way that makes clear to the rest of the sales team that such conduct will not be tolerated or rewarded.

A warning sign that your company may have a problem is an executive – whether CEO or head of sales – who responds to doubts about the ability to reach internal targets by saying, 'Do whatever it takes.' That phrase may be understood as authorizing irregular deals in order to avoid a revenue shortfall.

Such exhortations sometimes arise because the CEO believes that Street expectations must be met, even if they are too high.

Make sure your systems keep up with your company's growth. Young public companies prefer to devote their resources to product development and sales, rather than to finance. But if one were to survey outside auditors' management letters, a recurrent complaint would be that the company's revenue growth has outstripped its accounting systems. Many companies still continue to use systems that were adequate at the $10 mn revenue mark after they pass $100 mn. The time to upgrade is before the IPO – not after, when a hiccup will likely have serious reverberations in the market.

A related issue is upgrading personnel. Many companies have run into trouble by keeping in place a controller or other finance executive long after the company has outgrown their experience level. Skills that were adequate for a private company may not suffice in a public company.

Create a meaningful audit committee. This can serve as an effective prophylactic against accounting improprieties. Finance personnel with knowledge of troublesome issues may be reluctant to share them with the outside auditor, but more likely to divulge them to the audit committee, if asked the right questions.

Unfortunately, many audit committees play a passive role, merely listening to reports from the outside auditors. An invigorated audit committee should meet periodically and privately with employees who would likely be aware of irregularities if they were occurring, such as the head of credit and collections, or division controllers. They cannot always ferret out accounting problems – sometimes a conspiracy of silence may be impenetrable, even by the board. But there will be other situations in which an honest employee, who feels pressured by superiors to cross the line, may be relieved to find someone on the board who will back them up. In any event, knowing that the audit committee engages in these inquiries may discourage some executives from pursuing questionable transactions in the first place.

Involve the auditors in everything. The best defense in a shareholder suit or SEC proceeding challenging a company's accounting is that the outside auditors approved it. This does not mean that the accountants are always right. But it is difficult to accuse management of fraud if they disclosed an accounting practice to the auditors and the auditors approved it.

In such a situation, plaintiffs' lawyers typically try to show that the auditors did not know every tiny detail about the transaction. As a result, the more detailed the disclosure, the greater the protection provided by the auditors' approval.

Consulting the auditors on difficult accounting issues is especially valuable for a new public company, with fewer internal resources than a more mature firm. If you ask the auditors to bless a practice, you should be prepared to listen to them if they reject it. Plaintiffs' lawyers will have a field day if a transaction that they attack as improper was criticized by the auditors but still booked.

Auditors should also conduct timely quarterly reviews, as opposed to retrospective reviews at year-end. Year-end reviews of the interim quarters are the worst of all worlds: if the auditors disagree at year-end with a decision made at the end of the first quarter, the company may face a restatement. Having the auditors conduct review procedures before announcing quarterly results reduces that risk as well as the likelihood of disputes during the annual audit.

So what is the reward for following these tips? I can't guarantee that you will not be sued if your company encounters some adversity. But the odds are that, if you implement these principles, you will reduce your risk of experiencing a corporate Chernobyl. And if you are sued by the plaintiffs' securities bar, you will be able to point to values, policies and systems that reflect a fundamentally honest company.

Boris Feldman is a partner in the litigation department of Wilson, Sonsini, Goodrich & Rosati.


The views expressed in this article are those of the writer, and do not necessarily represent the views of the firm.