Tip of the Week: Is the House in Order? Getting Ready to go Public
You're excited. You have met an investment banking or law firm. They have suggested that going public might be a logical strategy to help your company grow, raise capital, make acquisitions, etc. But are you really ready? Even assuming going public makes sense, are there any barriers that might make it difficult or a slower process?
In this tip of the week, I outline a few things to do early on in the process, ideally before the due diligence review begins, to ensure that barriers, some of which could be insurmountable, do not get in the way or, at the very least, are found out as soon as possible.
1. Are you auditable? To go public you will need to have your financial statements audited going back two years (three for larger companies). One of the first questions you need to ask is whether your financial records are in good enough shape to be audited. For example, a client in the distribution business, with very clean financial statements, recently discovered he could not go public because 25% of his customers were retailers that he owned or controlled, and that IRS rules appeared to require consolidating the financial statements of the distributor and the "controlled" customers. Unfortunately, the retailers' records were extremely disorganized and unable to be audited, ending the quest to go public. If you are not auditable, you may want to clean up your records going forward and postpone going public until you have two years of good clean financials.
2. Did you issue all shares? In many early stage companies, "corporate formalities" like issuing stock tend to get overlooked in favor of more important things, like survival! It is more difficult to go back and do this as part of the shell's or investment bank's due diligence review of your company. Get a good corporate lawyer to make sure the company's stock records fully reflect what you have always known is the arrangement between the owners but may not have been written down.
3. Is your intellectual property owned by the company? Patents can only be issued in the name of the individual inventor, then he or she has to assign the patent upon issuance to the company. This last step is sometimes overlooked or, frankly, sometimes the inventor waits to see how things are going before giving up his or her rights. Often trademarks were issued in a prior company, or in the CEO's name, and the same need to assign applies. If you are ready to go public, the IP has to be assigned to the company, or some kind of license arrangement giving the company the right to use the technology, is arranged. Again, it's usually better to do this before due diligence by the shell and investment banker begins.
4. Are all affiliated relationships memorialized? It is important to be up front in the due diligence process about any arrangements, understandings or contracts between the company and its shareholders, officers, directors, affiliates and their relatives. This needs to be disclosed once public, there is nothing unlawful about doing this, but some investment banks prefer to avoid conflicts of interest, for example, when the business rents a facility that is owned by the CEO. If these arrangements exist, and you want to retain them, and they are not in writing, you should memorialize them so there is no dispute as to the nature of the relationship.
5. Is there litigation? If you are in any litigation, there may be times that it is better to make it go away rather than have to explain it to an investment bank and shell owners; even if you promise that the case will settle soon, or at a certain price, or that you have a winning case, the existence of the case could spook an investor and they usually prefer to go public with no material outstanding litigation.
6. Are there any issues in management's background? If a member of management, or the board, or even a large shareholder, has civil or criminal legal problems in their background, particularly if it relates to securities matters, examine the issue carefully and very early on. How serious were the problems? How important is this person to keep around and possibly have the embarrassment of disclosing their background? Can counsel advise that the matter may not need to be disclosed? Could it prevent the company obtaining an exchange listing?
7. Have you run the financials as if you were public? Many private companies are run loosely with regard to financial decisions. Maybe the CEO thought it was right to pay for a colleague's vacation because he worked extra hard. Maybe other perks might seem embarrassing if they were publicly disclosed. You should examine whether these types of things should come out, and try to avoid them in the two years before going public.
8. Are your investors on board? Sometimes prior investors in your company have a right to veto transactions such as IPOs and reverse mergers. Check your investment documents to see if that is true before you start the process, and determine the right time to reach out to investors who have the veto power, but generally the earlier the better.
9. Got a good law firm? As early as possible, engage a law firm with experience representing companies going public, to help with all these issues and more. Disclaimer: your humble blogger runs just such a law firm!
In this tip of the week, I outline a few things to do early on in the process, ideally before the due diligence review begins, to ensure that barriers, some of which could be insurmountable, do not get in the way or, at the very least, are found out as soon as possible.
1. Are you auditable? To go public you will need to have your financial statements audited going back two years (three for larger companies). One of the first questions you need to ask is whether your financial records are in good enough shape to be audited. For example, a client in the distribution business, with very clean financial statements, recently discovered he could not go public because 25% of his customers were retailers that he owned or controlled, and that IRS rules appeared to require consolidating the financial statements of the distributor and the "controlled" customers. Unfortunately, the retailers' records were extremely disorganized and unable to be audited, ending the quest to go public. If you are not auditable, you may want to clean up your records going forward and postpone going public until you have two years of good clean financials.
2. Did you issue all shares? In many early stage companies, "corporate formalities" like issuing stock tend to get overlooked in favor of more important things, like survival! It is more difficult to go back and do this as part of the shell's or investment bank's due diligence review of your company. Get a good corporate lawyer to make sure the company's stock records fully reflect what you have always known is the arrangement between the owners but may not have been written down.
3. Is your intellectual property owned by the company? Patents can only be issued in the name of the individual inventor, then he or she has to assign the patent upon issuance to the company. This last step is sometimes overlooked or, frankly, sometimes the inventor waits to see how things are going before giving up his or her rights. Often trademarks were issued in a prior company, or in the CEO's name, and the same need to assign applies. If you are ready to go public, the IP has to be assigned to the company, or some kind of license arrangement giving the company the right to use the technology, is arranged. Again, it's usually better to do this before due diligence by the shell and investment banker begins.
4. Are all affiliated relationships memorialized? It is important to be up front in the due diligence process about any arrangements, understandings or contracts between the company and its shareholders, officers, directors, affiliates and their relatives. This needs to be disclosed once public, there is nothing unlawful about doing this, but some investment banks prefer to avoid conflicts of interest, for example, when the business rents a facility that is owned by the CEO. If these arrangements exist, and you want to retain them, and they are not in writing, you should memorialize them so there is no dispute as to the nature of the relationship.
5. Is there litigation? If you are in any litigation, there may be times that it is better to make it go away rather than have to explain it to an investment bank and shell owners; even if you promise that the case will settle soon, or at a certain price, or that you have a winning case, the existence of the case could spook an investor and they usually prefer to go public with no material outstanding litigation.
6. Are there any issues in management's background? If a member of management, or the board, or even a large shareholder, has civil or criminal legal problems in their background, particularly if it relates to securities matters, examine the issue carefully and very early on. How serious were the problems? How important is this person to keep around and possibly have the embarrassment of disclosing their background? Can counsel advise that the matter may not need to be disclosed? Could it prevent the company obtaining an exchange listing?
7. Have you run the financials as if you were public? Many private companies are run loosely with regard to financial decisions. Maybe the CEO thought it was right to pay for a colleague's vacation because he worked extra hard. Maybe other perks might seem embarrassing if they were publicly disclosed. You should examine whether these types of things should come out, and try to avoid them in the two years before going public.
8. Are your investors on board? Sometimes prior investors in your company have a right to veto transactions such as IPOs and reverse mergers. Check your investment documents to see if that is true before you start the process, and determine the right time to reach out to investors who have the veto power, but generally the earlier the better.
9. Got a good law firm? As early as possible, engage a law firm with experience representing companies going public, to help with all these issues and more. Disclaimer: your humble blogger runs just such a law firm!
Labels: Tip of the Week
posted by David N. Feldman at
9/30/2007 10:36:00 AM
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