While the term “small business” ceased to apply to Facebook long before it went public, the company’s path from dorm room LLC to $100 billion behemoth underscores the serious challenges facing start-ups with far fewer resources.
In the 1980s and 1990s, a company like Facebook might have made the leap to Wall Street in just three or four years. But in the 2000s, it took Facebook eight years, which is the norm these days. Since 2006, the average age for companies making their initial public offering has doubled, and whereas small companies made up the majority of annual IPOs just 15 years ago, they are now in the minority.
That’s because today’s small businesses see the IPO market as inaccessible. Congress acknowledged as much with the recent passage of the JOBS Act, which addressed a number of issues that have been identified as necessary to build a new IPO “on ramp” for smaller companies.
Yet, while the legislation did address some key issues these companies often face, it was by no means a panacea. Many of the hurdles that middle market firms must clear on their way to a public offering are unique compared to the ones facing larger companies, and they are often overlooked or difficult to “legislate away.”
While these hurdles are numerous, there are a few that stand out.
New type of company, new type of management
Small companies don’t get to the floor of the NYSE or NASDAQ without the guidance of superior management. Without their strategic vision and entrepreneurial drive, the very ideas that form their foundations would not exist. But at the same time, the job of public company CEOs is different from their private company counterparts. Of those who make the transition, few have experience with the rigors of the offering process or the requirements of public company leadership.
According to a 2011 survey, the reallocation of CEO time from company strategy to reporting and compliance was virtually tied with reporting burdens as the top challenge for private companies going public.
This challenge extends to the boardroom. Private companies often have boards representing their founders or early investors, and identifying the right independent directors is not only tough – it’s often a significant reversal of strategy for companies. Facebook, whose small board has drawn criticism for being composed primarily of early investors, showed that this challenge can be daunting for IPOs of any size.
Financial and accounting challenges
If you ask any senior executive at a newly public company about major IPO challenges, chances are they will put accounting and compliance at the top. Most private companies do not have the “bench strength” or financial processes to adequately respond to the rigors of public company reporting.
While the JOBS Act did address this issue in part by providing relief to certain companies with regard to an audit of internal control over financial reporting, the legislation did not remove the requirement for CEO/CFO certification. This is often most notable in the area of financially relevant IT systems – the management team suddenly finds overhead costs skyrocketing as compliance and financial reporting become mandatory.
While it is important for a company considering an IPO to be prepared to pounce on the right market opportunity at the right time, this can lead to an absence of focus on the post-IPO plan. Companies entering the market with unsustainable forecasts and valuations — IPO euphoria — quickly see shareholder value erode.
While one might be tempted to cite the Facebook example, smaller companies with far lower market capitalizations should be especially concerned with establishing a credible track record of consistent performance. The JOBS Act might smooth the on ramp, but without performance sustainability, the post-IPO track could be rocky.
Phyllis Deiso is the national SEC practice leader for McGladrey, an assurance, tax and consulting services provider based in Bloomington, Minn.