Private equity firms often look to sell holdings on the public market in order to realise gains on investments and increase returns to their investors. Crowe Horwath LLP, one of the largest public accounting and consulting firms in the US, provides private equity groups with four recommendations to help them successfully divest of a portfolio company (portco) through an initial public offering (IPO).
"In recent months, we’ve seen an uptick in IPO activity, which is causing many private equity groups to revisit an IPO as a viable exit strategy for some of their holdings," says Tony Klaich, a partner in the Private Equity practice within Crowe’s Risk Consulting Group. "It’s the private equity group’s responsibility to prepare the portco by upgrading its personnel’s skills, hiring more experienced professionals, seeking outside assistance or taking other steps necessary to ensure compliance."
Klaich explains that public companies face numerous requirements regarding corporate governance and internal control over financial reporting (ICFR) that private companies typically aren’t prepared for, including regulatory requirements under the Sarbanes-Oxley Act (SOX), particularly Section 404. "Private equity groups should expect their portfolio management teams to establish corporate governance and compliance programs well before launching their IPO," he adds.
According to Klaich, private equity groups should address the following issues before taking a portco public.
Enhance corporate governance. Private equity groups should assess a portco’s corporate governance processes. According to Klaich, benefits of good corporate governance include better risk management, reassured stakeholders and reduced cost of capital, so establishing a strong corporate governance program can help the company attract new investors when the IPO is launched.
Increase tone-at-the-top and entity-level activities. Private equity groups should check to make sure an ethical tone at the top that trickles down to all levels of employees is incorporated into the portco’s management assessment efforts.
Provide accurate financial reporting. Private equity groups assume reputational and other risks if their portcos do not have sound internal controls over financial reporting prior to going public. Weak ICFR increases the likelihood of inaccurate data being included in a company’s financial statements and disclosures that are included in the registration statement. If questions arise about the accuracy of financial statements and disclosures, this can cause problems with the Securities and Exchange Commission (SEC). SEC issues can impact the market’s interest and the demand for shares, thus impacting the amount of capital to be raised.
Address Sarbanes-Oxley compliance requirements. According to Klaich, for most portcos, a SOX 404 compliance program should begin at least 18 months before compliance is required. Compliance will be required upon issuance of the company’s second 10-K, a required financial document, so working backwards from the due date is important. Private equity groups should expect their management teams to complete a scoping exercise and risk assessment early on to identify, evaluate and prioritise the company’s vulnerabilities. According to Klaich, the most problematic areas in recent years have been related to revenue recognition, tax, information technology, general controls, stock-based compensation, segregation of duties and judgments and estimates, such as inventory and accounts receivable reserves.