An initial public offering (IPO) is a complex, time-consuming and costly undertaking. Unfortunately, many companies that seek the benefits of “going public” underestimate the significant costs involved, as well as the ongoing costs of being a public company.
The JOBS Act
In 2012, Congress passed the Jumpstart Our Business Startups (JOBS) Act. The act was designed to reduce the cost of going public for certain “emerging growth companies” (EGCs) and to ease the regulatory burden on EGCs during their early years as public companies.
Now, nearly four years after it was enacted, has the JOBS Act had the desired impact? Probably not, according to a recent survey by PricewaterhouseCoopers and Oxford Economics. According to the survey report, Considering an IPO? An insight into the costs post-JOBS Act, 84% of IPOs filed in 2014 involved EGCs, but the JOBS Act doesn’t appear to have provided significant cost savings for these companies.
One thing that has changed, however, is that companies are getting better at anticipating the costs of being public.
JOBS Act Benefits
In an effort to spark IPO activity, the JOBS Act created an “IPO on-ramp” by easing many of the filing and disclosure burdens for EGCs. For example, EGCs may include two years of audited financial statements (instead of three) with their registration statements. Generally, an EGC is a company with total annual gross revenue of less than $1 billion in its most recently completed fiscal year.
After an EGC goes public, it initially enjoys relief from several reporting, disclosure and auditing requirements. For example, it’s exempt from the Sarbanes-Oxley Act’s requirements regarding auditor attestation on internal controls. It continues to enjoy these benefits through the last day of the fiscal year following the fifth anniversary of its IPO.
EGC status may be lost earlier, however, if the company reaches $1 billion in annual gross revenue (adjusted for inflation), issues more than $1 billion of nonconvertible debt in any three-year period, or becomes a “large accelerated filer” for purposes of SEC reporting. (Generally, that means a public float of $700 million or more.)
The JOBS Act also contains several provisions designed to improve access to capital markets, including crowdfunding and expanded private placement exemptions.
The Considering an IPO? survey report provides valuable insights into the actual costs associated with going, and being, public. Here are some highlights:
- CFOs were more likely to be surprised by the costs of going public than the costs of being public.
- Nearly 60% of companies surveyed were prepared for the increased cost of being public, up from 55% in a similar 2012 survey.
- Direct costs of going public (excluding underwriter discounts) averaged $3.9 million.
- Underwriter discounts in average-size offerings ranged from 4% to 7% of gross proceeds.
- The cost of being public includes certain one-time costs as well as recurring costs. Typically, private companies incur more than $1 million in one-time costs to become public companies. Around 60% of respondents spent more than $1 million per year on recurring costs of being public.
- For IPOs, “there is no discernible cost savings when filing as an EGC.” The reason: The biggest cost associated with an IPO is the underwriter discount, which is driven by deal size and isn’t affected by the JOBS Act. Costs likely to be affected by the act, such as auditor’s fees, “are not significant enough . . . to result in noticeable cost savings.”
- Half of the respondents reported spending between $100,000 and $500,000 to implement processes and controls required by Sarbanes-Oxley.
The report noted that, while EGCs can elect to defer the Sarbanes-Oxley auditor attestation requirement, their CEOs and CFOs still must certify to the quality of their internal control environment and their financial statements in periodic reports.
Know the Costs
To avoid surprises, private companies contemplating an IPO should carefully estimate the costs associated with going, and being, public. EGCs that went public recently should bear in mind that, once they lose their EGC status, additional disclosure and compliance requirements will likely increase their costs.