The decision for a private company to go public is a major one. The growth implications of an IPO (initial public offering) are far-reaching and the rewards can be incredible, but how should a company prepare for this and what exactly are the important focus areas? I've had the unique pleasure and experience on numerous occasions to architect pre-IPO Boards and have documented many interesting observations. One that stands out is the fact that business founders, CEOs, and insider Board Members, if they are already appointed, are commonly short-sighted in their formal Board composition focus until forced as a requirement to become a public company. As you might imagine, an impending IPO quickly mandates a spotlight on the need for a properly architected and effective Board of Directors.
First, understanding the benefits for a private company to become public is important. There are many good reasons for a private company to consider an IPO. To name just a few, public companies and their shareholders have the ability to:
- Cash in a portion of the founder’s or owner’s equity without giving up all of their control.
- Gain access to public equity markets, opening the door for potential future capital raises.
- Leverage the abundant price-to-earnings multiples commonly available in public markets by monetizing an equity interest in the company.
- Make acquisitions of other companies by issuing equity directly to the public or sellers to raise the funds for a cash purchase.
- Attract and reward key employees and Directors by offering stock-based compensation and incentives.
All of these benefits are great opportunities for growth-minded organizations.
When it comes to requirements of Board makeup, there are many important considerations in both the value and requirements of a properly structured IPO Board. The stock exchanges in the U.S., and many other global jurisdictions, mandate the following:
- One Independent Director on the Nominating/Governance Committee, Compensation Committee, and Audit Committee at the time of listing (Nasdaq), or by the earlier of the date the IPO closes or five business days from the listing date (NYSE).
- A majority of Independent Directors within 90 days thereafter.
- Fully independent Nominating/Governance Committee, Compensation Committee, and Audit Committee within one year.
Note: Foreign private issuers and controlled companies are exempt from some of these mentioned standards. (A 'controlled company' is one in which more than 50% of the voting power for the election of Directors is held by an individual, a group, or another company.)
But why wait to architect your ideal Board or implement these Board composition mandates just before or during the IPO process, or within the grace period? There are many benefits to accomplishing this much earlier and well in advance of an IPO...
It still remains somewhat surprising to me that grace periods exist as it relates to post-IPO Director independence and specific Board Committee independence compliance. Many post-IPO Board's expend a large amount of effort during their first year as a public company focused on Board restructuring and Director replacement when they should be laser focused on their strategy and governance roles. Additionally, the time it takes to get to a well-oiled Board machine, settled into the organization, and have the all-important trust across the entire Board can take time. All of this taking place simultaneously to numerous other first-year public company obligations can overload a Board and force it into a tailspin. Pre-IPO organizations commonly miss out on many of the benefits an in-place, properly-architected, and honed Board can offer in the years leading up to an IPO event. We must always remember, however, that market timing remains of utmost importance, and an extremely aggressive schedule can be warranted in certain instances so as not to miss the ideal market window.
'The Implementation of Corporate Governance in Pre-IPO Companies,' an article in the Harvard Law School Forum on Corporate Governance posted by David F. Larcker and Brian Tayan in December 2018 on the topic of The Implementation of Corporate Governance in Pre-IPO Companies, provides some interesting data. On average, the companies in their sample were nine years old at the time of IPO. Major milestones for IPO companies in the study included the following (note: these data points are average results and the order in which each event occurs varies widely across individual companies):
5 years prior to IPO:
- The company hires the CEO (if different from the founder) who eventually takes the company public.
4 years prior to IPO:
- The company implements the financial and accounting systems in place at the IPO.
- The company hires the external auditor used at IPO.
3 years prior to IPO:
- The company first becomes serious about developing a corporate governance system
- The company recruits its first independent, outside board member.
- The company recruits the CFO who eventually takes the company public.
2 years prior to IPO:
- The company hires an in-house General Counsel.
The referenced Harvard Law School Forum on Corporate Governance article provides many other interesting IPO data points and study results - worth a read.
Regardless of the point at which the Board-build / rebuild effort becomes the major focus in the IPO process, proper Board architecture must be applied and include the required regulatory compliance guidelines (independence requirements mentioned earlier). Direct focus on attracting and appointing great Non-Executive Directors to your future public company-required Board Committees (Audit Committee, Compensation Committee, and Nominating/Governance Committee) plus remaining, but not mandated, Board Committees early in the process can reap great rewards. In addition to properly constructing all Board Committees and the overall Board with experienced members, plan for incorporating these pre-IPO considerations, as well:
- Aim for at least 50% of Board Members to have previous public company Board experience.
- Having at least 1 Board Member with previous pre/post-IPO experience is advantageous.
- In addition to engaging an outside leading IPO law firm, it can also be advantageous to have a seated Board Member with this same legal experience pre-IPO. Remember that great Boards are designed around an organization's current and upcoming phase(s) of growth, so architect the current Board accordingly. Your General Counsel (GC) will thank you.