Governance issues often overlooked in pre-IPO planning

New report outlines five critical governance considerations that boards and management should examine in the run-up to an initial public offering.

Pre-IPO hurdles were lowered after passage of the JOBS Act in 2012, making the process easier and less costly for smaller companies. But laying the corporate governance groundwork often gets overlooked, according to a report issued by PwC and the Center for Board Governance.

The transition from private to public is still a complex juggling act, the report’s authors argue, and qualified board members with public company experience can play a critical role in helping the soon-to-be public company transform itself and adapt to the realities of being public.

‘When a company embarks on an IPO, management faces a multitude of responsibilities in a condensed period of time, and governance questions can overwhelm boards and executives if they aren’t prepared to handle the many layers of governance planning,’ said Mike Gould, a partner in PwC’s Deals practice in a statement accompanying the report. ‘As a result, governance decisions get put on the back-burner, creating unnecessary risk.’

The report, titled, ‘IPO governance: what works best,’ identifies five critical governance considerations that boards and management should examine in the run-up to an initial public offering.

1. Understanding SEC and exchange requirements for board and committee composition and governance practices

Requirements for both the structure of committees and the timing of implementation can vary slightly. For example, the NYSE requires that separate audit, compensation and nominating/governance committees be established, composed of independent directors. NASDAQ does not require a separate nominating/governance committee, but does stipulate that only independent directors serve on the nominating/governance committee, and, where no formal committee exists, that only independent directors fulfill nominating and governance duties. In addition, the NYSE requires at least one member of the audit committee be independent by either the date the IPO closes or five business days from the listing date, whichever is earlier, while NASDAQ’s deadline is the listing date.

Requirements are reduced if the company is controlled (i.e., 50 percent interest is held by a single shareholder or corporate entity).

2. Evaluating board composition for independence, relevant experience and qualifications

Companies should take a clear-eyed view of board makeup. Private company boards often include a significant majority of insiders and early-stage investors, but the majority of directors on public company boards need to be independent.

In addition, companies should consider “directors’ skills and the diversity of board members, which may help build credibility with investors,” argues Catherine Bromilow, a Partner in PwC’s Center for Board Governance.

3. Understanding shareholder and other influences

The IPO process by definition invites a new cadre of investors to take a stake in the company. Careful planning needs to be undertaken to understand what potential institutional investors expect from a governance standpoint and to identify and understand potential key influencers such as proxy advisory firms.

4. Reviewing governance choices and implications

Where latitude exists in governance decisions (e.g., combined or split board chair and CEO; staggered board; plurality or majority voting; mandatory retirement for directors) companies should focus on their particular circumstances while recognizing potential implications if shareholders disagree with governance structures. Choices on governance structures become acutely relevant for the newly public company if it also has a large contingent of governance-sensitive institutional shareholders willing to express their views through the proxy process. This analysis has become increasingly important as ‘discretionary voting’ by brokers has also become more restrictive in recent years. Companies can no longer assume that having a large retail ownership will easily translate into support for management because brokers can no longer cast ballots on governance issues, director elections and say-on-pay votes without specific client instructions.

5. Securing the right resources

Given the complexity of developing the right governance practices, companies need to determine the optimal path to ensure a smooth process. Smaller, resource-constrained companies may need to outsource relevant expertise and assistance, PwC argues, building that into the pre-IPO planning process. By including experienced legal counsel, auditors and compensation consultants in pre-IPO governance planning, the board and management can demonstrate they engaged in a thorough and methodical process if ever questioned after going public.

‘Governance decisions for both ‘going public and being public’ merit early attention and consideration,’ PwC’s Gould concluded. ‘Addressing these issues early and thoughtfully might even make the company look more attractive—if not to potential initial investors, at least to subsequent investors. And that could impact a company’s valuation and the benefits of its public debut.’

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