Sarbanes-Oxley (SOX) compliance
rigors have affected the exit
strategy landscape for CEOs and investors of privately funded and venture-backed companies. While the initial
public offering (IPO) is still the outcome
desired by many who toil to build a company, an acquisition may well be the exit
event of choice, given the current compliance requirements and IPO climate.
During the boom era in the late ’90s,
some venture-funded technology companies went public without posting significant sales dollars to their ledgers. Today,
companies must generally post above-average performance results or have a very
compelling story to garner interest from
underwriters.
“If your company is doing reasonably
well but not great, then chances are, as a
CEO, you should think about how ready
you are for an acquisition, because it’s
more likely an acquisition will be your exit
strategy,” says Paul Johnson, partner with
Procopio, Cory, Hargreaves & Savitch LLP.
Smart Business spoke with Johnson
about both exit strategies and what CEOs
should consider when evaluating their
options and preparing for the event.
What are the IPO advantages and disadvantages that CEOs should consider?
During the IPO, there’s the chance that
the stock held by the executive will increase in value, and holding the shares
over time creates a residual incentive that
engenders both a sense of accomplishment
and a financial reward for the CEO. This
can be especially gratifying for founders
who have nurtured the company from conception. However, another consideration is
that regulations usually only permit executives to sell their stock over the course of
time, and there’s no guarantee that the
shares will appreciate. There’s greater
access to public equity markets after an
IPO, so companies that require additional
funding to reach the next level of development may find more readily available financial resources after going public.
What are the acquisition advantages and disadvantages?
Unlike the IPO, where executives may
usually only sell their stock over time,
depending upon how it’s structured, an acquisition event can offer immediate cash
gratification for investors and executives.
Also because the executive’s entire stock
position is usually sold at the time of the
event, without a new option or a stock
grant from the acquiring company, there’s
no future upside or downside. While taking
stock in the new entity rather than cash is
sometimes an option, and doing so preserves some of the upside potential for the
executive, the former company generally
becomes a smaller part of a larger whole.
Accepting the acquiring company’s stock is
a change in the risk proposition for executives since it’s likely that the acquiring company will be run by others.
Are there other advantages driving the acquisition exit trend?
Perhaps one of the main attractions to
the sale event is that, under most circumstances, the selling executive will not have
to directly face the relatively new rigors of
public company reporting in the post-SOX
era. Examples of the burdens of being a
public company include the pre-SOX obligations of filing 10-Qs every quarter and 10-Ks every year, preparing and filing annual
proxy statements and filing 8-Ks. Sarbanes-Oxley has added to this list CEO and CFO
certification of 10-Qs and 10-Ks, which
comes with potential criminal liability for
misstatements, a significantly accelerated
time frame for 8-K filing, an expanded list of 8-K-triggering events as well as SOX 404
attestation by auditors and management as
to the company’s internal controls. Few
entrepreneurs really want to deal with all
of the administrative headaches that public
company executives must face.
What else should be considered when choosing between an acquisition and an IPO?
Certainly both processes are long and
arduous, and the due diligence process is
more thorough than many imagine, so
executives should get professional advice
and prepare for the event by cleaning up
any intellectual property and stock ownership issues. Executives should also consider the tax consequences resulting from
each event. Because an acquisition for
cash is a liquidity event, it usually results in
immediate tax consequences, whereas the
IPO itself does not have tax consequences
on the stockholder until he or she sells.
Should CEOs consider their future goals
when selecting an exit strategy?
An important consideration in choosing
an exit strategy is the CEO’s future plans.
In theory, founders and executives who
choose to stay with the company should
have more control following an IPO.
Although they still must report to a board
and please public shareholders every quarter, any retained executives won’t have to
report up through an additional layer of
management, which becomes the most
likely scenario if the company is acquired.
For certain execs, becoming part of a
larger organization offers advantages. If
they want to continue to be involved with
the organization because they believe that
it can truly benefit from being acquired,
this is often an option. But, the acquisition
will change their focus and their ability to
control the outcome. Knowing yourself
and your goals as well as contemplating
the notion of reporting to others are important considerations when evaluating your
options. I’ve observed that many entrepreneurs start another venture after they’ve
cashed out. Launching a new company just
seems to be in their blood, but dealing with
SOX compliance isn’t very appealing.
PAUL JOHNSON is a partner with Procopio, Cory, Hargreaves &
Savitch LLP. Reach him at [email protected] or (619) 525-3866.