Life After Going Public

The initial public offering (IPO) has been underwritten, the SEC has accepted your Form S-1 filing, institutional investors have been secured, the NASDAQ bell is ringing – and then what? You did it; your company’s stock is now being publicly traded: What does that mean for founders, executives and employees of the business?

Although it may seem that going public is the finish line and the end of late-night phone calls and closed-door meetings, it also appears this is just the beginning. With going public comes great excitement and great responsibility – more eyes on your financials; more frequent, formal filing obligations; and pressure on company performance to keep the stock price on the rise.

Filing Requirements (Including Exceptions)

SEC rules have mandatory quarterly and annual reports (Forms 10-Q and 10-K, respectively) that require specific disclosures to be certified by the company’s CEO and CFO. There is a common misconception that upon completion of an audited financial statement, the outside audit firm is responsible for the reported information; that is not correct. Management of the company will always take full responsibility for the disclosed information.

Certain companies may qualify as an “emerging growth company” or a “smaller reporting company” which impacts the disclosure requirements and timing for which certain accounting pronouncements will be adopted.

An emerging growth company is one which (1) has total annual gross revenues of less than $1.07 billion during its most recently completed fiscal year and (2) as of December 8, 2011 had not sold common equity securities under a registration statement. A company continues to qualify as an emerging growth company for the first five years after it completes an IPO unless (1) its total annual gross revenue are $1.07 billion or more; (2) it has issued more than $1 billion in non-convertible debt in the past three years or (3) it becomes a “large accelerated filer.” The benefit of this designation is that these companies are permitted:

• To include less extensive narrative disclosure than required of other reporting companies, particularly in the description of executive compensation;
• To provide audited financial statements for two fiscal years, in contrast to other reporting companies, which must provide audited financial statements for three fiscal years;
• Not to provide an auditor attestation of internal control over financial reporting under Sarbanes-Oxley Act Section 404(b);
• To defer complying with certain changes in accounting standards; and
• To use test-the-waters communications with qualified institutional buyers and institutional accredited investors.

A “smaller reporting company” is one which (1) has public float of less than $250 million OR (2) has less than $100 million in annual revenues AND (a) no public float OR (b) public float of less than $700 million. Public float is computed by multiplying the market price by the number of the company’s common shares held by non-affiliates PLUS the product obtained by multiplying the common shares covered by the registration statement by their estimated public offering price. A company’s public float may be zero.

Disclosure Requirements:

Rate reconciliation – The annual report (Form 10-K) must provide a table that reconciles the statutory tax rate of the company to the effective tax rate.

Income taxes by jurisdiction – There is a required table which breaks out the current and deferred taxes by jurisdiction (federal, state, foreign).

Uncertain tax position rollforward – The report discloses a table which reflects any increases and decreases to the uncertain tax positions within the period.

Equity Considerations for Employees and Executives

When a company goes public, shares and options are often subject to a lock-up period – typically 90-to-180 days – during which company insiders, such as employees, cannot sell their shares or exercise stock options.

It is imperative to reread all outstanding equity grants you hold at the time you become aware of your company going public. Many restricted stock grants have a provision for certain events in order for the stock to vest and often times an IPO is one of them. If you did not make an IRC. Sec. 83(b) election on this stock when it was granted, the tax on these awards is coming. This will be based on the value on the date of vesting less the value on the date the stock was granted. This difference in price (“intrinsic value”) will be reported on your W-2 and subject to ordinary income tax on your personal tax return.

If you already hold stock in the company, you should know your basis in the stock (what you paid for it) and compare that to the market value. Upon sale of the stock, you will pay capital gains tax on the difference in what you sell it for and what you paid for it. The capital gains tax rates are very different if you hold your stock for greater than a year prior to selling; if you are able to wait for that time to lapse then it is generally recommended to do so.

Valuation

In order to determine the fair market value of equity, which is a major factor upon issuance of stock and exercising of options, the stock must be valued under IRC Sec. 409A. A common misconception around the value of an entity’s stock, is that the investors set the value during fundraising. However, the true valuation under IRC Sec. 409A must be determined by an external valuation team. To take advantage of the IRS safe harbor (i.e., not be subject to certain IRS penalties), IRC Sec. 409A valuations should be done annually or each time the company has a material event, like a new financing.

Tax Considerations

There are certain IRC regulations and FASB provisions that only apply to public companies or that should be considered upon IPO. This impacts not only the taxable income computation along with the disclosure requirements within the tax footnote of the financial statements.

Excess Executive Compensation (IRC Sec. 162(m)) – The CEO, CFO and three highest paid executives of the corporation are limited to $1 million per year. This annual limitation is based on deductible remuneration by the company and thus includes base compensation, salary, any equity award exercises or vestings (including windfalls) and certain benefits.

Net Operating Loss Limitation (IRC Secs. 382, 383) – When there is a greater than 50% change in ownership of a corporation within a three-year period, the net operating loss and credit carryforwards of the company may be limited.

Golden Parachute Payments (IRC Sec. 280(G))- If a corporation makes “parachute payments,” which:

• Are payments in the nature of compensation that are contingent on a change in ownership or control of a corporation;
• Are paid to a “disqualified individual;” and
• Exceed three times the disqualified individual's “base amount,”
  then all amounts paid in excess of one times the base amount (“excess parachute payments”) are nondeductible to the employer.

Conclusion

As you can see, going public is a time of endless possibility but also can be quite intimidating. It is very important to identify the appropriate outside consultants and advisors that can guide you on what needs to be done and when to do it. Management will be fielding questions from employees and investors, and it is important to be prepared and informed to provide confidence to those around you that investing in your company will be a home run.

Our Current Issue: Q3 2021

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• Life After Going Public