JOBS Act Creates Opportunities for PE Firms and Portfolio Companies to Shift Resources From Compliance to Growth
June 8, 2012
As the global economy continues to expand, private equity groups are evaluating opportunities for taking their companies public. New U.S. legislation governing financial reporting for emerging public companies has opened a window of opportunity for private equity firms and their portfolio companies to revisit their plans for initial public offerings (IPOs).
By reducing some newer public companies’ compliance burdens and improving their access to the public capital markets, the Jumpstart Our Business Startups (JOBS) Act – signed into law by President Obama on April 5 – aims to spur the growth of smaller businesses in the United States. Companies planning IPOs will be able to devote fewer resources to meeting regulations and more to business expansion and innovation.
For the first five years after issuing an IPO, so-called emerging growth companies will no longer need to comply with Section 404(b) of the Sarbanes-Oxley Act (SOX), which requires that external auditors attest to the company’s internal controls over financial reporting. Previously, new public companies had only two years to become compliant with Section 404(b).
Emerging Growth Companies
The JOBS Act defines “emerging growth companies” as businesses with less than $1 billion in revenue, less than $1 billion in nonconvertible debt over a three-year period, or a market cap that is less than $700 million. The act provides a new opportunity for private equity firms wanting to exit company ownership, since many emerging growth companies are backed by private equity.
Because of the delay in the auditor attestation requirement, the management of an emerging growth company will be able to ramp up its SOX programs more gradually, allowing the company to build the scale and complexity of its compliance program over time, save on initial implementation costs, and focus on innovation and growth.
Although exempt from the Section 404(b) requirement, these companies must continue to comply with the other provisions of SOX. Section 404(a), for example, continues to apply, meaning that management still must implement internal controls and certify the design and operating effectiveness of the controls.
A Risk-Based Approach
During the five years following an IPO, an emerging growth company should take a risk-focused approach to SOX compliance – in particular, managing the organization’s risk of costly restatements or other material weaknesses that can hurt its reputation. Management should aim for the right balance between implementing internal controls that enable management to certify with confidence and maintaining the entrepreneurial culture that’s so vital to any growing company.