A vision for the IPO future: decreasing the costs of going and being public

In any list of the advantages and disadvantages of going and being a public company, the disadvantages principally boil down to one issue: cost.

These costs include

  • the direct costs of the IPO itself;
  • the cost of public-company audits;
  • the cost of annual, quarterly and periodic reporting; and
  • the potential costs of increased litigation exposure and risk.

There are internal costs (for example, the cost of internal accounting and compliance infrastructure) and external costs (legal, accounting and auditing fees). Accounting firm PriceWaterhouseCoopers has prepared a helpful deck outlining the costs and considerations of going and being public.

The JOBS Act didn’t help much

The JOBS Act attempted to ease some of these costs with IPO on-ramp and testing the waters provisions, confidential submissions and scaled disclosure requirements for emerging growth companies (EGCs). However, preliminary evidence suggests that the JOBS Act has not reduced the direct offering costs (legal and accounting fees) or underwriting discounts incurred by EGCs going public. Also, some commenters have noted that the JOBS Act may have actually increased the costs to an EGC going public, as a result of information asymmetries relating to the prospects of the issuer, which can play a role in an IPO being “underpriced.”

The research suggests that at least so far as we can tell, despite some evident advantages, the JOBS Act has not effectively reduced the cost of going or being public.

Reduced disclosure won’t help, either

The solution to this problem is not reduced disclosure. Up to now, the focus has been centered on reducing the amount and type of disclosure that companies are required to provide during the IPO process and on a periodic basis. As we’ve seen, not only have recent efforts to reduce the burden of disclosure on small public companies not had the intended effect, but reduced disclosure may actually have the opposite effect (by increasing information asymmetries).

Similarly, for years the SEC has been taking steps to improve “disclosure effectiveness.” This is laudable, but is something more akin to bringing a knife to a gun fight. Chances are that the minor changes, if any, resulting from the SEC’s disclosure effectiveness efforts would do little to meaningfully reduce disclosure and compliance costs to companies.

At any rate, reduced disclosure or improving disclosure effectiveness could only indirectly reduce costs, and only then in theory.

Public disclosure is good

Before proposing a potential solution, I want to pause to note that I think companies being public (i.e. being required to publicly disclose business and financial information) is good for the companies, their investors and the marketplace as a whole. Information asymmetries are reduced, the price accuracy of the company’s stock is enhanced, and untoward behavior from insiders is deterred.

Therefore, I believe more companies should be going public sooner (not later, as is the recent trend). In fact, I envision a future in which there is no practical difference between “private” and “public” companies, because companies of all types and sizes will eventually have some scaled level of mandatory disclosure requirements.

The major counter-argument to mandatory public disclosure is and always has been the high compliance cost incurred by the companies going and being public. So…

We need market and technological solutions to decrease public company costs

To me, the obvious solution is to directly reduce the direct and indirect costs of going and being public with market solutions.

Here are some proposals:

                Create cost-effective technology to streamline process flows for public company disclosure

We should be demanding technological solutions for streamlined process flows for public company disclosure. Service providers are not all to blame for high costs of going and being public – a lot of the cost is due to inefficient process flows, both internally (the company’s internal accounting and compliance policies, procedures and processes) and externally (the interaction among the company and its legal, accounting and auditing firms, and within those firms).

Enhanced technology can and should be deployed to improve and streamline these processes to (a) minimize the time and effort required to prepare the required qualitative and quantitative disclosures, (b) focus the energies of company management on disclosures that are the most meaningful in the context of the company, its business and financial results, and (c) improve communication and coordination among the company (including between and among management and its board of directors and its committees) and its external service providers.

There are existing market solutions that assist in this regard, but there needs to be more of a push in the direction of creating cost-effective solutions if we are to see a significant reduction in the cost of going and being public.

                Adopt alternative fee arrangements

We should be championing alternative fee arrangements among public company service providers. Even in today’s rapidly changing and highly competitive market for such services, attorneys and accountants are notorious for giving unrealistic estimates in advance and having opaque billing practices. Alternative fee arrangements (such as fee caps, fixed fees, success fees as a percentage of deal value, etc.) could give companies more visibility in the amounts they will be paying to external service providers for their work product in connection with going and being public.

Law, accounting and auditing firms must do their part to increase efficiency in their provision of services to be able to profitably meet the market demand for high-quality services within an alternative fee arrangement model. This may require rethinking or even overhauling the traditional leveraged billable-hour model and restructuring firm hierarchies, governance and staffing policies. Also, this may require investing in (and actually using) technology to make internal process flows more efficient.

                Invest in cost-effective risk assessment tools

The act of going public and the continuous acts of staying public are risky endeavors. All other things being equal, companies who are much more risk-averse will spend a significantly larger amount of money in an attempt to analyze and mitigate the potential risks they (or their investors) face. There is nothing wrong with that, but the cost rises where there are more uncertainties about what risks are out there. Companies that are are equipped with the tools to be able to better assess those risks will have more information and therefore can make an informed decision about what risks they are willing to take, balanced against the cost associated with attempting to mitigate such risks. Companies can then allocate resources in proportion to the magnitude or likelihood of a potential risk.

Cost-effective solutions should be created to enable public companies of all sizes to better assess and mitigate their potential risks.

Set up mandatory insurance pools

The SEC and the public exchanges could require all public companies to maintain insurance for losses incurred by the company and its investors as a result of inadequate or incorrect public disclosure. A heretofore non-existent insurance market would emerge to mitigate the risk of going and being public, and investing in public companies. This is very much a moon-shot proposal, but it’s worth some consideration in the interest of incentivizing companies to go public.

The challenge

The biggest challenge in reducing the costs of going and being public is the inertia behind the massive and historically change-averse participants in the securities industry. I’m talking about the law, accounting and auditing firms that support public companies, underwriters and investors. Their very business models are in large part dependent upon charging increasingly high fees while staffing such matters with professionals who have limited (if any) incentives for cost-saving on behalf of their clients.

I’m bound to ruffle some feathers in saying this, but I think the industry has to change, and change big, if there is to be any meaningful reduction in the costs to a company for going and being public.

Similarly, we are a long way from having the technological tools necessary to automate or even partially augment the process of preparing public disclosures. Solutions need to emerge, and emerge fast, if the reality is to catch up with the vision of meaningfully reducing the costs of going and being public.

* * * * *

Note: If you’re interested at all in the subject of this post, I encourage you to read and comment on the SEC’s recent concept release on the business and financial disclosure required by Regulation S-K.

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