April 11, 2021
By Andrew Chrostowski
Private companies enjoy certain advantages over public companies — not least of which is the ability to eschew short-term performance metrics in favor of executing a longer-term strategy to create greater value.1 Their governance structure is far less scrutinized, and decisions can generally be taken more quickly. Shareholders are typically relatively limited in number and often focus on one of two models: profitable operations that return cash to them; or application of their capital to drive growth in the pursuit of scale. In this environment, it is possible for the board and management to view this as a limited scope of responsibility and thereby simplify their strategic considerations.
Despite such advantages, there has always been a certain allure in becoming a high-flying IPO. More recently, the siren’s song of a SPAC (Special Purpose Acquisition Company) has many private companies considering accessing capital in the public markets. Not all of these transactions will succeed or create value for investors. Indeed, the costs of formal preparation and the high bar of compliance may simply be out of the question for some organizations. Others may simply have the good fortune not to require additional equity capital to sustain themselves or their planned growth. That said, I believe there are seven distinct ways in which preparing your private company for an IPO — focusing on the process and not the end goal — can help you build a foundation for superior sustainable performance.
Just some of the reasons to set this goal:
1. Jump Starting Transformational Change
Organizational change is always hard. One thing that COVID-19 taught us was that circumstances that align everyone’s interests can accelerate transformations. One Fortune 500 CEO I spoke with last year told me his company went from a 5% rollout of Microsoft Teams to a 99% rollout in less than a week after declaring a “work from home” policy. He went on to elaborate that without the pressures from the pandemic, it would have taken a formal change management committee, weeks of training, and six months to deploy. What can we draw from that? The pressures of preparing for the potential to be a public company can focus resources on achieving a level of functional competence across key departments without all of the costs of completing the process. It enables a “just do it” mindset with the advantage of clear, well-defined standards of performance.
2. Including Stakeholders and ESG&T into Strategic Risk Discussions
In her recent book, Gloom to Boom, author Andrea Bonime-Blanc enumerates eight infrastructure elements to managing a resilient organization, but specifically identifies governance and culture as the two that provide the most leverage toward achieving resilience.2 When a board expands its focus to include stakeholders beyond the shareholders, they incorporate considerations that ultimately can lower costs (as in energy conservation and environmental programs); increase retention and recruiting (by creating a culture attractive to potential candidates where employees can be their authentic selves and do their best work); and improve governance (by introspection of risk management and attention to sustainability).
3. Better Investor Relationships through Communications
Private companies can have a broad range of shareholder communications from informal to regularly timed, depending on their own controlling documents. Minimum communication can, over time, leave some investors in the dark about company performance, objectives, priorities, and risks. Nature abhors a vacuum, so these gaps can be filled in with doubt, uncertainty, and dissent, potentially even leading to litigation. Public companies are legally compelled to be meticulous about shareholder communication, and I believe there is a great benefit to be derived from the discipline of preparing and delivering regular and comprehensive shareholder communications.
Investor relations should not be a “public company only” function.
4. Better Forecasting and Financial Controls
“Just because they don’t have to comply with SOX doesn't mean private companies can’t mine it for ideas to apply to their own governance challenges,” says Doug Gawrych of Grant Thornton’s private company practice3 and I agree with him.
Accurate financials are the bedrock upon which good governance is built, and all boards — private and public — focus on this. Every CFO ensures they are accurately representing the most complex transactions to their audit committees and boards. The objective is always to ensure the numbers reflect the performance of the business. When it comes to being “IPO-ready,” SOX 404 compliance is certainly the most expensive requirement of the Sarbanes Oxley Act4 to meet, but even without the full audit procedure, I believe there is great value in a business digging deep on internal controls, organizational structures, and procedures. A private company has the luxury of taking what is useful from this construct and applying it.
Forecasting is another function that public companies must get right or face the consequences with respect to valuation. Those consequences are much less for private companies, but the discipline of producing and evaluating quarterly forecasts can drive continuous improvement in what I consider to be the most fundamental management control process: sales and operations planning. Forecasting is fundamentally different from plan development in that plans are created at a point in time, and forecasts need to account for all variables as they change over time from that baseline. In addition, the level of detail required to model performance drives greater understanding and analysis of all business fundamentals, thereby assisting management in applying effective countermeasures more quickly.
5. Improved Board Discipline
Every public board director understands that liability comes with the rewards of board service. In my experience, public boards spend more time making sure all board actions, decisions, and deliberations are properly recorded — and it is always done with an eye toward potential litigation and legal discovery. I believe private boards can benefit from reviewing with their counsel their practices, records, and retention policies in a similar light. Queuing up board discussions with well-defined decision documents to support the discussion and lay out what factors and alternatives should be considered is a good practice. It allows better preparation by the board leader and focuses the deliberations leading to a decision. The timely preparation of thorough board materials is a discipline every public chair demands, as it enables deeper questions and better decisions. It’s also a good method to calibrate management on the quality of thinking the board is expecting.
6. Accelerated Digital Transformation and Improved Cybersecurity Resilience
One can hardly check any news feed today without coming across yet another successful hack, ransomware, data privacy violation, or data exfiltration event. To public company officers, it is a clarion call to action as the SEC, and other regulatory bodies, take the gloves off with respect to ensuring compliance. Fines and penalties today are substantial.
According to Chris Hetner, former SEC Senior Cybersecurity Advisor to the Chairman of the United States Securities and Exchange Commission, “US federal regulators have been significantly escalating penalties related to cybersecurity and data privacy. We’ve seen fines of $16 million, $25 million, $170 million, $700 million, even $5 billion, from a range of regulators that includes the Federal Trade Commission, Federal Communications Commission, Securities and Exchange Commission, and Department of Health and Human Services.”5 That should be enough to get any leader’s attention. Add to that the risks imposed by violations of GDPR (General Data Protection Regulation) in the European Union, which can impose fines, even for the “less severe” infringements of up to €10 million, or 2% of the firm’s worldwide annual revenue from the preceding financial year, whichever amount is higher. These regulations were specifically designed to apply to all businesses, and any commercial organization that is not compliant should be prepared for significant impacts.6
Having an IPO-ready mindset for your private company means moving privacy, technology, and cybersecurity into its own committee with a holistic-systems thinking approach to understanding digital transformation risks and opportunities.
7. A Fresh Look at Your Business Model and Strategy
I have heard it said that the best way to learn a subject is to teach it. A relevant corollary for CEOs of private companies might be: The best way to vet your business strategy is to explain it to a banker. You’ll reconsider the total addressable market (TAM), your assumptions and proof points around customer adoption, competitive threats and alternatives, market dynamics, sales forecasts, and revenue growth.
An IPO-ready company will have scrutinized its business model and strategy until it is refined to the point it can be credibly explained to informed financial experts. If you accept the sage advice of General Norman Schwarzkopf that the more you sweat in peace, the less you bleed in war,7 then you get my point.
In short, challenging your private company to be IPO-ready can mean:
Big goals can marshal organizational energy that can be focused on accelerating progress. Being “IPO-ready” can advance a company toward superior and more sustainable results without paying all of the six to seven figure costs associated with audits, lawyers, and assessments.
Beyond that, you preserve the option to access the public markets with less friction, effort, and uncertainty should the time come to do just that.
Andrew E. Chrostowski is the chairman and CEO, RealWear, Inc. He is also an NACD Directorship Certified Director.
1 Peter Gleason, May 31, 2018 “Companies Weigh Public vs. Private Options,” https://blog.nacdonline.org/posts/ceo-corner-may
2 Andrea Bonime-Blanc, Gloom to Boom - How Leaders Transform Risk into Resilience and Value, Routledge, 2020 p. 306
4 Sarbanes Oxley 101, March 28, 2021, https://www.sarbanes-oxley-101.com/SOX-404.htm
7 Gen. H. Norman Schwarzkopf, May 30, 1991, The Baltimore Evening Sun, https://www.baltimoresun.com/news/bs-xpm-1991-05-30-1991150152-story.html