Act Public Before Going Public
Laying the groundwork for a successful initial public stock offering includes paying close attention to the company’s tax function.
After several years of increasing numbers of U.S. companies making initial public stock offerings, starting in late summer 2011, some companies postponed going public as economic and market conditions grew turbulent and uncertain. But even a holding pattern might have some advantages if companies use that time to better prepare for the numerous demands that accompany going public, such as audit and tax assistance in preparation of financial statements. In doing so, companies will be looking to their tax department and advisers for guidance in navigating the labyrinth of complexities associated with managing the tax accounting component of the initial public offering (IPO) process.
Earlier this year, evidence indicated IPOs had been rising for several years after previous doldrums (see Exhibit 1). The U.S. was again the No. 1 market for IPOs (“Take that China! U.S. is Number One (in IPOs),” The Wall Street Journal, June 16, 2011).
Current economic volatility may delay IPOs, but it is not expected to curtail their eventual advancement. According to an article in the Chicago Tribune (“IPO pipeline stopped up by market volatility,” Aug. 10, 2011), “Analysts say they don’t believe IPO activity will dry up in the same way it did during the global financial crisis in 2008.” Volatility drives the “stressed” capital to the sidelines, the article said, quoting California IPO adviser Lise Buyer. “The buyers who are left are the dream team buyers of long-standing, big mutual fund companies who tend to have a longer-term horizon,” Buyer said. “So while the price might come down, the quality of the investor goes up.”
Perhaps the most important advice that a company should follow in preparing its tax function for an IPO is to “act public before going public.” From perfecting the tax team and refining internal controls to establishing a quarterly close process and preparing interim tax provisions, it is important that the pre-IPO company operate as if it is public with respect to all key facets of its tax function. Only then will the pre-IPO company experience a smooth and successful transition to public status.
Following is a step-by-step guide instructing private companies on how to “act public” with respect to their tax function before starting the IPO process:
1. Establish an Independent, Proficient Tax Team
The level of complexity will increase when the company becomes public. Many advisers who can offer basic, cost-effective services to a private company may no longer be adequate for a public company. Therefore, a private company must review internal resources and external advisers to ensure they employ the necessary technical and public company expertise before initiating the IPO process. Most companies will experience some level of increased costs associated with their tax accounting and should prepare for that outlay.
Private companies may find it efficient to rely on their external audit firm to provide many tax services for the company, including the tax provision preparation. However, additional caution must be taken as a company prepares itself for an IPO to ensure continued auditor independence.
Independence requirements tend to be more lenient for auditors of a private company, held primarily to AICPA independence standards, than those of a public company, subject to more restrictive PCAOB/SEC (Public Company Accounting Oversight Board/U.S. Securities and Exchange Commission) independence requirements. What is considered a permissible non-managerial service under the AICPA independence rules may be considered an impermissible managerial service under PCAOB/SEC requirements. This is especially true with respect to tax provision preparation under FASB (Financial Accounting Standards Board) Accounting Standards Codification (ASC) Topic 740, Income Taxes (including assistance with all component parts of the tax provision, such as ASC Subtopic 740-10, formerly FIN 48, Accounting for Uncertainty in Income Taxes). It is also true with respect to assistance with developing and maintaining internal controls. Pre-IPO companies and their advisers should review the company’s tax services to ensure that, where tax assistance is provided by an external audit firm, independence will be maintained under both AICPA independence rules as well as the more restrictive PCAOB/SEC requirements for all years incorporated in SEC filings.
For tax services that are considered permissible, non-managerial services (services other than tax accounting) under both AICPA and PCAOB/SEC independence rules, the company may continue to choose the audit firm to perform the work. However, such tax services, though permissible, will require audit committee approval. Proper measures should be taken to ensure work is approved well before the services are rendered.
2. Develop and Refine Tax Internal Controls
Although the Sarbanes-Oxley Act of 2002 (SOX) is not expressly applied to private companies, many private companies have adopted its best practices in some form. However, an IPO will trigger required compliance with SOX rules. Therefore, we recommend developing and refining tax internal controls more than 12 months prior to the IPO to facilitate the transition from private to public status.
Although tax internal controls should be tailored expressly to a company’s specific tax function, Exhibit 2 provides a basic example of what tax internal controls may include.
This article has been excerpted from the Journal of Accountancy. View the full article here.