Transparency: More Than Meets the Eye

For any entrepreneur who sees an IPO down the road, observing public-company reporting standards is well worth the effort

By Gabor Garai

Small-business owners can't be blamed if they view the Sarbanes-Oxley Act's requirement for greater oversight of financial results by executives of public companies with a sense of detachment, if not outright amusement. "Whew!" they may be inclined to exclaim, "Glad I don't have to bother with all those extra details."

Unfortunately, a surprise awaits the most ambitious entrepreneurs, particularly those whose dreams run to an initial public offering (IPO). While privately-held companies have no immediate reporting or filing issues under Sarbanes-Oxley, those business owners who might soon seek to raise investment funds and/or take their outfits public face a challenge -- an immediate one.


  Start with Sarbanes-Oxley's demand for independent auditors, which isn't a requirement that can be met overnight, since independent accountants will need to be retained for at least a couple of years prior to any initial public offering (IPO). Any entrepreneur thinking of taking his outfit public also will want to have an independent board and audit committee. Recruiting such a board is a time-consuming effort. Moreover, he or she must watch how much stock is made available to board members. While handing out cheap shares prior to an IPO makes it easier to attract and retain top-notch board members, distributing too much would make them nonindependent.

Similarly, the appropriate processes for financial and nonfinancial reporting must be practiced for a significant period prior to the IPO. Not only will this make compliance easier after the IPO but, for reasons of marketing and legal liability, investment bankers will likely require such compliance before taking a company public.

Because it encourages the kind of information flow that appeals to investors, Sarbanes-Oxley also can be expected to have an impact on venture capitalists. The reporting and financial discipline it lays out will likely become a template that VCs will be anxious to impose on the outfits in which they invest. Entrepreneurs who don't abide by the act's criteria risk alienating investors -- and that's not the way to get off on the right foot when seeking funds.


  What if you don't ever see your business going public? Well, the above considerations also apply if you are thinking of selling your business to a buyer, or a group of buyers, that is or includes a public company. Alternatively, you might sell to a private equity fund that would utilize your business as the vehicle for a consolidation strategy that results in a public company.

In all these situations, the issue of being "Sarbanes-Oxley Ready" will arise. In the worst case, not being compliant could torpedo a deal. In the best case, it could boost the purchase price and see a shorter, less difficult due-diligence process. For a potential buyer familiar with the disclosure discipline imposed by Sarbanes-Oxley, being up to the legislation's demands could be the equivalent of the Good Housekeeping seal of approval, enhancing investor confidence and company valuations. As Sarbanes-Oxley matures, it can be expected to become the de facto information standard for investors and acquirers.

Gabor Garai is a partner in the Boston office of the national law firm Epstein Becker & Green, specializing in the financing and growth requirements of small and midsize companies.