When a private company makes plans to go public, there is often little fanfare or advance notice. Some of the radio silence is due to the Securities and Exchange Commission (SEC) requirements in relation to official filings of notices. Some of the silence is simply due to the fact that a company going public is often big news and puts the corporation under a magnifying glass. It is easier for a company to make preparations in the relative solitude of anonymity. There are, however, several signs prior to the official notification and filing that can indicate that a company is about to make the big leap.
- Before making the required SEC filings and announcements, private companies that are about to go public will often signal their intentions by taking various actions in preparation for the initial public offering (IPO).
- Companies might implement procedures that tighten their recordkeeping and accounting, looking to show they have strict financial policies and internal controls that prevent fraud and mismanagement.
- Before going public, a company might change its senior management, hiring new executives with proven track records for leading companies to profitability.
- Companies might also sell off non-essential business segments and take all allowed accounting write-offs in order to present improved financial statements.
Corporate Governance Upgrades
Public companies that trade on U.S. stock exchanges are required under the Sarbanes-Oxley Act of 2002 (SOX) to maintain certain standards in the management of the corporation. These standards include having an external board of directors, developing and assessing an effective set of internal controls over the financial management of the company, and creating a formal process where employees and others can have direct access to the audit committee to report on illegal activities, as well as those that violate company policy. A sudden flurry of new policies and procedures could be an indication of a move towards an initial public offering (IPO).
"Big Bath" Write-Downs
Public companies, and those that are about to go public, have their annual and quarterly financial statements scrutinized by investors and analysts. Private companies considering going public often assess their own financial statements and take any write-offs they are allowed under Generally Accepted Accounting Principles (GAAP) all at once to present better income statements in the future.
For example, accounting rules require that companies write-down inventory that is unsalable or worth less than the original cost. However, there is substantial leeway in making that determination. Companies often keep inventory on their balance sheets as long as possible to ensure they are meeting asset ratios for banks and other lenders. Once a company contemplates going public, it often makes sense to write-off the inventory sooner rather than later when it would impact shareholder profitability.
"Unicorn status" refers to a private company that has reached a $1 billion valuation, a turning point that often leads investors and the media to speculate if the company will soon go public.
Sudden Changes in Senior Management
Once a company contemplates going public, it has to think about how qualified its current management is and whether it is in need of some spring cleaning. To attract investors, a public company needs to have officers and managers who are experienced and have a track record of leading companies to profitability. If there is a full-scale overhaul in the upper echelons of a company, it may be a signal that it is trying to improve its image in advance of going public.
Selling Off Non-Core Business Segments
A company that springs up from scratch can often have some business units attached to it that are ancillary to its core, or main, business purpose. An example of this is an office supplies company that has a payroll processing business. The secondary business does not connect directly to the main business. In order to market a company in an initial public offering, the prospectus is expected to show a clear business direction. If a company is shedding its non-core operations, it may be a sign that it is getting lean and mean in preparation for a public share offering.
The Bottom Line
Because of the ability of a private company to keep quiet on its intentions to go public until the formal SEC-required filings and announcements, it can be difficult to assess whether a company is heading in that direction. However, there are always more subtle signals for those seeking them out. These signs include the company upgrading its corporate governance standards, taking big accounting write-offs, overhaulings its senior management team, and selling off non-essential business segments.