Key clues a company is preparing for an IPO
Fact checked by Vikki VelasquezReviewed by Charles PottersFact checked by Vikki VelasquezReviewed by Charles Potters
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 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 to go public 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.
Key Takeaways
- Before making the required SEC filings and announcements, private companies that are soon 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, to show they have strict financial policies and internal controls that prevent fraud and mismanagement.
- A company might hire new executives with proven track records of leading companies to profitability.
- Companies might also sell non-essential business segments and take all allowed accounting write-offs in order to present improved financial statements.
1. 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 relating to the management of the corporation. These standards include:
- Having an external board of directors
- Developing an effective set of internal controls for the financial management of the company
- Creating a formal process for employees and others to use to report illegal activities and 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).
2. “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.
Generally, big bath refers to an unethical practice by which a company manipulates its income statement to make the financials look worse than they are, so that they’ll look better in a subsequent reporting period.
Private companies considering going public often assess their own financial statements and take any write-offs that 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 that they meet 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.
Important
“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 whether or not the company will soon go public.
3. 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 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 a company is trying to instill better leaders and improve its image in advance of going public.
4. 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.
Why Does It Matter If a Company Is Private or Public?
Knowing which a company is can be useful to investors. A private company has few regulatory constraints and isn’t required to file financial documents or share its financial data with the public. If it issued shares, they don’t trade on a public exchange. A public company is required to disclose its financial data to the public. As a result, investors can inform themselves about a public company’s past financial performance and plans for the future before deciding whether to invest. In addition, the shares of a public company trade on a public exchange, making them easily accessible to anyone to buy or sell.
Why Does a Company Decide To Go Public?
A company may decide to go public to raise funds through the sale of shares, to increase the liquidity of its shares, and to gain publicity for itself and boost its market value.
Is It Better To Invest in a Private or Public Company?
That depends on what you’re trying to achieve as an investor and your investor characteristics, for instance, with regard to risk. Generally speaking, it may be safer to invest in a public company because its financial activities and performance must be made public. As a shareholder in a public company, you can make your views about a company’s operations, financial position, vision, and more known to management. In addition, publicly-traded shares are usually liquid and trade on a public exchange, which means you can buy as well as sell them easily.
The Bottom Line
Because of the ability of a private company to keep quiet about 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 who stay alert. These signs can include the company upgrading its corporate governance standards, taking major accounting write-offs, overhauling its senior management team, and selling off non-essential business segments.
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