The
Sarbanes-Oxley Act of 2002 imposes a number of requirements on Public Company Executives, Boards of Directors and Audit Committees.
• Sarbanes-Oxley Act was passed in 2002 to restore investor confidence in public companies in the wake of the accounting scandals that rocked the business world.
What is Sarbanes-Oxley?
•Sarbanes-Oxley is an Act designed to enhance corporate responsibility as it relates to financial reporting issues. Sarbanes-Oxley established new requirements and created an oversight and standards group called the Public Company Accounting Oversight Board or PCAOB.
Who is subject to the Sarbanes-Oxley Act?
• Public companies issuing securities, public accounting firms, and firms providing auditing services whether they are domestic or foreign must comply with Sarbanes-Oxley.
• It is the smaller public companies that may have found the cost and time burdens of being a public company not worth the benefits.
• Sarbanes-Oxley Act has created new burdens for public companies such as the costs associated with the new requirements.
• Going private can take public companies only a quarter or two or it can be a lengthy process, depending in part on the firm's ability to buy back stock and get below the 300-shareholder mark, beyond which a company is considered a public entity.
• Other more financially secure public companies have realized that they have no need for outside capital which leaves these companies asking: Why pay the costs associated with being public?
• Public companies need to comply with Section 404 of Sarbanes-Oxley, which requires auditors to assess whether a company's internal controls are sufficient to produce accurate financial statements.
•The Sarbanes-Oxley Act requires officers to certify their financial statements and holds them criminally accountable for errors or omissions.
•Companies with proven track records of revenues, profits and customers as well as audited financial statements are a rare commodity in the current funding environment.
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Summer 2004
By Sean Denham CPA
Senior Manager
Sarbanes-Oxley Act was passed in
2002 to restore investor confidence
in public companies in the wake of
the accounting scandals that rocked
the business world. It addresses auditor independence,
financial disclosure, corporate responsibility and ethics. In
the short-term, this law has created new burdens for public
companies. The law requires officers to certify their
financial statements and holds them criminally
accountable for errors or omissions. One item the Act may
have been missed was the costs associated with the new
requirements. Companies are paying more in legal,
insurance, executive search and audit fees than ever before.
Compliance costs related to the Act have skyrocketed.
There will be higher legal fees, accounting fees and
internal costs, such as in having to increase resources for
financial reporting. For large companies, the costs can run
into the millions of dollars. For smaller companies, in
many cases it's clearly in the hundreds of thousands. Of
particular concern is the looming need to comply with Section 404 of Sarbanes-Oxley, which requires auditors to
assess whether a company's internal controls are sufficient
to produce accurate financial statements. Section 404 will
require significant internal and external costs.
With the costs associated with being a public company rising, many companies have considered alternatives such as "going private."
With the costs associated with being a public company
rising, many companies have considered alternatives such
as "going private." According to recent studies, such
transactions increased 30 percent from August 2002
through November 2003, compared with the 16-month
period preceding the law. Typically, it is the smaller public
companies that may have found the cost and time burdens
of being a public company not worth the benefits. The cost
of being a public company has escalated 100 to 200 percent
over the past 12 to 18 months. Observers predict it will gain popularity in the coming year, as companies seek to cut costs, reduce potential
shareholder litigation and regain a sense of control.
One of the most well known benefits of public ownership has been better and cheaper access
to capital. With the tightening in the capital market that has occurred over the last few years,
this benefit has proven to be elusive for many small to mid-cap companies. Other more
financially secure companies have realized that they have no need for outside capital which
leaves these companies asking: Why pay the costs associated with being public?
The ideal public company to consider privatization is one with:
- A market capitalization of $250 million or less;
- A book value that substantially exceeds market capitalization;
- Fewer than two financial analysts covering the company and issuing regular
research reports on it;
- A price-earnings ratio of less than 10;
- Cash on hand greater than market capitalization; and
- Average trading volume of fewer than 50,000 shares a day.
Going private can take a company only a quarter or two or it can be a lengthy process,
depending in part on the firm's ability to buy back stock and get below the 300-shareholder
mark, beyond which a company is considered a public entity. In many cases, the acquirer is
comprised of some or all of the company's executive team. Negotiations take place between
that team and the public company's independent directors and can span three to six months or
more from start to finish. The transaction can be structured any number of different ways,
including a merger, sale of assets or tender offer for public shares. Funding for the acquisition
also can take a variety of forms and may include both debt and equity. Companies with a low
stock price and large cash reserves can sometimes buy back sufficient shares internally.
Companies without that luxury will need to procure loans or find large-scale equity investors.
Many venture groups and newly formed private leveraged buy-out funds are now considering
these kinds of transactions. Companies with proven track records of revenues, profits and
customers as well as audited financial statements are a rare commodity in the current funding
environment. The result may be a well-funded private company positioned for either a sale
transaction in subsequent years or a substantial public offering once the markets rebound.
There can be drawbacks to going private, one of which is that companies no longer have
access to financial markets to raise capital but must instead seek private sources. Costs to go
private will generally mean higher interest expense due to the additional debt incurred with
paying out investors.
For many public companies, 2004 already is presenting significant operational and strategic
challenges. The new Sarbanes-Oxley requirements will only increase these burdens in the near
term. As executives consider all of their alternatives, the going private transaction should be
among them.
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