What Regulations or Legal Requirements Must a
Company Meet in Order to go Public?
There are really no official qualifications under federal law for a company to
go public, apart from meeting the very specific filing requirements and rules
of the U.S. Securities and Exchange Commission (SEC) regarding disclosures.
These disclosures, however, must meet certain SEC requirements. For
example, typically the SEC looks for three years’ worth of pre-IPO audited
financial statements. A company that does not have strong accounting
systems in place faces an uphill battle in preparing SEC forms. And investors
are less likely to buy stock in a company that has a history of fraud, poor
management, or a weak financial history. Therefore, the SEC requires that
companies seeking to initiate a public offering fully disclose all information
regarding finances, management, operations, and products/services, as well
as all known or likely risks and any adverse or negative information
regarding the company.
The SEC does not rule a company in or out based on these disclosures—that
is for investors to determine. Thus, disclosure of weak earnings, professional
or even criminal negligence in terms of fraudulent accounting practices,
product safety concerns, or company management will not foreclose a
public offering—but it may impact the success of the public offering.
For example, investors may be reluctant to invest in a company that has
lawsuits pending or has management in place who previously committed
some type of fraud. Additionally, known concerns about the value of the
company, competition, and risks associated with its products or services are
just a few issues that must be disclosed in the registration and the
prospectus filings. Failure to do so can result in significant civil and/or
criminal sanctions.
A company can also be sanctioned for improperly promoting the IPO during
the pre-filing period. Therefore, a company should have clear rules and
guidelines regarding company communications. A company seeking to go
public will hire a financial specialist known as an underwriter whose job it is
to determine the best price at which to offer the stock. These underwriters
are essentially banks that agree to buy all the shares being issued by the
IPO, thus guarantying that the company gets the amount of capital sought
through the IPO.
The underwriting bank assumes the responsibility for selling the shares to
investors. The bank charges a fee, or “spread,” for its efforts, which it
deducted from the revenue raised by the IPO. However, the more legal and
regulatory violations or other adverse factors existed or currently exist, the
less likely that a company will be able to enlist the services of an
underwriter to underwrite the IPO.
Again, there are various federal and state laws that govern the IPO process,
such as the Securities Exchange Act, Sarbanes-Oxley Act of 2002, and
Jumpstart Our Business Startups Act (JOBS Act), which strives to minimize
the regulatory requirements for certain companies (see the full text of the
act PDF). It is imperative that anyone involved in an IPO process be
experienced and up to date on the laws and process.
