What Does Sarbanes-Oxley Mean for Companies That Want to Go Public?
BY Amy Feldman
Added costs may keep smaller businesses away.
Conventional wisdom has it that Sarbanes-Oxley is preventing companies from going public. While that hasn't been proved--Nasdaq will have more IPOs this year than last year if the trend holds--the regulations have clearly made it more expensive to go public and stay public.
Because public companies need to comply with Sarbanes-Oxley, including the costly rules on internal controls, a company planning an IPO needs to have a cash hoard set aside in advance. It will face higher audit costs, higher insurance costs, and more regulatory-related duties for its staffers.
The added costs of Sarbanes-Oxley are one reason, among many, that IPO-ready companies are now larger and more established than they used to be. Jim McGeaver, chief financial officer of business software company NetSuite, which is based in San Mateo, Calif., notes that 10 years ago when he worked at Photon Dynamics, that company had no trouble going public with $20 million in revenue. "Now that has to be in the $50 million to $75 million range for the investment bankers to even look at you," McGeaver says. "It is just going to mean that companies will go public later in the cycles."
Staying public is tougher and costlier for precisely the same reasons. The new costs are pushing some companies to go private and others to delist. Any company with fewer than 300 shareholders can delist by simply filing Form 15 with the Securities and Exchange Commission. That's exactly what companies such as Earl Scheib, a Sherman Oaks, Calif., auto-painting company, and Ohio Art Co., maker of Etch A Sketch, have done. All told, a record 198 companies delisted in 2003, the first full year after the passage of Sarbanes-Oxley, and another 134 did so in 2004, according to a study by Christian Leuz, a professor of accounting at the University of Pennsylvania's Wharton School. That compares with just 67 that jumped in 2002 and 43 in 2001. Another study by law firm Foley Lardner found that 21% of public companies have considered going private or selling out as a result of the act.
Daniel Goelzer, a member of the Public Company Accounting Oversight Board, says that regulators are grappling with these issues. "I think it is true that Sarbanes-Oxley Section 404 and other changes have made the bar somewhat higher for being a public company," Goelzer says. "I don't think we know exactly how much it has risen yet since some of these things are still being worked out, like 404. On the other hand, I would say yes, you do have to have a certain level of sophistication in your financial reporting systems and your recordkeeping systems. But I wouldn't want to see anything that we do choke off access to the capital markets for emerging businesses, which are the key source of growth for the economy. And I think we need to keep that in mind as we go about our work."