Positioning for the IPO

Victor H. Boyajian
February 2008
 Consequences of Going Public

z Benefits
Access to public markets for future financings
Liquidity for stockholders
Enhanced market value
Stock as currency for future acquisitions
Employee recruitment and retention
Enhanced stature and perceived stability

z Burdens
Additional legal and accounting expenses for regulatory compliance
Sarbanes-Oxley
Annual and quarterly disclosure
Obligation to disclose executive compensation
Disclosure of personal financial information
Compensation, stock ownership and transactions, and related party transactions required for
officers and directors
Director and officer insider trading limitations
Enhanced scrutiny
Additional constituencies
Public shareholders
Institutional Shareholder Services (ISS) and other shareholder activists
Analysts
SEC
May affect operating flexibility
Importance of quarterly performance/meeting expectations

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 Strategic Considerations

z Understand liquidity / exit alternatives and their respective burdens and benefits
Sale to strategic acquiror
Sale to financial buyer
Initial public offering
Partial liquidity option for founders
Dual track
Go it alone

z Select issues to consider

CEO mindset
Cashing out vs. liquidity and financing growth
Investor mindset
Company and market considerations
Cost of capital / access to capital
Currency: future acquisitions
Control
Management / operational flexibility
Earnings demands
Customer and other third party considerations
Liability
Regulatory environment
Intense scrutiny
Ongoing costs

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 Strategic Considerations

z Key timing issues

Issuer may go effective without audited financial statements for the most recent fiscal year up until 45
days following the end of the most recent fiscal year
An issuer with a December 31 fiscal year has until February 14 to file without the most recent
audited financial statements
Sarbanes-Oxley: issuer must be compliant as to internal controls by the filing of the second annual report
with the SEC

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 Key Early Action Items
6-15 months prior to the IPO

z Establish strategic action plan

z Fine tune business plans and associated financial projections

z Put in place an experienced management team

This may require adding individuals with public company experience in:
Marketing
Operations
Investor relations
Finance
Strong experienced CFO is essential
Important to develop bench strength and depth

z Develop budgets and measure performance

Get in the habit of preparing attainable budgets and be able to articulate why a variance may have
occurred
Strong forecasting capabilities are essential
Note that there is no requirement to provide forward looking information

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 Key Early Action Items
6-15 months prior to the IPO

z Begin selection process for the underwriters

Identify potential candidates and begin to consider respective roles
Court lead bankers
Position yourself for the bake-off
Several factors to consider:
Dedicated team
Analyst coverage
Level of interest in the company
Track record with similar IPOs
Reputation
Distribution capabilities and focus
Aftermarket support

z Begin courting potential candidates for the board

Identify potential candidates as early as possible
Consider engaging a recruiting firm to assist with this process
Recruiting firm should not be to the exclusion of other networks
Keep in mind need for majority of independent directors
Skills
Board/management dynamic
Experience/reputation

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 Key Early Action Items
6-15 months prior to the IPO

z Address issues relating to stock options and other equity awards

Cheap stock
Stock options which are issued at less than the fair market value of the underlying stock can trigger immediate
adverse tax consequences

Accounting for cheap stock

The difference between the exercise price and the fair market value must be accounted for as a
compensation expense and amortized over the vesting periods of the options
This could in some circumstances impact IPO price per share

The board of directors must determine fair value of equity awards

Back of the napkin valuation techniques ascribing a discount to most recent preferred stock offering to
determine exercise price is not sustainable
Valuation should be based on objective, verifiable evidence documented contemporaneously with the
issuance
SEC recommends an independent appraisal of the fair market value of the stock at the grant date for
issuances prior to the IPO

SEC review
SEC may challenge the exercise prices of stock options granted while a company is private, claiming that
exercise prices were below fair market value at the time of grant
SEC generally will review stock options and other equity awards granted during the 12-24 months prior to
the IPO

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 Key Early Action Items
6-15 months prior to the IPO

IRC 409A
Provides for restrictions on nonqualified deferred compensation arrangements
Stock options granted at a discount to fair market value are subject to 409A
Implement a plan to get compliant as soon as possible
Obtain a written report prepared by a qualified, independent valuation firm
May be relied upon for up to 12 months unless there is a material change at the
company
Substantial penalties for noncompliance
20% excise tax on optionee

SFAS 123R
Requires companies to expense stock options and other equity-based compensation arrangements
Implement a plan to get compliant as soon as possible
Obtain a written report prepared by a qualified, independent valuation firm
The report should use generally accepted valuation approaches and include a detailed
description of the company and valuation techniques (both utilized and not utilized)
The written report should be obtained at least every fiscal quarter during the four to six
quarters preceding the IPO (and must be completed every fiscal quarter thereafter)

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 Gearing Up
3-9 months prior to the IPO

z Select accounting issues

Implement an experienced accounting and internal controls team
Create a roadmap for compliance with SEC rules regarding:
Management reports on internal controls
Disclosure controls and procedures
Certifications of accuracy of financial statements and periodic reports to be filed following the IPO
Review management letters issued by independent auditors and address identified material weaknesses
or other recommendations
The prospectus must contain audited statements of:
Operations (for the three most recently completed fiscal years)
Cash flows (for the three most recently completed fiscal years)
Balance sheets (for the two most recently completed fiscal years)
Some underwriters request an audit of the most recent year-to-date period if late in fiscal year
Common problem areas:
Revenue recognition
Deferred charges
Accounting for business combinations
Goodwill amortization periods
Capitalization policies for intangible assets
Reserves
Related-party transactions
Stock-based compensation

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 Gearing Up
3-9 months prior to the IPO

z Obtain audited financial statements of acquired (or to be acquired) businesses

Determine whether the acquired (or to be acquired) business is a significant subsidiary
Investments in and advances to the subsidiary exceed 10% of the Companys total assets; or
Share of the total assets of the subsidiary exceeds 10% of the Companys total assets; or
Equity in the income from continuing operations of the subsidiary exceeds 10% of the Companys income
If any of the significant subsidiary thresholds exceed 20% then depending upon the relative size of the
transaction, audited financial statements for up to 3 years may be required
Financial statements for the earliest of the three fiscal years required may be omitted if net revenues
reported by the business in its most recent fiscal year are less than $25 million

z Pro forma financials of the Company and acquired (or to be acquired) businesses
Must be furnished when a significant business combination has occurred during the most recent fiscal year or
subsequent interim period for which a balance sheet is required

z Review and modify any prohibited loan arrangements and related party transactions
Under Sarbanes-Oxley, publicly-traded companies are prohibited from providing any personal loans or credit to
directors and executive officers
Company must conduct an appropriate review of all related party transactions on an ongoing basis and all such
transactions must be approved by the companys audit committee or another independent body of the board
Policies and procedures for the review, approval, or ratification of any related person transaction must be
disclosed

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 Gearing Up
3-9 months prior to the IPO

z Begin process of drafting Managements Discussion and Analysis (MD&A)

The registration statement must contain a discussion and analysis of the companys financial condition,
changes in financial condition and results of operations
The MD&A typically includes period-to-period comparisons of the three most recent fiscal years and the
current fiscal year-to-date compared to the corresponding prior year period

z Controls and procedures

Sarbanes-Oxley requires management to provide an assessment of the effectiveness of the Companys
internal controls
The Companys independent auditor must attest to that assessment
Note that the SEC has extended the date that non-accelerated filers must begin to comply with the
auditor attestation to fiscal years ending on or after December 31, 2008
In addition, CEOs and CFOs must certify as to their Companys financial statements filed with the SEC and
to the effectiveness of the Companys SEC disclosure controls

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 Getting Ready
1-3 months prior to the IPO

z Compensation Discussion and Analysis (CD&A)

Begin to prepare the discussion and analysis of compensation policies
Elements of executive compensation (and as a whole) must be addressed for Named Executive Officers
Disclosures must be vetted through the companys internal control procedures
CD&A must cover:
Principal executive officer
Principal financial officer
The three most highly compensated executive officers (with total compensation > $100,000)
Up to two additional individuals for whom disclosure would have been provided but for the fact the
individuals were not serving as executive officers at the end of the fiscal year

z Confirm suitability of executive compensation practice

The top five Named Executive Officers have a $1 million cap on the deductibility of compensation
Includes stock option grants
Certain compensation (including stock option gains) may be exempt if it is performance based
Be aware that various private company practices are subject to disclosure (especially perquisites) and
there is heightened scrutiny for related party transactions

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 Getting Ready
1-3 months prior to the IPO

z Review executive compensation arrangements

Establish incentive compensation plans
Consider base salaries, bonuses, long-term incentives (restricted stock/stock options), perquisites
and benefits
Keep in mind that the average percentage of shares authorized for management and employee
equity incentive plans is approximately 12%-16% of the total shares outstanding
Establish executive employment contracts for key contributors
Consider providing Change in Control benefits

z Implement competitive compensation levels for the board of directors

Consider cash vs. equity allocation
Employee directors receive no additional compensation for their services as directors
Average NACD trends for total annual director compensation (cash and equity):
Smaller companies ($50 million to $200 million in revenue)
$58,265 [51% cash/49% stock]
Small companies ($200 million to $600 million in revenue)
$85,362 [47% cash/53% stock]
Medium companies ($600 million to $1.7 billion in revenue)
$117,914 [44% cash/56% stock]
Large companies ($1.7 billion to $9 billion in revenue)
$137,191 [46% cash/54% stock]
Top 200 companies (greater than $9 billion in revenue)
$176,673 [42% cash/58% stock]

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 Getting Ready
1-3 months prior to the IPO

z Assess corporate governance practices and policies

Appoint independent members to the board of directors

There must be a majority of independent directors on the board
Independent directors are required to meet separately in regularly convened executive sessions
(in addition to committee meetings)

Establish committees of the board

Compensation committee
Comprised of independent directors
Nominating committee
Comprised of independent directors
Audit committee
Comprised of at least three independent directors
Heightened level of independence
Cannot be compensated by the company in any way either directly or indirectly
Cannot be affiliated with the company but a less than 10% ownership is acceptable
One member must be independent financial expert

Consider establishing a lead independent director

Provides leadership to the independent directors on an on-going basis
Can act as chairman to the executive sessions of the board when management is not present

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 Getting Ready
1-3 months prior to the IPO

z Assess corporate governance practices and policies (continued)

Adopt code of ethics

Applicable to:
Principal executive officer
Principal financial officer
Principal accounting officer or controller
Persons performing similar functions

Adopt a code of conduct

Applicable to:
Directors
Officers
Employees
Must contain the standards set forth in the code of ethics at a minimum
Make sure it is understandable by all employees of the company

Establish whistleblower procedures

Procedure for treatment of complaints regarding accounting, internal controls, or auditing matters
Audit committee is responsible
Must have a procedure for confidential, anonymous submission by employees

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 Getting Ready
1-3 months prior to the IPO

z Structure entity: C-Corp.

z Reincorporate
State of incorporation: Delaware
Delaware General Corporation Law is one of the most advanced and flexible corporation statutes
Dedicated Court of Chancery
Extensive legal precedent in corporate governance matters
Familiarity and relative predictability

z Amend charter and by-laws

Consider anti-takeover defenses in light of the sensitivities of institutional investors and markets
Classify/stagger board of directors
Require specific advance notice for director nominations and stockholder proposals
Create a class of undesignated preferred stock (blank check preferred)
Supermajority vote for amendments to the charter and bylaws
Dual class common stock (not favored)
Eliminate private company governance and control mechanisms
Cumulative voting
Ability of stockholders to act by written consent
Right of stockholders to call special meetings
Preemptive rights
Protective voting provisions
Consider guidelines provided by key shareholder advisory services such as ISS

z Consider implementing a stockholder rights plan (poison pill)

Most recent IPO issuers have not adopted a poison pill

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 Getting Ready
1-3 months prior to the IPO

z Assess indemnification of directors and officers arrangements

Review adequacy of indemnification provisions in charter and bylaws
Review form of director and officer indemnification agreement
Secure additional director and officer liability insurance

z Conduct corporate housekeeping

Capitalization
Records must accurately reflect all:
Stock issuances, transfers and cancellations
Option and warrant issuances, exercises and terminations
Convertible debt issuances, transfers, conversions and cancellations
Anti-dilution adjustments and other securities transactions
Lock-up agreements
Employees and existing stockholders will be required to enter into lock-up agreements with the
underwriters
Registration Rights
Determine number of shares subject to registration rights and whether they apply in the case of an
IPO
Analyze whether underwriters can reduce or eliminate such shares and order of priority for cut-backs
Determine steps required to obtain amendment or waiver of registration rights and applicable notice
periods
Pre-IPO actions:
Authorize enough shares to cover IPO
Effect a stock split to achieve a proposed offering price in desired per share price range
Make changes while company is private and obtaining stockholder approval is easier

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 Getting Ready
1-3 months prior to the IPO

z Conduct corporate housekeeping (continued)

Intellectual property
Conduct intellectual property audit

Adopt communications plan

Preparation for Quiet Period
Select investor/public relations firm

Begin process of obtaining any required third party consents

Settlement of claims
Resolve prior to IPO
Material unresolved disputes must be disclosed in the registration statement

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 Getting Ready
1-3 months prior to the IPO

z Due diligence process

Organize diligence materials
Complete and accurate minute books
Board and stockholder consents
Capitalization records
Material contracts
Underwriters will review all records, contracts and documents in connection with the company
Consider establishing an electronic or off-site war room

z Begin drafting of business section of the prospectus

z Select underwriters
Establish roles
Book runners and co-managers
Sole book runners vs. joint book runners
Market conditions
Size of offering
Consider syndicate economics

z Consider exchange and other listing alternatives

New York Stock Exchange vs. NASDAQ
The preponderance of emerging growth technology IPOs are listed on NASDAQ

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 Timetable for an IPO

15 months 6-15 months 3-9 months 1-3 months 0 0+5 Weeks 0+12 Weeks 0+13 Weeks

Strategic
Considerations
Focus on
Accounting Issues
Begin Drafting Organizational Commence
Prospectus Meeting Road Show
Evaluate Closing
Management and and Book
Draft Prospectus Building Settlement
Board Formal
Underwriter Diligence Process Date: T +3
Court Investment Pitches Process SEC Declares
Bankers
Continues Registration
Select
Stock Option Underwriters Statement
Pricing Issues Registration Effective
Corporate Statement
Housekeeping Filed with SEC Offering
Priced
Continue
Drafting Shares Begin
Prospectus Trading

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