An initial public offering takes place when a private corporation or company decides to raise investment capital by offering stock to the public for the first time. Growing companies always seek to expand and generally use initial public offerings. Large companies that are privately owned that seek to become publicly traded can also do it. The Securities and Exchange Commission (SEC) identifies an Initial Public Offering (IPO) when a company sales its shares to the public for the first time. It is also referred to as a stock market launch where private companies transform into public companies as their shares in the stock. Before taking a company public, it must meet basic financial and legal requirements set by the location where one expects to list it.
Various exchange platforms have different requirements to make the initial public offering. For instance, to list a company’s stock within the New York Stock Exchange requires that the firm generate a total of $10 million in the form of pre-tax earnings throughout the past three years. A minimum of at least $2 million over its two most recent years. For the NASDAQ Global Select Market, pre-tax earnings should be more than $11 million in the aggregate within the previous three fiscal years and more than $2.2 million in each of the two recent fiscal years. However, both exchange markets have alternative markets which have financial requirements that are less rigorous (Ghosh, 2017).
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There are various accounting standards which are required in an IPO so as to help investors to make informed decisions. One of such standards are the financial statements and notes. These are standardized financial reports that give details on the performance and condition of the company. The number of required audited financial statements largely depends on the company size. The auditor should also provide an independent financial opinion of the company. Additionally, the selected financial disclosures in critical financial sections of the company have to be summarized within a column. The data should present and show all the important trends in the financial condition of the company attributed to its business operations. The duration of such data also depends on the company size (Elder and Zhou, 2002).
Under the SEC rules, a company should have its last three years of audited financial statements before deciding to register and go public. If the company lacks its three previous years of audit, it can choose to create them given that the systems and records in place allow the auditor to look back. The financial statement should show a two-year audited balance sheet along with a three-year income statement of cash flows. Additionally, there should be five years of selected financial data and inclusion of long-term liabilities or obligations, total assets, net sales and operating revenues and cash dividends which are declared on every common share (Ledenyov and Ledenyov, 2014). With such huge requirements for a company that decides to go public, pre-planning is critical because the entire process can be costly and time-consuming.
Various legal considerations have to be taken into consideration when a company decides to go public. The law requires that companies should disclose its financial conditions, operating results, management compensation, and its other business operation areas. When privately-owned companies decide to make an IPO, such laws begin to apply. Disclosure laws are usually monitored and enforced by the SEC. These laws usually have statutory authority and are subject to changes over time.
Regulations that call for a mandatory corporate disclosure are also known as integrated disclosure system. It requires that companies which are publicly traded prepare annual reports for the SEC and another annual report for its shareholders. The FORM 10-K is an annual report for the SEC where its contents and form are usually governed by federal statutes. Such an annual report standardizes reporting and reduces the differences in reporting requirements for the SEC and shareholders. The Form 10-K provides details on responses and operating information by the management. The Generally Accepted Accounting Principles (GAAP) should be adhered to when preparing any such reports. Such rules and the GAAP are critical in facilitating investor confidence and trust (Certo, 2003). However, the SEC regulations are to be followed to the letter.
Publicly traded companies should present its financial details to investors. The law additionally requires that the disclosure of all business material, contracts, and compensations be given to top executives such as the CEO and additional top 5 executives. The company should also disclose its entire business plan to investors when deciding to go public.
Disclosure laws also apply to the owners of securities in the securities industry. Principal shareholders, officers, and directors that have more than 10 percent of the share should submit reports to the SEC. These reports include a Form 3, a personal statement that details ownership of the company’s securities, and a Form 4, a record of any change in ownership (Cofee et al., 2015). These laws also apply to the immediate families of the directors, officers, and principal shareholders. Shareholders that own more than five percent should also make it known to the SEC.
Private companies may choose to go public for various reasons. Such a company should take into account various considerations for its initial public offering. The financial and legal obligations set by the SEC should be considered to the detail for such a procedure. The costs involved along with the logistics and planning for going public may discourage companies.
References
Certo, S. T. (2003). Influencing initial public offering investors with prestige: Signaling with board structures. Academy of management review , 28 (3), 432-446.
Coffee Jr, J. C., Sale, H., & Henderson, M. T. (2015). Securities Regulation: Cases and materials.
Elder, R., & Zhou, J. (2002). Audit firm size, industry specialization and earnings management by initial public offering firms.
Ghosh, A. (2017). Pricing and performance of initial public offerings in the United States . Routledge.
Ledenyov, D., & Ledenyov, V. (2014). Strategies on initial public offering of company equity at stock exchanges in imperfect highly volatile global capital markets with induced nonlinearities.
