The New Pressures of a Public Company

A company’s IPO is an exciting moment. It is the culmination of years’ worth of backbreaking work to build a company and months’ worth of preparation for the IPO. However, as exciting as this moment is, it is only the beginning. As a company’s IPO approaches, its leaders should prepare for the variety of new, ongoing challenges the company will face once it is public. Being aware of and preparing for these new pressures will allow companies to operate and perform more successfully after their IPOs. Some of the most significant pressures public companies face include the following:

1. Pressure from the legal environment for public companies
2. Pressure from several regulatory entities
3. Pressure from shareholders and potential investors
4. Pressure on leadership, including managers and directors

When a company goes public, it is choosing to enter a new playing field. In this new arena, the company will be playing a new game with new rules. The primary aim of this article is to make business leaders aware of the pressures that exist on this new playing field. IPOhub has additional articles that offer more in-depth information including suggestions on how to handle these pressures. Links to these additional articles are provided at the end of the article.

Legal Environment

Public companies are effectively playing a new game when they enter the public market. The rules of the new game are the laws and regulations surrounding the public equities market. These laws dictate what businesses can and cannot do. At times, legal compliance can seem burdensome and expensive; however, the law creates the protections and incentives for firms and investors to behave properly. Without these laws, the equities market as we know it would not exist.

Without a knowledge of the rules, no company can expect to play the game effectively. Large fines, loss of public trust, damage to company reputation, and even a forced shutdown or delisting from the public market can plague unprepared companies. In order to learn the rules, companies should start with a basic understanding of the laws that undergird the equities market in the United States. The laws surrounding public companies include several categories such as federal, state, and tax laws.

Federal Laws

The federal government plays a key role in establishing the ground rules that direct acceptable behavior in the equities market. Several laws are particularly important in the equities market because they define, shape, and regulate the market. Those laws, along with brief descriptions, are listed below.

State Law

Public companies are also subject to the laws of the states in which they are incorporated. States may enforce a variety of regulations on public companies. These regulations could range from state taxes to diversity requirements for corporate boards. Public companies will also face additional state taxes and regulations for each of the states in which they do business. In order to avoid lawsuits and large fines, companies need to carefully research and understand these laws. In addition, companies should build the internal systems necessary to comply with state laws.

Tax Law

Certain tax laws will also become applicable to public companies. Most public corporations are legally registered as C-corporations for tax purposes. These corporations will experience double taxation—once at the company level and again at the individual level when dividends are paid to shareholders. Public companies need to be aware of the taxes they are subject to in order to avoid penalties and to take advantage of special tax breaks that might be available.

Another important aspect of taxes is that tax law is a moving target. Tax law is constantly updated. Companies need to have the systems in place to accurately recognize and pay tax obligations now and in the future. Whether a company’s accounting is done in-house or outsourced, it can expect the costs of compliance to grow once it is a public company.

Regulatory Entities

Once a public company understands the rules of the game, it is important that they understand who is refereeing the game and how the rules are enforced. Public companies are required to comply with and report to many different regulatory entities. Some of these entities enforce the securities laws we discussed before, while others enforce more general laws or non-legal issues. Understanding how these regulatory bodies work will help a public company avoid negative public reports, large fees, temporary closures, and forced delisting from stock exchanges. While many of these organizations also regulate private companies, public companies face increased pressure from a greater number of stakeholders.

A public company must be aware of the following organizations:

The Securities and Exchange Commission (SEC)

The SEC is the most significant regulator of public companies. The purpose of the SEC’s regulations is to protect the interests of investors. The SEC places a variety of requirements on public companies and monitors them for compliance. These requirements include filing public disclosures that report on company performance. The SEC also lays out rules for the release of information, such as Regulation FD (Reg FD), and other rules dictating acceptable behavior for company insiders.

The SEC requires a variety of public disclosures like the 10-K, 10-Q, and 8-K, which are filed on an annual, quarterly, and ongoing basis respectively. Companies are required to file all of these reports according to the standards of the U.S. Generally Accepted Accounting Principles (GAAP). Failing to comply with reporting regulations or filing false reports can result in large fines and the loss of public trust. Non-compliant reporting can also result in the forced delisting of a company from the public market or in lawsuits between the company and the relevant injured parties. To avoid these potentially negative outcomes, a company needs to be aware of and ready to file these reports accurately. For more information about specific SEC filings and regulations, see our “SEC Filings Overview” or “Audit Prep for the Big Leagues” articles.

In addition to the reporting requirements, there are a variety of other rules that the SEC enforces. For example, Reg FD prevents companies from disclosing material non-public information to investors or analysts without also making the information available to the public. Employees and company officials need to understand these rules because even the unintentional release of information can lead to fines and lawsuits. The SEC also regulates and monitors company insiders and large shareholders. These individuals and organizations are required to comply with the laws that dictate acceptable managerial and stock trading behavior. The law specifically dictates certain blackout periods in which company insiders are not allowed to trade their shares in the company. By law, insiders are also prevented from releasing private information about the company to outside parties. Company leaders need to be aware of these regulations so they do not unwittingly create difficulties for the company or their personal reputation.

Stock Exchange Regulations

In addition to the various governmental agencies that public companies report to, each company has to follow the regulations of their stock exchange. Each major stock exchange has a comprehensive set of codified rules that apply to any company that is listed on the exchange. The regulations cover everything from regular disclosures and board composition to corporate responsibility and shareholder’s meetings. Stock exchange rules are detailed, strictly enforced, and often go beyond the standards set by the SEC. For example, the rules of the New York Stock Exchange require stock prices and market cap to remain above $1.00 and $15 million respectively. Public companies are required to comply with these rules, and the stock exchanges monitor compliance closely. A full list of the rules and regulations for each stock exchange can be found on its respective website.^{1 2}

When a public company fails to comply with stock exchange regulations, they risk being delisted from the exchange. Being delisted can badly damage a public company’s reputation, especially among investors. The prices of most delisted stocks drop significantly. While companies can make the necessary changes and relist on a major exchange, involuntary delisting is a negative outcome that can harm a company’s future funding opportunities. To prevent unnecessary delistings, companies should postpone their IPOs until they are fully prepared to consistently meet the stock exchanges requirements. For more information about which stock exchange would work best for your company, see our article on choosing a stock exchange.

Other Regulators

There are many other important regulators of public companies to be aware of including the Federal Trade Commission (FTC) and the Occupational Safety and Health Administration (OSHA). The FTC regulates all matters surrounding competition, and other acts within the economy that are considered harmful to consumers. This includes collusion, acquisitions that over-concentrate the market, or unfair pricing practices. OSHA enforces regulations concerning working conditions and safety standards. Both of these regulators are responsible for all companies in the U.S. However, public companies should be especially careful to manage their relationships with these regulators due to the potential publicity that public companies will face.

Investor and Stakeholder Relationship Management

Once public companies understand the rules of the game and who is enforcing those rules, they also need to understand how to work with their new teammates: shareholders. Shareholders expect transparency, timeliness, consistency, and candor from public companies. Unhappy shareholders can cause public companies to lose their reputation with customers and future funding opportunities.

Having shareholders introduces several new relationships that are important for public companies to understand. In order to build trust with investors, public companies need to learn how to manage relationships with public media, analysts, and current shareholders.

Relationships with the media

Becoming a public company means more information will be available to the press through the company’s public reports. Public records make it more likely that the press will cover the company’s performance, increasing exposure to the general public. For better or for worse, this means that a public company faces increased pressure to manage what the media is reporting. Communicating with the media in constructive ways can prevent misunderstandings that might otherwise result in losing customers and future investors.

Relationships with analysts

Because of the potential impact that analysts’ projections can have on stock prices, equity analysts can become either an important contributor or a detractor for a public company’s reputation. Analysts have different needs than the general public, which means companies will have to communicate with them differently. Analysts have an incentive to gather as much information as possible. Because of this, companies should be careful not to reveal more information than is allowed by law. In order to maintain legal and mutually beneficial relationships with investors, companies should set proper expectations and cater their communication to meet analysts’ needs.

Relationships with shareholders

The law clearly dictates how public companies are allowed and required to communicate with their shareholders. These obligations include periodic and ongoing reports, and annual shareholder meetings. Companies are required to disclose key financial and performance information to shareholders.

Beyond the required disclosures to shareholders, it is in a company’s best interest to be open with shareholders to a reasonable extent. For example, many non-financial disclosures are now seen as standard. For example, Corporate and Social Responsibility (CSR) reports and Environmental, Social, Governance (ESG) reports are becoming increasingly important. Providing additional reports and information can build trust and potentially open new funding opportunities in the future.

In addition to normal communication with shareholders, companies often deal with activist shareholders as well. Activist shareholders are shareholders, or groups of shareholders, with enough power to be influential when they exercise their voting rights. Often, these shareholders try to advocate for and to affect change within a company. Regardless of whether management agrees with the activists, company leaders should find ways to hold productive conversations with these shareholders. Otherwise, a divide might open up between management and shareholders that hurts the value of the company. For a more in depth understanding of activist shareholders, see our article about shareholder activism.

Leadership Pressures

The leaders of a public company also need to understand how the new rules of the game will apply to them individually. Leaders of a public company need to fundamentally change the way they manage risk, make decisions, and set objectives for the company. The additional pressures that company leaders will face include new leadership structures, increased accountability, and increased liability. Each of these pressures will shape the actions that leadership is able to take. Some of the new leadership pressures will be faced by all company leaders while others will be specific to management or the board of directors.

General Pressures

One of the most significant leadership pressures on an IPO company is the pressure to find, attract, and retain the right people. Most companies will bring on an entirely new set of c-suite executives as they are preparing to go public. This process is difficult, and the difficulties continue after the company has gone public. Often, the executives that helped take the company public won’t be the best match for the company once it has gone public. Finding and keeping the right people before and after going public is also made difficult by many of the personal risks executives and directors will face as part of the leadership team.

Public company leadership is exposed to much more personal liability through legislation such as SOX. Additionally, many current societal trends, including increased personal allegations, have created extra liability. Officers and directors are required to personally sign off on many of the regulatory reports. This means that officers and directors can be held personally liable for any fraud or other behavior that is not found to be in good faith.  Company leaders must make sure that they have all the proper controls in place to prevent themselves from being held liable for problems that otherwise could have been prevented.

One way that companies compensate for leadership risks is by paying for directors and officers liability (D&O) insurance. D&O insurance helps protect several things including the personal assets of company leaders, the liability faced by the company when indemnifying leadership, and the potential losses to the company itself. Especially considering the increased risks faced by public companies, paying for D&O insurance can quickly become a large expense. Over the past several years, D&O insurance costs have been rising due to increased claims and increased severity of claims. The COVID-19 pandemic only accelerated the rising costs.

Pressures on Management and Officers

Officers and managers in public companies do not have the ability to make decisions as quickly or independently as private company leaders. In a public company, many decisions have to be approved by the board or by shareholders. This means that the CEO cannot continue to make her or his own independent decisions, regardless of personal history in the founding of the company. If CEOs lack the discipline to stay within their new bounds, the board could remove them from their position in the company. This has been the case with some prominent company leaders such as Steve Jobs at Apple.

Pressures on the Board of Directors

A public company’s directors are also put under a tremendous amount of pressure. These pressures include the financial risks mentioned above as well as other risks relating to the execution of their position as a director.

Board members are normally elected by shareholders every year. These elections are largely influenced by the bias of large institutional shareholders who own larger portions of company equity. Large investment companies such as Vanguard and Blackrock often rely on the services of proxy advisory firms that recommend which board members to elect. These proxy advisory firms are the topic of many discussions right now. Many regulators believe these firms have too much unregulated influence in the market.

Before a company can go public, it needs to establish a board of directors that meets a variety of specific requirements. According to regulations from the SEC and the major U.S. stock exchanges, a majority of the board members need to be independent. To be independent, a board member needs to meet several requirements. These requirements include not being an executive for the company, not having a controlling stakeholder interest, not having worked for the company in the past three years, and not having any family members who are employed by the company. There are also a variety of committees that must be in place before a company goes public. The required committees include an audit committee, a compensation committee, and a nomination/governance committee. There are specific requirements for the composition, qualifications, and independence of each of these committees. It takes a minimum of three independent board members just to be able to staff these committees. The various requirements for board composition can put tremendous pressure on the current board and management to find well-qualified board members.

Board requirements can change as well, further complicating the process of establishing board members and committees. New regulation is also being rolled out in some jurisdictions in the U.S. regarding diversity quotas on company boards. These quotas include gender and racial diversity requirements. Proxy advisory firms also use criteria for board members that many analysts consider arbitrary such as age limits, ESG requirements, and others. These types of quotas will make board elections much more complicated, and likely place even more pressure on directors to find qualified board members. For more information about forming a public company board, read our article “How to form an effective board of directors”.

Other Potential Pressures

Growth Pressures

Once a company goes public, its progress and performance are tracked by stakeholders. The stock exchange, analysts, and shareholders all expect the company to perform well and grow consistently. The expectations of these stakeholders put pressure on management to make decisions that are focused on creating short-term results—results that keep their stakeholders happy. Going public can give a company the capital it needs to grow. However, the demand for growth doesn’t end after the IPO. If a company performs poorly, even for a brief period, it will likely be devalued. Because of the potential downsides of poor performance, companies should wait to go public until they have the necessary momentum to sustain their growth.

Technological Pressures

The increased visibility of public companies could make them a more likely target for malicious hackers. While this also applies to private firms, the pressure to be technologically secure should be a primary concern for public companies. Hackers can have a profound influence on a company’s bottom line. When important information is stolen, the company will face significant repercussions. If proprietary information is stolen, a company can lose its competitive edge. If private customer information is stolen, companies can lose customers, face hefty fines, or find themselves involved in expensive lawsuits. These losses can cause the company’s stock price to fall, hurting both the company and its various stakeholders.

Dividend Pressures

In addition to the increased costs of legal compliance and reporting, public companies also have to decide whether or not to pay a dividend. Paying a dividend means that the company will have less cash to work with in other areas. However, dividends are also attractive to many investors because they create a sense of stability and can raise demand for a company’s stock. For these reasons, companies should examine which option fits best into their overall strategy. Choosing whether or not to pay a dividend will set a precedent for a company and could potentially impact its future funding opportunities.

Conclusion

An IPO can be an important step in a company’s development. However, an IPO is much more significant than a one-time opportunity to access public markets; choosing to go public means that a company is entering a new playing field, choosing to play a new game, and placing themselves under a new set of rules. Public companies will face a host of legal requirements, regulatory burdens, relationship-related stresses, leadership difficulties, and security threats. Company leaders need to understand these pressures and be ready to navigate them. In order to successfully manage each of these pressures, a public company also needs to have the right people, resources, and systems in place before they go public. When a company is properly prepared to handle the pressures of being public, an IPO can help propel the company to a successful future.

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