Risk & Compliance

Not an Automatic Marriage

When they prepare to go public, companies should pay special attention to constructing their boards.
Marielle SegarraApril 29, 2013

There is a lot to accomplish in the run-up to going public, and corporate governance might seem like one of the easier parts of the process. But it is essential, says a new report from PwC.

Soon after a company files its initial public offering, it will begin to face scrutiny from shareholders and institutional investors, all of whom will be armed and ready to “potentially throw darts at its governance structure,” says Catherine Bromilow, a partner in PwC’s Center for Board Governance. Spending time before the IPO recruiting the right directors will allow a company “to go to market with a credible board that tells potential and future shareholders that [it takes] the role of being a public company seriously, and [is] ready to play in the big leagues,” Bromilow says.

Unfortunately, preparing the company’s board of directors to go public can be more difficult and time-consuming than companies expect, says the report, which relied on interviews with more than a dozen executives, directors and legal advisers. “Too often, companies that are going public are very focused on getting the registration statements right and they don’t understand the scope of what they need to do from a governance perspective,” says Bromilow. “Too many end up leaving those decisions too late in the process, and then they don’t necessarily make decisions that are the best for them in the long term.”

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In particular, companies that are preparing to go public often need to reshape their boards. The New York Stock Exchange and the NASDAQ Stock Market both require that a majority of a company’s directors be independent. (Controlled companies — those in which one person, group or entity holds more than 50 percent of the power to elect directors — are exempt from this requirement.)

For many private companies, that rule presents a challenge. “Private companies do have a board, but typically if you have the traditional owner- or family-founded company that’s going public, you tend to have a lot of insiders on your board, a lot of friends and acquaintances,” Bromilow says. “So you have to think about how you’re going to reshape the board” to meet the majority requirement, she says.

Such a change is easier said than done. In its research, PwC found that “time and again, even something as simple as adding a new director to your board seemed to take longer than a company had envisioned,” Bromilow says.

First, companies should consider whether a director will jell with the existing board and be able to withstand scrutiny from shareholders and institutional investors once the company goes public. Once a company chooses its directors, those candidates could withdraw from the running at a moment’s notice. “It’s not an automatic marriage,” Bromilow says. “Directors are going to be looking at the company very critically and skeptically. [It’s a question of ] whether or not they’re going to risk their reputation and whether or not they think the company has a chance to succeed longer term. Even if you have a good reputation, one of the things we’ve heard is it’s not at all unusual for the director to be ready to sign up and change his or her mind,” she says.

All told, the process can take a long time. “It’s not unusual to see companies that are already public take a year or longer to identify and add a single new director, so it’s important that pre-IPO companies not underestimate the time it will take them.” Bromilow says. “If I were running a company, I would want to start 912 months ahead.” Finding new directors could take more or less time than that, depending on the size of the company and its networks.

In shaping their boards, pre-IPO companies must also consider the audit committee requirements they will face, depending on their chosen stock exchange. In addition, the Securities and Exchange Commission requires companies to name at least one “audit committee financial expert,” a person who understands generally accepted accounting principles and internal controls, among other functions.

Bromilow says the best way to build a pre-IPO board is to think strategically about what skills and experience (such as audit expertise or social media acumen) the company will need moving forward. After that, companies can decide which directors it should replace.

Giving a director the boot can also be tricky. In PwC’s 2012 annual corporate directors survey, nearly one-third of directors said there was someone on their board who should be replaced. “Once you have a director on your board, it tends to be difficult to get that person off your board,” Bromilow says. 

Companies have to be “brave enough to have a really difficult conversation and ask a director to leave,” which is even harder to do when directors are friends and acquaintances. Even so, companies should make these changes at least four to six months before they file an IPO, she says. “It’s clear that it’s very difficult to shift board composition, especially once you’re public,” she says.

Even controlled companies, which are exempt from some governance requirements, may want to reconsider their board makeup before they go public. “Controlled companies need to be able to attract capital,” and they will do that by “being able to tell potential shareholders that they are going to be a well-run and well-governed company,” she says. “Even in controlled companies, it doesn’t mean you don’t have people looking” (and waiting to scrutinize your board choices), she adds.