October 20, 2003
Buyout King Needs SOX Appeal
Dear Deal Guys,
After years of rollups and mountains of debt now reduced to mere molehills, my buyout fund’s only surviving portfolio company is now a debutante who’s ready for the world. Like a proud parent, I just get misty-eyed over the thought of my little baby being sold to the highest bidder. Then again, the thought of paying cash for that 20,000 sq. foot cottage in Aspen makes my heart more than warm. How do I dress up my budding flower into an attractive acquisition prospect for all these strategic buyers who, since the recent run-up of the stock market, are hungry for growth?
Buyout King Just Trying to Put Food on the Table
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Dear Buyout King,
We know it’s hard for a proud parent to think this way but your little baby needs SOX appeal. Yes, even though you’ve been running a private company, you’re finally going to have to pay attention to all those SOX client alerts that has been clogging your in-box from every law firm that can spell C-A-S-H-C-O-W.
As you know, the CEOs and CFOs of those potential deep pocket strategic (that’s read: public) buyers have to sign those pesky 302 and 906 certifications that, under SOX, subject them to personal liability and jail time for the accuracy of their public companies’ financials. The prospect of target’s sketchy financials getting morphed into the buyer’s essentially means that CEOs and CFOs may be taking personal responsibility for target’s financial statements and results of operation. It’s no wonder that public company buyers are turning up the due diligence heat on private targets.
For example, if a target’s officer is to become an officer of the public buyer, then buyer wants due diligence on any loans currently in place for that officer (remember, SOX prohibits loans to executives and directors). This is a particular problem for fund-back companies because the buyout guys always want management to have significant skin-in-the-game, which many times means company loans to officers to buy stock. A public buyer must now deal with these loans as it structures comp arrangements for target managers that will stay on.
We could drone on about the SOX parade of horrors but we’ll leave that to others. Just remember that SOX doesn’t have any grace periods for a private target’s un-SOXy things when being acquired by a public company (except the one about 302 certifications not applying to target’s financials filed in an 8-K relating to an acquisition).
So, it may turn out that the most attractive private company acquisition prospects are those who have the their financial and corporate governance house in order so that it can seamlessly fold into SOX compliant public buyers. If you don’t care about silly things like exits (sale or IPO), liquidity (publicly registered debt) or you simply feel “too SOXy for your shirt”, feel free to run your private company like your own little fiefdom with no regard to SOX compliance. On the other hand, if you want to eventually sell or do an IPO, you may have unwittingly whacked your debutante with a big ugly-stick.
(Comments? Gripes? Pls feel free to email us: wilson.chu@haynesboone.com or lglasgow@gardere.com )