On April 5, 2012, President Obama enacted the Jumpstart Our Business Startup (JOBS) Act, thereby opening up opportunities for smaller companies to gain access to capital in the public markets. Now with the emergence of the new “Emerging Growth Company,” businesses with less than $1,000,000,000 in annual gross revenue, small business owners should become familiar with the steps in the IPO process.
One of the most important steps when taking any company public in the United States involves conducting an audit of the company’s financial statements. The Securities and Exchange Commission requires companies that want to go public to file audited financial statements for the previous two fiscal years of the company’s operations with the Commission. This is a requirement that extends both to larger reporting companies with greater than $700 million market cap, and to Emerging Growth Companies. In either instance, the audit is critical to the going public process. Therefore, the process of selecting the right audit firm is as equally critical.
So how does an Emerging Growth Company attempting to go public select an audit firm? There are many factors that can play into the decision. Here are three key factors that I believe should be taken into consideration when deciding which audit firm to hire.
Is the Price Right?
The audit engagement fee is often the single area of concern for many prospective companies looking to go public. Audit costs can constitute a considerable portion of the total going public costs. Emerging Growth Companies can ensure that they are getting a fair price by using two common sense methods.
The first method involves simply putting the audit job out to bid. The company should narrow its selection down to at least three firm bids. Of course, one should evaluate all factors equally before going with the lowest bidder, but telling audit firms that you are seeking bids from other firms should ensure that they offer you a fair price.
The other methodology involves performing sort of a comparable audit fee analysis. This is performed by comparing the offer received to historical audit fees charged to companies that have already gone public. You can easily get this information by going to the Securities and Exchange Commission’s website and obtaining S-1 registration statements. In those documents, companies are required to disclose all expenses incurred with their public offering. The audit fees should be towards the back of the document along with the other fees summarizing the total cost of the offering. The results could vary, but narrowing down your search of comparable companies to those which are similar in size to yours should provide enough data to evaluate the bid.
Is the Audit Firm Registered?
Another important and sometimes overlooked factor in selecting an audit firm as the IPO auditor is to determine whether the firm is appropriately licensed and registered to conduct such audits. In practice, CPA firms that provide audit services to private companies must be licensed and registered with the state board of accountancy in the state in which they reside. In contrast, CPA Firms that audit public companies must not only register with their state board, but must also register their firm with the Public Company Oversight Board – or PCAOB. The PCAOB was started in response to the Sarbanes-Oxley Act of 2002, as a non-profit organization charged with the responsibility of overseeing public company audits and as well as the auditors that offer these services.
The PCAOB maintains a list of all registered audit firms right on their website. This list is very comprehensive and has the names and addresses of audit firms from around the world. The list can be searched and sorted by firm name, city, state, country, and category. You can simply find the audit firm you are evaluating to see if that firm is on the PCAOB’s list, or you can use the list to find a firm to work with. Unfortunately, you are still at the beginning stages of your auditor selection process, and you must take note of another important step in the process.
You see, not all registered firms listed on the PCAOB website are created equal. If you visit the PCAOB website, you will notice that beside each of the firms listed there is a category (See Exhibit 1.01). The PCAOB assigns a category A thru E as follows:
Category A – Issued an audit report for at least one issuer. (Registered Firms – PCAOB. (n.d.)
Category B – Issued no audit reports for issuers but played a substantial role in the audit of at least one issuers. (Registered Firms – PCAOB. (n.d.)
Category C – Issued no audit reports for issuers, and did not play a substantial role in any issuer audits, but issued a report on the financial statements of at least one broker-dealer. (Registered Firms – PCAOB. (n.d.)
Category D – None of the above. (Registered Firms – PCAOB. (n.d.)
Category E – Has not yet filed a Form 2 Annual Report. (Registered Firms – PCAOB. (n.d.)
Registered Firms - PCAOB.(n.d.). Retrieved from http://pcaobus.org/Registration/Firms/Pages/RegisteredFirms.aspx_br
Generally, I would not recommend working with firms in any category other than Category A. Years ago, I consulted with a company that wanted to hire an audit firm which was registered as a category B. The client ignored our warning not to proceed with the audit firm. The audit firm conducted the audit, and gave the client an unqualified audit opinion letter. Unfortunately, the audit firm conducted the wrong type of audit procedures and issued the wrong type of audit report. The client ended up having to select another audit firm, which incidentally was rated Category A, and had to go through the whole audit process again. The second audit added an additional three months to the IPO timeline. So please stick with Category A audit firms!
Is the Audit Firm Compatible with Your Company?
Finally, compatibility of the audit firm and an Emerging Growth Company is another very important factor that should be considered. Smaller emerging growth companies that engage with a top tier audit firm with the intention of adding professional cachet to their public offering could end up paying a premium in audit fees. Fortunately, there are a large number of smaller, more affordable local and regional audit firms that have been able to gain significant experience conducting public company audits for smaller companies.
Additionally, Emerging Growth Companies with multiple and or international subsidiaries have additional compatibility considerations. Questions that should be asked include: Does the audit firm have multiple offices in the countries where the company’s subsidiaries operates? If the audit firm has a single office located in the United States, is it apart of a larger international accounting association with firms in multiple countries? These are important questions that one should ask, because this can have a direct impact on the audit fees. For example, there may be instances where the audit firm has to fly a team of auditors from its main office to various company locations to audit the company’s subsidiaries for extended periods of time. As a result, the company will bear the fee burden of airfare, hotel and meals for the time the firms auditors are present. Alternatively, if the audit firm has multiple offices, or is a part of an international organization with offices in the same cities as the company’s subsidiaries, there should be cost savings associated with this.
There are many other considerations associated with selecting right audit firm. It’s important that the Emerging Growth Company ensure that they consider carefully consider all of the factors mentioned to ensure they select the right audit firm. Remember, this is a long-term relationship, so it’s important to make the right choice the first time.
Registered Firms - PCAOB. (n.d.). Retrieved from http://pcaobus.org/Registration/Firms/Pages/RegisteredFirms.aspx_br
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