By Brian P. Sullivan, CPA, CFA
The proliferation of special purpose acquisition companies (SPACs) in 2020 and 2021 have resulted in many companies electing to access capital markets through an acquisition by a SPAC. But whether becoming public through a SPAC, a traditional initial public offering, or a direct listing, having effective internal controls is a necessary step in a successful transition to going public. The Sarbanes-Oxley Act of 2002 (SOX) requires publicly traded companies in the United States to maintain sufficient internal controls over financial reporting (ICFR) to ensure accuracy of financial statements and prevent corporate fraud. SOX requires management to perform an annual assessment of internal control effectiveness, and most large publicly traded companies are required to have an external auditor’s assessment of the effectiveness of the company’s ICFR.
The following are important considerations for achieving an appropriate internal control environment.
Tone at the Top
Having proper ICFR requires commitment from executive leadership and management, which in turn helps employees understand its importance. A common misconception about internal controls is that they interfere with operations, forcing companies to spend extra time on tasks such as conducting reviews, approving financial transactions, and performing reconciliations. However, when operating as a public entity, these controls are essential for presenting accurate and timely financial records to investors. Executives who instill a culture of compliance – including the establishment of necessary entity-level controls (e.g., board governance and related committees, employee code of conduct, written policies and procedures for key process) – generally have fewer challenges in dealing with ICFR requirements as a publicly traded company.
Technical Accounting, Internal Controls, and Tax Experience
Executives looking to transition their company to a public entity should employ appropriate professionals to establish, maintain, and modernize internal controls. Whether through a chief financial officer, controller, director of internal audit, or other position, the collective resources should be able to manage the following important financial aspects during the process:
- Financial reporting – Companies going public should have finance and accounting personnel who are skilled in Securities and Exchange Commission (SEC) reporting and are aware of periodic disclosure and reporting deadlines. It is also critical to have personnel with the requisite accounting experience to address adoption of new accounting standards or operational changes that require assessment of the appropriate accounting treatment.
- ICFR – Publicly traded companies should have professionals proficient in developing, monitoring, and maintaining processes and controls to reasonably assure that financial statements and related disclosures are not intentionally or unintentionally misstated. The applicable professionals should understand the internal control framework used by the company. Most U.S. based companies adhere to the 2013 Committee of Sponsoring Organizations of the Treadway Commission (COSO) Internal Control Integrated Framework.
- Tax – Publicly traded companies have more complex tax obligations and estimates than private entities. For example, a private company that previously was a pass-through entity for tax purposes and becomes part of an umbrella partnership – C corporation (Up-C) structure – generally has to establish an opening tax position and enter into a tax receivable agreement, allowing former shareholders to participate in the tax benefits. It’s important to have an experienced tax professional review interim and annual tax provisions and deal with the complexities arising from any tax receivable agreements.
High-quality internal controls require the appropriate software and technology. Various systems may be needed, for instance, to support financial data for SEC filings, internal management reporting, operational metrics, and data analytics. The more automation that is incorporated into the various processes, the more confident the finance and accounting department can be in providing accurate reporting and disclosures with sufficient time to meet 10-K and 10-Q filing deadlines. Companies should look for opportunities to reduce manual controls with automated processes, including those that harness artificial intelligence. Automation can improve speed while reducing errors, helping companies provide accurate, reliable information in a timely manner. Given the ever-increasing threat of cyberattacks or the costly impact of a data breach, strong information technology controls can protect confidential information and safeguard company assets.
Beyond the Process of Going Public
A culture of compliance, finance and accounting personnel with the necessary expertise, and high-quality technology systems combine for a stronger control environment and lay the groundwork for addressing challenges faced by a publicly traded company. But even if management elects to remain private, the company will benefit from improved internal controls. Timely, accurate, and reliable financial information are invaluable to management seeking informed strategic decisions.
Brian Sullivan, CPA, CFA, is an audit and assurance senior manager with Deloitte in Philadelphia, Pa. He can be reached at firstname.lastname@example.org.
This blog is not a substitute for professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action, consult a qualified professional adviser.
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