Private energy companies encounter many financial reporting decisions that must be considered during the IPO process. It should also be noted that these same considerations may also apply to reverse mergers and sales of private companies to public companies. Because private energy companies are typically not suited to handling the financial reporting requirements of a public company, the JOBS Act allows certain benefits for emerging growth companies, which are companies with less than $1 billion in revenue, including:
- the ability to file IPO documents confidentially up to 15 days before the IPO road show;
- the ability to present two years of audited financial statements in the IPO documents; and
- a temporary exemption from the compliance requirements of the Sarbanes-Oxley Act.
Despite the relief provided by the JOBS Act, some of the more common financial reporting matters that must be navigated are summarized below.
Determining the predecessor entity and which financial statements should be presented
Determining the predecessor entity and which financial statements to present in the Form S-1 filed in connection with the IPO often involves judgment and requires review by the company, its legal counsel, and its independent auditors. This is often an item that should be precleared with the SEC in advance of the initial confidential S-1 filing.
Audited financial statements of significant acquisitions
Depending on the significance of acquired businesses, companies will be required to present either one or two years of audited financial statements for each acquisition. Thus, companies should ensure that the acquired business is audited at the time of acquisition.
For an E&P company, the significance of the acquisition and whether or not it is deemed to be the predecessor will dictate if full carve out financial statements or abbreviated statements of revenues and direct operating expenses are required to be presented (including the unaudited Standardized Measure of Oil and Natural Gas (“SMOG”) disclosures noted below).
Adopting public company financial reporting requirements
While the JOBS Act can provide relief for private companies from adopting certain public company financial reporting pronouncements if elected, certain requirements cannot be deferred. Three of the common financial reporting requirements are the following:
- Segment reporting – This presentation often changes as companies evolve, but companies will be required to present discrete financial information for products and/or service lines based on what information is reviewed by the energy company’s chief operating decision maker.
- Incentive compensation reporting/valuation – In addition to determining the appropriate financial reporting presentation of incentive compensation arrangements, companies often are required to engage professionals to perform the complex valuations of these arrangements. This information also is often required to be presented in the executive compensation section of the S-1.
- SMOG – For E&P companies, SMOG disclosures are required to be presented for all years that financial statements are presented. This requires the company to coordinate with external and internal reserve engineers to present oil and natural gas reserves and related cash flows on a basis as prescribed by the SEC. While an unaudited financial statement disclosure, this continues to be a focus area for external auditors and the SEC.
While private companies often do not prioritize the items above until a transaction is imminent, allocating the time and resources to these financial reporting matters as the situations are encountered ultimately could save time and money when a company is preparing for a transaction, whether it is an IPO, divestiture, or reverse merger.