Whether entrepreneurs intend to undertake a public offering, pursue a strategy of being acquired or simply try to maintain and grow a successful private company, they should make efforts to manage their companies as though they were public entities.

More often than not, owners of emerging and small private companies spend little effort in implementing systems necessary to accurately report the true financial condition of their companies. Although the goals of public and private companies may be different, the need for valuable information is equally important in both.

All companies should provide for a minimum level of control, documentation and corporate governance. This should include: an effective system of capturing the company’s financial transactions in the books of the company; approval and documentation of all transactions in the company’s stock, stock options or ownership interests; proper approval of all significant transactions in accordance with the company’s operating agreement or bylaws; accurate segregation of business and officer expenses and activities in the accounts of the company; maintaining compliance with all tax, securities and regulatory laws to which the company is accountable; and an effective system of reporting the activities and operations of the company to the management and board.

Although these systems may seem expensive on the surface, their actual cost may be surprisingly reasonable, and the cost of not having these systems in place may be catastrophic.

Saving time, money

Certainly, any company striving for a public offering has the natural incentive to implement these systems. The process of going public is much less expensive and requires much less of management’s time if the books and records of the company are kept in a manner consistent with what is expected of a public company. This cost savings comes in the form of significantly lower audit and accounting fees and lower legal fees. Underwriters have also been known to walk away from deals where companies have not administered their companies properly.

Public companies are also required to report earnings quarterly and prepare annual financial statements for filing with the Securities and Exchange Commission. Additionally, they are required to report significant transactions when they occur and to report their operations and information about their stockholders in more detail than a private company. These requirements generally have very stringent time requirements, as well.

Once the company has achieved its public status and is subject to these requirements, the ongoing reporting requirements are much less of a burden, as the company is operating under these conditions.

Helping buyers

Companies that are not necessarily pursuing a public offering but are seeking to eventually be acquired should maintain their books to provide information valuable to prospective buyers. The books and records should provide an acquirer with comfort about the true operations and legal situation of the company. With proper controls, the due-diligence and valuation process becomes much less strenuous and time consuming and vastly less expensive. Because information is easily gathered and documented, results of operations, specific product lines, assets and liabilities of the company can be identified and supported, providing the buyer with the information needed to complete the transaction. Just as importantly, when the legal and tax status of the company is not in question, acquirers are much more likely to go forward with an acquisition that may be more favorably structured for the seller.

Management of a company is based on an understanding of the performance of that company and the maximization of its cash flows to its owners. In order for owners to understand the return on their investment in the company, it needs to be managed in such a way that its performance is reported accurately.

There are other circumstances where the valuation of a private company needs to be known. These include: implementing an employee stock ownership plan, generational transitions in ownership, divesting interest in the company, or an unexpected sale of the company. Accurate data regarding the financial condition and operations of the company provide the owners with the ability to determine the value of their company and manage it in order to maximize its benefit to them.

In the end, the systems used by management have a major impact on the success of the organization.

Jim Pitrat, CPA, is a manager at Singer Lewak Greenbaum & Goldstein LLP, Certified Public Accountants & Management Consultants. He can be reached at [email protected].

Entrepreneur’s Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact James Klein at (213) 743-1759 with feedback and topic suggestions.