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Wednesday, October 24, 2012

Jeff French: Why private companies shouldn’t be forced to act like public companies


By Jeff French
The diversity of cars, motorcycles, vans, and commercial trucks on the roads reminded me how logical it is that states require different levels of testing to become a licensed driver of different kinds of automobiles. Imagine how much time and energy would be wasted if there was a single standard, meaning that everyone would need to qualify on every vehicle, even if they only wanted to drive a car.

Yet this is exactly the situation in which most privately held companies find themselves when they prepare financial statements. Despite having little interest in raising capital from the public, private companies are generally required to meet the same complex accounting standards as publicly traded companies, as determined by U.S. Generally Accepted Accounting Principles (GAAP). Complying with and implementing these complex standards is becoming increasingly expensive. This issue applies to a very wide segment of companies. Private companies account for more than half of the United States’ nonfarm GDP. In Dane county alone, private companies represent 96% of all employers.

Fortunately, relief may be on the horizon. The Board of Trustees of the Financial Accounting Foundation (FAF), which oversees accounting rulemakers, recently voted to establish a new Private Company Council (PCC) that will serve as the voice of millions of privately held companies during the standard-setting process.

This Council will have two principal responsibilities:

* First, to review existing accounting standards to determine whether exceptions or modifications are necessary to address the needs of users of private company financial statements.

* Second, to serve as the primary private company advisory body to the Financial Accounting Standards Board, the primary rule-maker, as new standards are developed.

We think it’s a good start. But the PCC has an unprecedented opportunity to do something much bigger. The PCC can help develop the first useful body of knowledge about private companies and how they use financial reporting.

The private company information challenge

For private companies, financial reporting is typically focused on accountability and stewardship, not accessing public capital markets. A 2011 survey of CFOs by Grant Thornton found as much, with two-thirds of private company CFOs responding that their purpose for preparing audited statements was to demonstrate accountability to owners and creditors or to meet other legal requirements. Only 4 percent said that their primary objective was providing information useful for valuing their equity or debt securities.

There are other cultural and operational obstacles in the quest for relevant financial information about private companies. Busy executives at small and mid-sized private firms seldom have the time or resources to involve themselves in the standard-setting process until the final reporting requirements are issued and they prepare to comply. Therefore, feedback from private companies is often focused on practical issues rather than theoretical concerns.

This is where the PCC can bring enormous value. There isn’t a meaningful body of information on this critical job-formation engine because there’s never been an effective process to ask the questions. If the PCC creates a mechanism to gather information on how these companies use financial information, then they can be an effective conduit to ensure that standards consider private company needs and contribute to their growth and prosperity instead of hampering it.

Giving private firms a choice

As a firm with thousands of audit clients, nearly 90 percent of which are private companies, we support companies that want to access the public markets and back better rules to allow them to participate. However, we recognize that many private firms want to stay private. It’s time to create a support structure that gives companies a true range of options to determine their identity and future—public or private.

We welcome the formation of the PCC. But we realize that this is just the beginning of a long journey to shape a better, more efficient reporting structure for private companies. In return, these firms will have more time and resources to invest in the facilities, personnel and innovation needed to ensure growth and long-term success.

-- French is Grant Thornton's Wisconsin audit practice leader. He has served both public and private companies in the manufacturing, distribution, service, and technology industries for 25 years.

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