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Zynga’s IPO hiccup: why they got it right in the end

We tend to assume the worst when we hear the words “material weakness,” and for public companies required to comply with the Sarbanes-Oxley Act, it’s certainly not good news. But in terms of Zynga’s hiccup last week, in which the social media company restated revenues during its IPO filing process, it’s not as bad as it might seem. What did Zynga do, and why it was right in the end? We can draw a lesson from this tale.

First, full disclaimer: RoseRyan has had the honor of working with Zynga on discrete projects, and we respect the work of our colleagues there. We weren’t involved in the work leading up to their IPO (but would have loved that).

Zynga’s situation: they are not alone
Last week, Zynga filed an amendment to its S-1 registration statement, which included restating revenue for the quarter ended March 2011. Here’s why they had to restate:

A portion of Zynga’s revenue is derived from the sale of virtual goods. In accordance with today’s accounting literature, the up-front customer payments for these virtual goods are to be recognized as revenue over the estimated customer relationship period, and the company recognizes this revenue over the average playing period of paying players.

So far so good, right? Not quite. Unfortunately, Zynga did not update its estimates for playing periods associated with two of its games. The result: too little revenue was recognized, and for the March 2011 quarter, the difference was material enough to require that they restate their financial results.

Zynga is not alone in the challenges it faces in pre-IPO finance and accounting work. With innovative business models popping up every day and a continually changing accounting landscape, many companies find themselves in similar situations. The difference is that most of them resolve issues like these before their initial S-1. For Zynga, identifying the issue in the middle of its SEC filing process put them under a huge public microscope.

Material weakness: yes or no?
Zynga’s amended S-1 filing disclosed the restatement snafu as a “material weakness” in its internal control structure in the context of its risk factors. In other words, they highlighted the issue as an example of one way in which the accuracy of their financial statements could be at risk. As with most companies, this risk factor is just one of a laundry list of risk disclosures provided to investors.

Technically speaking, Zynga is not yet required to comply with the reporting requirements relating to internal controls. And once they go public, they’ll have until their second annual report to tackle this reporting requirement. In the meantime, however, they are still required to maintain effective internal controls to ensure accuracy in their financial statements.

Having said all that, I believe calling out their material weakness was the right thing to do. Putting their cards on the table shows that Zynga takes this mistake seriously, and transparent financial disclosure certainly builds credibility and trust with investors and analysts.

Moral of the story
If you’re planning an IPO, start early and give yourself enough time to sweep under the bed and take care of those dust bunnies before you’re under the microscope. Investing in preparation will pay dividends … we promise.

At RoseRyan we live and breathe these issues every day. We know most companies aren’t there—and I mean the vast majority. But we keep talking about it, pushing our clients in this direction and helping with their housecleaning.

And we give kudos to companies like Zynga that provide transparency to the issues they face.

To learn more about what we advise for pre-IPO companies, check out our recent intelligence reports, IPO in Your Future? and Ace Your IPO Filing.

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Do auditors care about XBRL?

When I talk with finance executives about implementing XBRL, nearly everyone asks, “What will auditors be looking for? Do they care about XBRL?” The answer is no, they don’t. But they do care about your controls, and that relates directly to how you design and document your due diligence in XBRL creation process. Ultimately, as XBRL gets built into your close process, the more it may start to fall into the SOX environment.

While XBRL exhibits are not subject to SOX 404 internal controls over financial reporting, they are nevertheless subject to disclosure controls and procedures (DC&P). This means that management is responsible for the implementation of controls over the XBRL creation process as well as documentation that the DC&P are performed and reviewed. How can companies provide evidence to their auditors that management, including the CEO and CFO, have evaluated the effectiveness of the design and operation of DC&P?

To design proper DC&P controls, you first need to ask, “How do you know your XBRL files are complete, accurate, consistently mapped and comply with the mandated XBRL structure?” A best practice is to develop an XBRL technical and compliance checklist to document every aspect of your XBRL creation process, from taxonomy mapping and appropriate extensions to common error reviews, technical and SEC validations, structure compliance issues. You may also want to involve your disclosure or audit committee in the review and consideration of your DC&P process and get them on board with your XBRL strategy.

As XBRL technology becomes more embedded into your overall financial reporting process and integrated into the creation and preparation of your financial statements, XBRL controls may start to fall within the scope of SOX 404. As this happens, you should reevaluate your XBRL controls under SOX 404 framework.

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A mismatched set of semi-global accounting standards—was that our goal?

Conceptually, a single set of high-quality global accounting standards sounds great: every company in every country follows the same rules and reports financial information in the same light. And with a growing number of countries adopting International Financial Reporting Standards (IFRS), it’s no wonder that IFRS is touted as “the” set of standards that can help us accomplish this goal. But the design and execution of this concept has presented insurmountable challenges, and the solutions being offered up leave much to be desired in terms of accomplishing the original goal … a single set of standards.

Adoption turns to endorsement. The SEC’s proposed roadmap issued in late 2008 considered adoption of IFRS, while the most recent SEC staff paper issued last May is considering an endorsement protocol, which would allow the FASB and SEC to cherry-pick the standards issued by the Internal Accounting Standards Board (IASB) and possibly supplement them with additional guidance.

Convergence becomes less converged. The FASB and IASB have been working together to converge the guidance of newly issued standards since they entered into the Norwalk agreement in 2002. However, some of the boards’ first major joint projects, including stock-based compensation and purchase accounting, resulted in substantial convergence upon issuance of the final standards—most of the guidance is the same but key differences remain. While their respective drafts of the proposed revenue recognition guidance are very close (after more than 10 years of effort, I might add), there are a number of differences of opinion in terms of other standards in the works, including leases, consolidation and insurance contracts. Speculation is that the best we’ll get here is also substantial convergence … if that.

Input adds to confusion. In early July, the SEC held a roundtable session to help evaluate the possible incorporation of IFRS into the U.S. reporting structure. The roundtable consisted of three panels of investors, smaller public companies and regulators. The result: a very mixed bag of reactions. The investor panel generally supported incorporation of IFRS but raised concerns about consistency in the application of the IASB’s principles-based standards. The panel of small public companies said the costs of such a substantial change outweighed the benefits. And then there was the regulatory panel, which ranged from cautiously supportive to very much against IFRS incorporation.

The SEC is still expected to make a decision by the end of this year about whether to incorporate IFRS and if so, how and when. Although nothing has been decided yet, it appears we are headed toward IFRS—International Financial Reporting Sometimes.

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Moving from SAS 70 to SSAE 16: seize the opportunity

Most service firms (like payroll and healthcare claims processors) have provided a SAS 70 report to their clients simply as a matter of course. Over time these CPA reports on the service organization’s internal controls have evolved from being solely an auditor-to-auditor communication to include information about risks beyond financial reporting, and in some cases they’re being used as a marketing tool.

As of June 15, SAS 70 reports were replaced by SSAE 16 reports. There are any number of publications and opinions about the transition (just ask Google), but it strikes me that there is an opportunity here to take a fresh look at the value of these reports. I’ve seen a tendency to for companies to include SAS 70 reports in the SOX controls only because they are available, and my guess is that there are probably quite a few them with other controls that cover the same bases. On the flip side, the SAS 70 might not address risks that need additional work to mitigate, or the business has changed and the risks are no longer consequential.

So, take a closer look at past SAS 70 reports and determine if you’re actually relying on them for your internal control environment. If you don’t need to include them in your SOX controls—don’t. (That will apply to the SSAE 16 as well.) You’ll save time and possibly a bit of money.

This is not to say there is no value to the SAS 70 or SSAE 16 report if you don’t need it for SOX. Companies just need to ask themselves whether that value is as a SOX control or for other operational or risk mitigation purposes. Seize this opportunity, and at the very least you’ll have a good understanding of your controls environment.

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We’ve got a new practice: XBRL!

Having been in the trenches with XBRL since it came on the scene, we’re pleased to announce the launch of our dedicated XRBL practice. Sure, it’s a business opportunity for us, but we believe we can go above and beyond. We’ve seen what companies are going through to comply, have a whiteboard full of best practices from phase-in groups, and we’ve helped our clients both do it right and benefit from it. XBRL is a necessary evil (sort of like SOX used to be), but with it comes the chance for companies to really take ownership of their data, and make sure their information is accurate, transparent and comparable to everyone who uses it.

Our chief XBRL guru is Lucy Lee, a newcomer to RoseRyan but an experienced hand at XBRL and compliance issues. She’s developed a six-step XRBL methodology, with quality assurance at its core, that we’ll use in every engagement. XBRL implementation is relatively new and still changing, but we stay on top of the rules updates and Edgar Filer Manual changes, including SEC guidance and most common errors. We can help with every aspect of XBRL implementation (not something everyone can claim), and when we’re done, we often leave companies with a more streamlined close and reporting process.

You can learn more about our new XBRL practice in our press release and in the Services section of our website.

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Help take the pulse of cleantech in Northern California

Part of Northern California’s cleantech industry? I invite you to take RoseRyan’s annual State of Cleantech survey, designed to take the pulse of this growing and influential sector and provide an insider’s view of what’s important and where it’s headed. There are 19 questions; it should take 10–15 minutes to complete. The deadline is July 29. You’ll find the survey here.

The questions cover far-ranging aspects of business and finance, including how many IPOs and M&As expected in the coming year, which cleantech sectors are predicted to do the best, and top business challenges and market risks for the year ahead. Our partners this year are Arbor Advisors, Barney & Barney and KPMG.

In last year’s survey, optimism prevailed—surprising, since it was set against the backdrop of the end of one of the most severe recessions in history. Respondents’ eyes were on opportunities in China, but there was also lots of concern about gaining access to capital and the decline of government incentives. What will shift in 2011? I’m very much looking forward to finding out.

Thanks in advance for your help. Please share it with other leaders in the field. And please feel free to let me know what you think about the survey itself, via the survey itself (there’s plenty of room for comments) or just send me an email (cvane [at] roseryan.com). We plan to release the results in August.

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Yes, you can work faster: use two monitors

There is a simple solution to improve efficiency and I’m surprised how many haven’t tried it: using two monitors. This isn’t a new concept. The AICPA says it can boost efficiency by 50 percent, according to this article from accountingweb.com.

When I need to compare two documents or use information from one window to complete a task in another, I’m far more efficient if I use two monitors. I avoid repetitive toggling back and forth or minimizing and maximizing windows or printing. In addition to the green benefits of working with less paper, consider the time savings of fewer keystrokes and printing time, as well as ensuring you’ve picked up the correct number to paste into the new spreadsheet—I’ll bet you’ve often toggled back and forth several times to check.

Using two monitors, it’s easier to handle these kinds of tasks:

  • Prepare reconciliations. I have the general ledger application screen on one monitor, and can cut and paste quickly to a spreadsheet on the second. And I can compare a prior reconciliation to the current month, which is useful for complex reconciliations. (If you’ve ever prepared or reviewed a tax provision, you get what I’m talking about!)
  • Follow multistep directions. I can read a help screen or an email from the IT department to do something in an application open in the second monitor.
  • Keep an eye on email. I keep my email window open on one monitor to quickly scan incoming emails while I’m working in the other monitor.
  • It’s even possible to put worksheets from the same workbook onto different windows.

It took me only half a day to get comfortable using a second monitor and finding the physical arrangement that worked best. You can stack the monitors one above the other or put them side by side (my preference).

I have a second monitor that travels with me as needed to supplement my laptop. Now I no longer have to squint at small text trying to have more than one window open on my laptop screen. In fact, the larger monitors available today make it comfortable to view four windows at a time.

As more work is done in soft copy, using more complex applications, don’t be surprised if you find yourself wanting a third monitor!

 

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Academic accolades for debt finance guide

Well, OK, we haven’t earned an honorary Ph.D. (yet). But we were heartened to learn that a teacher at DePaul University was so impressed by Chris Kondo’s recent report, “Debt Is Good (Sometimes): How to Tell When Borrowing is a Smart Way to Grow,” that he’s going to share it with his treasury management students.

Kudos to Chris for developing a clear and insightful guide that will be useful in a way we wouldn’t have imagined. (We let the DePaul teacher know about Chris’s second piece too: “Debt Demystified,” which tackles how to evaluate debt financing terms and structures.)

 

 

 

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Sales of private shares presenting new challenges; SEC reviewing rules

Last month, SEC chairman Mary Shapiro told the House Oversight Committee that the commission is reviewing the rules and restrictions surrounding the sale of private company stock. Current restrictions include, among others, a limit of 500 shareholders and the prohibition of general solicitation.

The SEC’s increased scrutiny of private company stock sales is the result of the increased visibility of these transactions, as shares of  Facebook, Zynga, Twitter and other highly anticipated IPO candidates are in high demand and are being resold to other individuals or entities. New Internet-based platforms, such as SharesPost and Second Market, that connect buyers and sellers in these private transactions are also upping the ante. (There’s a good look at the issues in the New York Times’ Dealbook blog.)

Companies and boards are responding in different ways to this pressure. Some, for example, are placing additional restrictions on private stock transactions or implementing new governance and internal control policies.

Where this is heading and what actions the SEC might take are up in the air, though the SEC said it’s considering loosening some restrictions, eliminating certain disclosure requirements, restricting communications in IPOs, and other measures. All parties—sellers, buyers and regulators—have their own agendas and responsibilities. But it’s certain that oversight and administration of private company stock sales will be an increasingly common challenge for company management and finance teams.

However it plays out, if you’re a company with privately held shares, you’ll need to consider a number of strategic and administrative issues, including:

  • Exercising the right of first refusal and other considerations such as co-sale rights
  • Control and knowledge of the shareholder base
  • Implications on your 409A valuations and future stock option pricing
  • The need for trading windows around the transactions
  • Implementing an insider trading policy
  • Defining what information will be released to new purchasers
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Entrepreneur insights: be open, take risks, encourage questions

My colleagues and I have just finished over a dozen interviews of Bay Area CEOs who were regional semifinalists in Ernst & Young’s Entrepreneur of the Year Award program. It was an amazing opportunity, and I want to share some of their insights on managing businesses, leading teams, what motivates them and how they overcome obstacles.

But first, congratulations to the 58 semifinalists—and 30 finalists, who were announced yesterday. There was a record of 166 Northern California nominees this year. The regional winners will be announced at an awards gala June 25 at the Fairmont in San Jose. RoseRyan is proud to be a sponsor of the program, which is in its 25th year.

  • Many candidates are serial entrepreneurs and have made fortunes; however, even though many of them don’t have to work, they wouldn’t want to be doing anything else. The most dominant theme: a strong work ethic and family are most meaningful to these CEOs.
  • One CEO shared three lessons on building successful companies: Figure out how to address the business problem, keep a synergy with your core business when you expand the tool set, and recognize that strategy that works in one area doesn’t necessarily work in another.
  • All these people share a sense of action. As one said, “You can’t just talk your way out of situations, you need to take actions. That is what employees and customers are expecting.”
  • I asked one candidate how he’s gone from being a technologist to running a company that is looking at an IPO. He said, “You need to be coachable by the top talent you bring in to run the functional departments.” True insight from a leader.
  • Several CEOs believed that honest communication and total transparency kept their employees with them during “dark hours.” “If your employees know who you are, where you are going, and who you are not or where you won’t go, it helps them make the best decision,” noted one. “If you have a 25-year-old programmer working at  2 a.m. [and] he/she doesn’t know what the company is all about or know exactly where we are going, they may make the wrong judgment.”
  • Some CEOs said that they like it when an employee questions a direction, because they know it means others are wondering the same thing. This was a good demonstration of leadership: A CEO doesn’t always have to be right, but they do want open discussion with their employees.
  • They all have vision—they are looking three or more years down the road.
  • They all take risks. Part of being a risk taker is a strong belief in yourself, your ideas and the people close to you in the effort. This was evident with every individual. It’s easy to look back and say you took a risk and it worked, but I think what separates these folks from most is that they did take the risk.
  • Here’s one for us finance pros. We asked the CEO of a company that recently went public what it’s like being public. He said (and I quote), “Being a public company is easier than being a private company because of corporate governance.” He said he wasn’t talking about SOX (leave that to the CFO) but about goals. Multiple investors with restricted stock have varying priorities; once public, their shares are converted to common stock and they are all on the same page about what the company needs to do.

Finally, what makes an entrepreneur or visionary? Lots of things. But one said it was because he has a “gift of talking with financiers and can translate the tech stuff into commercial talk.”

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