Getting Fit

Is your company ready for another layer of sophistication? Are your company practices scalable for growth while ready to respond to increased regulation, compressed reporting cycles and financial transparency? It may be time to become publicly fit so your management team will be ready to make the leap to a public company when the timing is right.

Based on the size and financial complexity of most midstream projects, becoming a public company is not a choice, it is a necessity. At some point, your early investors will want to cash out and your growing business will require much more funding than you can generally secure in the private environment. Then it may be time to access capital markets.

The good news for midstream businesses contemplating an eventual move to the public markets is that your company’s overall infrastructure and corporate culture is generally far more prepared to make the transition than many other types of companies, such as upstream oil and gas businesses where operations may revolve around a single risk-taking entrepreneur or a small group of entrepreneurs. Despite having somewhat of a head start, midstream businesses will find that preparing for a public offering is still time consuming and requires meticulous attention to detail because the financial metrics are different from other types of companies.

Here are the five incremental steps needed to make your company publicly fit:

• Augment current financial reporting capabilities;
• Adapt compliance requirements to include Securities and Exchange Commission (SEC) reporting;
• Modify risk-assessment processes;
• Expand corporate governance practices; and
• Strengthen internal controls and information technology systems.

Financial reporting

Generally speaking, midstream businesses already have established robust financial reporting capabilities. Your major investors, who have already risked millions to help you build your plant or your pipeline system, require periodic, timely, accurate accounting.

As a result, such reporting has already become an integral part of your culture. To move your company to the next level, however, you do not get a pass. The difference between reporting to private investors and reporting to public investors may be somewhat underestimated, but the differences are critical. For example, public companies have essentially non-negotiable reporting requirements that must be timely, accurate and comprehensive. While you probably maintain a similar rigid schedule for your private investment group, missing a deadline will not trigger a regulatory review or loss of trading privileges, as it could if you are either not timely or not accurate with public-company reporting requirements.

To begin the process of augmenting your reporting capabilities, you need to fully understand the strengths and the shortcomings of your current capabilities. Do you have the internal resources needed? You should accurately assess the level of expertise of your current personnel and the level of sophistication of your current financial-reporting technology.

For example, you may need to build your financial team, which is a cost that must be weighed carefully but cannot be shortchanged. A mature internal reporting infrastructure requires a team of financial experts, each with different roles and reporting responsibilities. While your company probably already employs some top financial minds, their duties may be too broadly defined.

At the very least you may need to hire someone new or prepare a current employee to assume the role of chief financial officer (CFO). While this title may already be part of your company’s structure, you should examine the actual duties to determine if the role is properly defined and positioned with the board and if the person filling the position has the appropriate experience and background. A CFO at a public company is a highlevel member of your management team with direct responsibility to the board of directors and, as such, will command a significant multi-layered compensation package.

While your company probably already generates relatively sophisticated financial reporting data, your technology may not have the capacity required for public companies. You should have fully automated systems capable of generating reporting in a wide variety of ways. Each member of your new financial team will have a specifically defined role and must have the capability to dissect and analyze data based on a specific point-ofview— but still within consistently applied accounting policies and procedures. This level of sophisticated financial technology allows you to generate both internal and external reporting that provides the data needed to make solid, long-term decisions, which is particularly important to midstream businesses.

For example, a midstream company building a multimillion- dollar storage or pipeline facility needs reliable, real-time financial performance data—viewed from several angles—to allow for intelligent decision-making based on a return that is years away and includes millions in sunk costs. Once the project is in operation, your financial team will be dealing with a predictive revenue model. This means there is a higher expectation that the skill set needed includes someone who really understands long-term planning, financial modeling, construction estimates and other such matters.

Compliance requirements

For a midstream company, this step may be one of the easier ones. Your company most likely already generates monthly, quarterly and annual reporting for sophisticated, exacting private investors. That same mindset applies to SEC reporting, but the procedures will most likely require some enhancing. In fact, depending on your type of business, you may already comply with government-mandated compliance requirements, such as Federal Energy Regulatory Commission compliance, so you have some understanding of the level of detail the government can require.

The SEC has specific reporting requirements that may necessitate some reporting adjustments or additions to your current efforts. Most business management teams, for either public or private companies, are at least familiar with the more common SEC disclosures, such as timely disclosure of material events on SEC’s Form 8-K, and the usual quarterly and annual financial filings.

Midstream companies have a high volume of material contracts with customers, vendors and partners, and the practices of negotiations and execution will need to incorporate thresholds for timely public disclosure.

The SEC has other requirements that may also require new procedures. For example, the SEC requires compensation disclosure based on your company’s most highly paid personnel. If those people are all top management, this may not be difficult to accommodate, but some companies pay significant compensation to marketing sales or plant engineers, who may not be immediately accessible within your current reporting process.

Additionally, if you currently rely on auditors for required annual disclosures for your private-equity investors, you will need to enhance procedures to internalize this as well because regulatory agencies do not allow public companies to rely on auditors for fundamental management functions, such as financial reporting.

Risk-assessment processes

For midstream companies, adapting to new compliance requirements may be fairly easy, but modifying risk-assessment processes is probably the most difficult step because of the strategic and long-term nature of riskassessment required for midstream companies.

While your risk-assessments already incorporate lengthy timeframes, unexpected extraordinary costs and other issues related to sales and deployment, at the public company level, your risk-assessment procedures need to also extend to internal processes across the company, which makes the requirement even more rigorous. As just one example, mature public companies focus on understanding and mitigating financial, operating, compliance and fraud risk to give comfort to the board and public investors.

On the other hand, private companies may be more focused on growth, while accepting a higher level of risk in return and unilaterally reporting that to the investors. Moving from a private to a public entity and dealing with risk acceptance and mitigation will take a mindset adjustment.

An example of increased risk-assessment requirements is the common industry practice of joint-venture deals, which include exclusive transportation contracts between upstream and downstream companies. This transfers some of the risk for midstream companies while at the same time providing for growth—if the company has enough credible contracts and can demonstrate a recognizable revenue stream.

However, these contracts also require highly sophisticated analysis capabilities that often include estimates, with all the potential variables, for a five- to 10-year period.

Despite all of these variables, demonstrating strong risk-assessment strategies within a public entity’s corporate governance structure is expected. Management is held accountable to the board of directors for the documentation.

As a private company, you probably already regularly report to a board of directors representing your privateequity investors. As a public entity, this responsibility is generally more formal and focused. For example, within a private company, the board may give the chief executive wide latitude because of its faith in his or her business talents. While that faith level may not change, the board of directors for a public company is much more keenly aware that they are representing public shareholders’ interests, and the board is the ultimate authority.

A workable structure for a public company requires company management to be held accountable to the board, which is independent but not disconnected from the company’s interests.

Internal controls and IT

Scalability is critical for technology-reliant procedures in a public company. While midstream companies tend to have more sophisticated technology than private companies in other parts of the oil and gas industry, your company may still need to earmark substantial funds for upgrades. A publicly fit company needs robust security, consistent backup and 24-hour support. Public companies are required to maintain readily accessible records. Most public companies keep those records at the ready for at least five years to satisfy this requirement.

If the time has come to move your private company to the next maturity level, begin by deciding which members of your management team will be responsible. Then prioritize new procedures and controls over financial reporting, compliance and risk-assessment utilizing technology. Finally, determine the timeframe you are willing to allow to convert your processes and establish a detailed plan aimed at accomplishing those goals within the allotted timeframe. Start now to realize the increase in value by matching your company’s maturity and readiness to be public with your control maturity.

The process of becoming publicly fit can be lengthy and, at times, onerous. However, midstream companies have little choice because of the nature of their businesses and the vast amounts of capital required to operate within this arena. It is just good business for midstream companies to make the transition as smooth as possible through effective, advanced planning