The Vermont Teddy Bear Co. Inc., a $66.6 million direct marketer of specialty gifts, best known for its Bear Grams, recently went private at $6.50 a share through an acquisition by private equity firm Hibernation Holding Company Inc. The company, which went public in 1993 and traded on the NASDAQ under the ticker symbol BEAR, terminated its securities registration on Sept. 30.

Compliance Week correspondent Melissa Klein Aguilar tracked down the company’s CEO, Elisabeth Robert—who also serves as CFO—to understand the role Sarbanes-Oxley played in the decision to go private, and the impact the law had on the company in general:

ABOUT THE SUBJECT

Elisabeth Robert is chief executive and chief financial officer of The Vermont Teddy Bear Company.

Robert joined the company as its CFO in Sept. 1995, was appointed a director in Jan. 1996, and was named treasurer a few months later. In Oct. 1997, the company's board appointed her to the office of president and CEO.

Before joining Vermont Teddy Bear, Robert was the CFO, EVP and founding partner of AirMouse Remote Controls, a manufacturing firm specializing in remote control devices. Prior to holding that position, she was an independent management consultant, and served as director of gas supply for Vermont Gas Systems.

In announcing the decision to go private, you cited Sarbanes-Oxley. How much of a factor was SOX, and was it the sole reason for going private?

It was not the sole reason. But there’s no question it was a factor, along with a general assessment of the marketplace and a desire to get our stockholders liquidity at the best available value.

I would say SOX was a material factor. It was becoming an increasing burden on our company over the past few years. Last summer, we were looking down the barrel of [Section] 404 and the internal controls documentation and testing. That was a barrel that we felt was onerous in terms of the additional cost, internal resources and distraction to the organization it would impose.

We’re a very small company and we have a small financial team. I’m both the CEO and CFO. Therefore, it was an added distraction to me at a time when the company was faced with growth opportunities. I felt personally the burden of SOX on my mindspace, on my ability to think about the future of the company.

You said you’re a small company. Describe “small.”

We had $66.6 million in sales for the fiscal year that ended in June 2005. We have about 300 full-time employees. We’re also a manufacturing company—we do all of our own direct marketing and we manage call centers and distribution centers. We consider ourselves an “insourcer” as opposed to an outsourcer. And our resources are limited, as they are in any small company.

How much of a factor was the cost of compliance, and do you have an estimate of what complying with SOX would have cost VTB?

While cost was certainly a factor, it was no more weighty than the distraction and depletion of mental energy.

We estimated the cost of complying was going to move from about $200,000 to $300,000 historically as a public company, to in excess of $600,000. That’s about 1 percent of our revenues.

A concern was not only what we estimated for the cost this year, but that the costs don’t seem to be leveling off. It seems that every prior estimate is significantly below what the current [cost] estimate is. From talking to our auditing firm, the expectation was that the costs of auditing in the SOX environment were going to continue to go up.

As a matter of philosophy, I don’t object to SOX. I think corporate America has brought this upon itself and to a large extent, deserves this. My concern is that there has been no sense of proportion. There needs to be a reassessment on the part of regulators to ensure that, proportionately, the compliance routine is manageable and makes sense for smaller companies.

Can you give us a breakdown of that $600,000? How much was internal versus external?

About 80 percent of it—all but about $100,000—was our estimate of external costs related to legal fees, auditing fees and support fees to develop the internal documentation and the testing standards for 404. The rest was associated with beefing up the internal controls function within the company.

We've been hearing that relations and communications between small companies and auditors are strained. What was your experience over the last year?

I think some of the strain comes from the fact that the auditors seem to be more into the minutia—they seem to have revisited their thresholds of materiality. We were seeing adjustments or things called to the attention of the audit committee that were not correctly accounted for in the range of a thousand or even hundreds of dollars.

The biggest strain, in my view, comes from the auditor independence rules. You have this team of experts, your auditors, and yet you really aren't able any longer to get the right answer from them or have them help you get to the right answer on how to account for a complicated transaction. You have to go the FASB Web site and look up the accounting rules, and you have to come up with the answer and they audit it.

I understand that in the case of Enron, Andersen ended up doing too much of the work and that compromised their ability to audit objectively. But for a small company, to have to have that level of expertise to deal with complex transactions when you have a team of experts that you work side by side with and pay for an audit seems ludicrous. It's very challenging and frustrating to not be able to get guidance and interpretation from our auditors. They're the experts. It seems counterproductive to providing the best possible financial reporting and disclosure for the shareholder.

The SEC and the PCAOB acknowledged that “chilling effect,” and have said that wasn't what the rules intended. Did that change anything?

I haven't seen any indication of a change. I got the sense the auditors are willing to be flexible and gives us clues to help point us in the right direction. But many times we tried one way and were informed that it was wrong, so we had to start over. I feel it has created an enormous amount of extra work, and it seems to be inefficient use of resources.

The SEC is looking at the effect of SOX on smaller companies, and they recently extended the 404 deadline for smaller companies by another year. Do you think that will help?

SOX wasn’t the only reason we went private. There were many reasons that it benefited our stockholders. But, we’re also not the kind of company to sit around and wait for somebody else to change how they regulate us. The SEC made its bed. They may want to realign the blanket and sheets, but they’ve done what they’ve done. Companies have to move forward.

We never held back throughout the process. We’ve been on a path to be compliant since Section 404 was introduced. We applied as much diligence and care and accountability in our 10-K filing this year, just before the transaction closed, as ever. We took seriously the need to be complaint. We had already made some progress toward the 404 certificate.

To say the SEC is now showing signs of relaxing a bit—there was no certainty there and we don’t know what it will ultimately rule in terms of any modifications for small businesses.

Can you tell us about the process you went through in arriving at the decision to go private? Who participated in that decision-making?

First, you have to realize that 12 shareholders own approximately 75 percent of the shares. We’re very closely held. Therefore, the majority of our shares were able to weigh in well in advance. There was a desire for liquidity on the part of many shareholders and a sense that the time was opportune to achieve the best value for all shareholders. Less than one-half of 1 percent of our voting shares voted against the transaction.

What did the process of going private entail? Was it difficult?

It was probably the most difficult business transaction I’ve ever been involved for a couple of reasons. The number of parties at the table is more than in a normal M&A transaction. You have the buyer and the seller, as well as a special committee of independent directors. Each party had its own financial advisory representation, and its own legal counsel, and you have the SEC on top of that. It’s an enormous number of people weighing in on myriad issues.

We started out contacting close to 84 potential buyers. That was narrowed to eight initial bidders. Then during the bidding process we narrowed the field to three, then one. The sheer diligence of the auction itself made this very complicated.

It was a delicate balancing act to achieve a win for both the exiting stockholders and the buyer. There’s a magical point where you’ve assured the exiting shareholders that they’re getting the best available value and the incoming investors are assured that the price they’re paying is aligned with their future return objectives. It’s more paramount to achieve that magical win-win in this process than in most types of M&A transactions.

How long did the process take?

From start to finish, it took about 13 months. The formal beginning was October of last year, when we engaged the investment bankers. But as a management team and board, there was some discussion for about a month leading up to that point.

One final question: Do you have any advice for other small companies in the same boat as VTB?

My advice to companies that are considering going private is to make sure that they have the support of independent directors who can participate credibly on a special committee. They also have to have legal and financial representation that's had experience with going private transactions. And, they need to be prepared for entertaining a very robust, diligent process that is very time consuming and very difficult.

Thank you, Elisabeth.