Chris Clapp, Managing Director, MorganFranklin Consulting

Michael Dandalides, Senior Manager, MorganFranklin Consulting

When preparing to file for an initial public offering (IPO), companies face many complexities and operational challenges. These nine lessons learned can help organizations avoid common pitfalls and prepare for life as public companies.

1. Identify the key drivers and metrics of the company’s success early. Early in the process, companies should identify the key financial metrics and other information they plan to provide to investors post-IPO and consider if this information can be included in their registration statements for additional consistency. Defining these key performance indicators (KPIs) is important, but being able to evaluate their impact on the business is even more crucial. Specific consideration should be given to the metrics that peers use to describe their businesses and guide future performance, along with any additional supporting materials they provide. Understanding and adhering to these standards will ensure that a company’s information is consistent with what investors are accustomed to receiving from industry peers while also demonstrating a commitment to open and honest communication. Additional financial and operating characteristics critical to understanding the nature and strength of a business can and should be provided.

2. Perform valuations early to prevent filing delays. The value of a company’s common stock typically experiences a drastic increase leading up to an IPO. Additionally, pre-IPO companies are often unaware that some complex financial instruments must be marked to fair value at each reporting period. Insufficient historical common stock valuations or failure to fully analyze these instruments up front can leave companies scrambling to perform third-party valuations and receive sign-off from external auditors. Unfortunately, the complex and time-intensive nature of such analysis often delays filing timelines. These costly delays can be prevented by evaluating a company’s historical common stock valuations, completing an inventory of all potential fair value instruments, and assessing the required valuation dates.

3. Maintain detailed legal documentation and ownership records. To complete an IPO, company ownership interests—including preferred stock, common stock, warrants, and stock options—must be tracked accurately from inception to date, and all corresponding documentation must be maintained properly. An IPO is an equity transaction, and a company’s existing capitalization table must be complete and accurate before issuing additional shares of equity. Proactive efforts can help companies avoid retroactively cleansing data and obtaining paperwork approvals from the board of directors. Companies must have capable systems and adequate processes in place for real-time tracking of stock-based compensation activity such as stock option grants, exercises, and forfeitures. Maintaining quality legal records, including board minutes and stock option agreements, can help prevent costly delays during the IPO process. Additionally, companies should be prepared to provide corporate documents during the due diligence process, and they should contemplate which material agreements will be filed as required exhibits to their registration statements.

4. Prepare quarterly financial data for SAS 100 reviews. For trending purposes, underwriters often require that financial information for the most recent eight quarters be presented in the Management’s Discussion and Analysis (MD&A), and they may request SAS 100 level “comfort” on these numbers. Interim financial statements included in the S-1 filing must be presented in accordance with U.S. Generally Accepted Accounting Principles (GAAP). The reality is that many private companies do not perform hard quarterly closes reflecting all necessary GAAP adjustments (e.g., they do not “true up” tax entries on a quarterly basis). This leads to unexpected delays as auditors complete their SAS 100 reviews of quarterly financial data—delays that can be prevented by identifying and recording missing quarterly entries before external auditors begin their reviews.

5. Don’t underestimate the time needed to complete PCAOB-compliant audits. Private companies generally have external audits performed in accordance with American Institute of Certified Public Accountants (AICPA) standards. However, annual financial statements presented in a registration statement must be audited in accordance with Public Company Accounting Oversight Board (PCAOB) standards. Companies are often surprised by the level of scrutiny external auditors apply during the transition to PCAOB-compliant audits. It is not uncommon for external auditors to request increased documentation from management and reassess past judgmental accounting conclusions. Management should maintain an inventory of all critical accounting issues and prepare technical accounting memoranda documenting conclusions for each issue. Critical accounting issues often include revenue recognition, capitalized software development costs, segment reporting, earnings per share, stock-based compensation, and other complex equity transactions like redeemable preferred stock and warrants.

6. Consider the implications of acquisitions. A company’s ability to communicate a good “story” is key to a successful IPO—and strategic acquisitions can greatly alter a company’s story. Certain types of companies earn significantly higher valuations in the public markets than others. A strategic acquisition can unlock synergies and lead investors to value a company differently. Companies should also consider each acquisition’s U.S. Securities and Exchange Commission (SEC) reporting implications. Depending on the significance of an acquisition, a company may have to provide up to three years of financial statements for an acquired business and present pro forma financial information. Preparing these disclosures can impact the timing of a registration statement filing.

7. Implement systems and processes. In preparing for IPOs, companies must evaluate their current systems and processes to determine if they will support life as public entities. For example, some pre-IPO companies still use general ledger systems designed for private companies that will not scale effectively with the businesses. As companies look to upgrade their systems, they should perform thorough evaluations of their requirements and the available options, choosing platforms that meet their current needs and offer flexibility to grow as the companies grow. Additionally, management should begin thinking about Sarbanes-Oxley Act (SOX) compliance and its impact on the business and day-to-day processes. An initial SOX assessment will provide insight into an entity’s key controls and help identify problem areas that require remediation for a company to ultimately achieve SOX compliance after going public.

8. Assemble a team of advisors. A successful IPO requires effective coordination of numerous stakeholders, including company personnel, company counsel, underwriters’ counsel, external auditors, investment bankers, accounting advisors, financial printers, investor relations resources, and valuation specialists. These stakeholders are vital to the IPO process and must be engaged early to ensure that they are ready to support the operations and growth of a company before and after it goes public. External partners provide experience and expertise in completing both the filing process and post-filing tasks. Identifying the right external partners is integral to ensuring a successful and smooth transition to public-company life.

9. Understand that ringing the bell is just the beginning. Successfully completing and filing the effective registration statement and watching the stock start trading may feel like the finish line, but it is really just the beginning in terms of life as a public company. As public registrants, companies must consistently and accurately close the books and produce financial statements by the required reporting deadlines. Companies often need to reduce financial close cycle times to meet SEC reporting requirements and, in addition to producing timely financial information, companies must also provide accurate guidance to investors and analysts. Accurately forecasting revenues, earnings per share, and KPIs is critical, as analysts will build their models and measure a company’s performance against those expectations. A company’s stock price may experience negative pressure if actual results “miss” the forecasted guidance. Enhancing the financial planning and analysis (FP&A) function early on the road to an IPO will provide an opportunity to fine-tune processes and avoid a disappointing earnings call for the first reporting period as a public company.

Download the PDF to learn how companies can prepare for an initial public offer (IPO). To learn more about how MorganFranklin can assist your organization, visit our IPO Readiness services page.