Thinking about the IPO
Sometimes it’s hard to know where to start when contemplating an IPO. The number of things to get done seems overwhelming. For most companies, only one or two members of the team have been through an IPO (and they often had limited roles, so never really learned the complete process). But, like most big projects, if you can start to break it down into more manageable tasks, it can be overcome. I’ll be honest - it will never be easy, but you can absolutely keep from going crazy with the right support.
IPO processes are amazingly unpredictable. We have frequently seen management teams asked by their board of directors to prepare rapidly for an IPO with little advance warning, which can lead to unnecessary stress and strain on a company, and missteps in execution. The good thing is that many IPO planning steps are also appropriate for a later-stage private company, particularly one that may ultimately be acquired. It is our view that most of the following tips would be equally helpful to a fast-growing private company with $50 million in revenue as to a company already planning for an IPO. We’re happy to discuss any time.
1. ADVISORS. Choose experienced advisors early, including attorneys and auditors. Significant experience in securities matters and public company financial reporting will be invaluable to company management, whether to support late-stage rounds with secondary liquidity to founders, or during the IPO process and afterward. On-the-job training for advisors is very costly – you need experienced advisors who have done it before. Stand alone IPO advisors (in addition to outside law firm and investment banks) have become much more common and can help you navigate the process of selecting investment bankers and developing your IPO story.
2. INVESTMENT BANKERS. Identify and begin meeting investment bankers and analysts in your market space well before you plan to start the IPO process. There is an opportunity cost to a banker of working with a company - it might limit other companies in the industry with which they work, time spent is time taken from other revenue generating activities. Therefore, you need to establish early on that it is important to them to work with you. As you get to know the bankers, start to consider appropriate number and mix of managing underwriting firms, including lead book-runner and other book-runners, and clearly defining roles. Even if you’re not planning to go public soon, cultivating relationships with top bankers early can be helpful – bankers are a great source of market intelligence, and can help you understand how your company would be perceived in the public markets or in identifying late stage investors or potential buyers.
3. BUILD OUT YOUR MANAGEMENT TEAM. You need to have the right management team in place. This can include CFO, a strong controller, financial planning and analysis team to prepare forecasts, and strong operational and sales management. It takes time for them to get up to speed, and they need to work with auditors to develop financial plan prior to beginning the IPO process. Not giving the finance team sufficient resources = delayed IPO or M&A exit.
4. MAKE SURE YOU CAN FORECAST YOUR BUSINESS. Unless you’re a biotech company with no revenue, your team has to be able to get a handle on your growth prospects - the ability to accurately forecast future results is one or the reasons SAAS companies have been so highly valued. If you’re an enterprise SAAS company, make sure you understand the math of your sales and booking process. If you’re not (for instance, if you’re a fintech company being paid on payment volume, or a consumer goods company selling things to the public), figure out how you can replicate some of the steady and predictable growth investors crave.
5. AUDITED FINANCIAL STATEMENTS. Delays in audited financials are the biggest cause of preventable delay in the IPO process. Make sure your PCAOB financial statements are close to finalized before commencing the process, audited by a leading audit firm with significant public company experience. It always takes longer to generate public company audited financials than people expect, particularly if the company has done any significant acquisitions in the years leading up to an IPO or significantly shifted its revenue model. Changes from private to public company auditing standards can cause huge issues if not done in advance. You will only need two full years of audited financial statements in your SEC filings if you qualify as an “emerging growth company.” If you have switched auditors during that period, consult with both firms, as your current firm may need to re-audit prior years in order to be able to give the underwriters “comfort” on all numbers in the S-1 registration statement. If you have undertaken acquisitions or other significant transactions, understand what additional financial statements may be required in your filing, including pro forma financial statements and separate audited financial statements related to the acquired businesses.
6. QUARTERLY FINANCIAL STATEMENTS. Most private companies don’t do a SAS 100 review of quarterly financials. Most underwriters will require eight quarters of reviewed financials if your company is generating revenue. In addition, you’ll need to prepare and present quarterly financials as the process moves forward. Undertaking the SAS 100 review of quarterly financial statements ahead of time will speed up the process later on. You can do this in conjunction with your PCAOB audit - but only if you ask for it and negotiate as part of your engagement letter with the auditors.
7. ADDRESS OUTSTANDING ACCOUNTING ISSUES. Work with your audit team to identify any sensitive issues in your significant accounting policies, and consult with auditor’s national office early and often. The SEC’s hot button issues are constantly evolving, and resolving revenue accounting and other issues can be time-consuming and also disruptive to the process. Restatements of financials have been known to kill or significantly delay IPOs.
8. AUDITOR INDEPENDENCE. Discuss with your auditors their independence under PCAOB and SEC rules. Understand what other relationships there may be between your auditors and your officers and directors. Be careful not to hire employees of your auditor until you understand the independence implications.
9. BOARD AND COMMITTEES. Understand the requirements for independent directors and the transition rules that will apply after your IPO. It takes time to identify and recruit new directors that will integrate well with your existing board and management, and finding audit committee experts to serve as audit committee chair is particularly challenging. Having at least one board member with significant public company audit committee experience in place prior to an IPO can be a helpful resource for a CFO during the IPO process. Be particularly aware of any close relatives of your board members who work for the company - did you give a summer job to the daughter of your audit committee chair? That could be a problem. Most of these independence issues can be addressed, but need to be dealt with early in the process.
10. CORPORATE GOVERNANCE. Begin to act like a public company. Focus on corporate governance appropriate for a public company and develop a culture of compliance. Work with counsel to adopt state-of-the-art corporate policies and codes of conduct.
11. INTERNAL FINANCIAL AND DISCLOSURE CONTROLS. Discuss with your advisors any “material weaknesses” or “significant deficiencies” in your internal financial controls and understand their impact on your SEC review. Many private companies end up with material weaknesses because of inadequate financial staff or insufficient accounting systems. Discuss up-front with underwriters and counsel during the process so that they have time to complete diligence. Be prepared to show your corrective actions. Also consider what key metrics (e.g. user numbers, non-GAAP measures, etc.) may be disclosed in the IPO registration statement and road show, and build internal controls to ensure the accuracy and consistency of these metrics over time.
12. SOX COMPLIANCE. Understand the transition period during which you will need to become compliant with the internal controls testing required by Section 404 of the Sarbanes-Oxley Act; if you qualify as an emerging growth company, you may have a few years before your auditors are required to formally test your internal controls under 404(b), but you will need adequate disclosures controls and procedures in place from the first days as a public company. Consider engaging an accounting consultancy firm (separate from your regular auditors) now to assist with compliance.
13. EXECUTIVE COMPENSATION. Consult with benefits counsel and compensation consultant to review compensation practices, including equity and non-equity incentives. Think about evolving at least some compensation from options to RSUs (restricted stock units). Begin to discuss compensation structure appropriate for a public company with board. Education of board may be required about typical compensation structures.
14. OPTION GRANTS AND CHEAP STOCK. Start getting more frequent 409A valuations (quarterly or more often) as IPO approaches and work with auditors to ensure that valuations are acceptable for accounting purposes. This issue has become more critical as the IRS has announced it will be targeting companies with cheap stock charges disclosed in their SEC filings for potential Section 409A enforcement. Consult with your valuation expert regarding their willingness to consent to being named in your SEC filings.
15. PUBLIC COMMUNICATIONS. As you get closer to an IPO, consult with counsel regarding public communications guidelines. Don’t discuss the fact that you may seek to go public, but you may want to begin a more formal process of regular business and factual communications about your company’s achievements which will enable you to continue to do so throughout the IPO process. Set up appropriate social media policies and review process for press releases. Key to communications is to always have a documented factual basis for all statements.
16. CORPORATE WEBSITE. Review and update your website to be consistent with draft registration statement as process goes along. Make sure you don’t make any unsubstantiated claims on the website.
17. STATE OF INCORPORATION. If you are not already a Delaware corporation, consider whether you should be, as the vast majority of public companies are domiciled in Delaware. Discuss with underwriters and counsel to understand impact on IPO marketing and shareholder rights post-IPO.
18. CORPORATE DOCUMENTS. Analyze charter and by-laws to make sure you are clear on who has approval rights. Review automatic conversion provisions in charter – would your IPO be a qualifying IPO that automatically converts preferred stock to common stock, or based on anticipated valuation range, could there be a need to negotiate with preferred? Who has registration rights? Do you have in place market “stand-off” agreements with all stockholders and optionholders agreeing to 180-day “lock up” in an IPO? Make sure that your capitalization records accurately reflect all stock, option and warrant issuances, transfers and cancellations. Outside counsel should conduct a full capitalization audit, and should analyze your historic option grants to ensure they have complied with Rule 701 of the Securities Act.
19. DUE DILIGENCE. Begin to assemble data room with all material agreements and corporate governance documents, and review minute books and material contracts, including any loan agreements and shareholders’ rights agreement, for issues in the event of an IPO. Consider the need for an IP assessment. The underwriters and their counsel will conduct extensive due diligence on your company, including a thorough review of these documents and matters. Many financial printers offer a datasite product, and some companies are using common online data storage firms like Box. Discuss pros and cons with counsel of different approaches.
20.RESERVE TICKER AND GET TO KNOW THE STOCK EXCHANGES. You can reserve a stock ticker symbol up to two years in advance of an IPO, which can be used on either exchange. if the CEO has a favorite, check on its availability early. Think about the ticker over the long term and try to avoid faddish tickers (not sure that SalesForce is thrilled to still be known as CRM….which described its business 15 years ago). Understand the benefits of both the NYSE and NASDAQ stock exchanges. Analyze the listing standards of your preferred market to ensure you will qualify to list there. Prepare to negotiate – NYSE and NASDAQ both want new listings, and will negotiate on marketing and other perks.
21. LEGAL DISPUTES. Review pending legal disputes and assess whether any of these disputes could impact the IPO. You’ll need to disclose to underwriters and possibly in the registration statement. It may be more efficient and cost-effective to settle prior to an IPO filing, when some litigants may get $$ in their eyes. If there are any parties that have threatened to sue, be prepared – many companies get sued promptly after filing to go public.
22. MATERIAL CONTRACTS AND CONFIDENTIAL TREATMENT. SEC rules require you to publicly file material agreements. Discuss with counsel which agreements may be required to be filed and review these agreements for confidentiality provisions that may need to be waived by the other party. The SEC has a review process allowing companies to redact portions of agreements that would be competitively harmful if disclosed. Don’t delay in figuring out how you are going to handle material agreements, as these requests must be resolved before pricing an IPO.
23. D&O INSURANCE. The exposure to liability is significantly greater for directors and officers of public companies than it is for private companies. Choose an experienced D&O insurance broker and coordinate with the broker early in the process to ensure that your officers and directors are adequately protected. Consult with experienced insurance coverage counsel before signing up a new policy – there are many important revisions that can affect future coverage.
24. PERSONAL FINANCIAL PLANNING FOR EXECUTIVES. Senior management should consult with personal financial advisors regarding wealth maximization and tax minimization alternatives. Bear in mind that any loans from the company to executives or directors must be repaid before the company’s first public filing with the SEC.