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IPO Readiness in Today’s Market

May 03, 2016

Finance leaders have to manage a diverse set of challenges in the run-up to an IPO, from system upgrades to market perception to a lack of companywide enthusiasm for controls. Experts from Armanino and Nasdaq recently joined finance professionals from leading Bay Area technology firms for a wide-ranging discussion about IPO readiness in today’s market. Here’s a summary of what participants had to say about some of their biggest concerns and best practices.  

Building processes and controls
From an operational standpoint, the pillars of IPO readiness are strong financial reporting systems, risk management, corporate governance, compliance and internal controls. As finance leaders work to put this foundation in place, their greatest challenge often is getting the rest of the organization on board. “The biggest difficulty is not necessarily in the design of these changes, but in maturing these processes and systems so they are consistently performed and hold up to external scrutiny,” said Eric Weis, a partner in the Governance, Risk and Compliance practice at Armanino.  

This transformation from the design stage to the maturity of operating like a public company can take up to two years, said Weis―something executive teams, and even some investors, may not expect.  The C-suite often has to be educated about the requisite governance and infrastructure changes, and the time it will take to put them in place. If this is the first time executives have had to consider things like IT general controls, the finance team needs to explain the issues, avoiding “legalese” as much as possible, and find a way to engage them in these unfamiliar conversations.

Documentation is critical to process adoption, and finance leaders said that to be effective, it has to be done in a user-friendly format. Flow charts are a lot more palatable, and more likely to be followed, than a Microsoft Word memo.

Another key part of documentation efforts is bringing in a technical accounting and controls specialist. The recommended timing of this, from a control standpoint, is six quarters before the IPO. But because IPO timing is so dependent on market conditions, participants advised bringing in someone who can handle the technical side but is also interested in operational work. If the IPO date is pushed back, this dual-purpose technical person can slot in to the finance team and help with the close process and other value-added work.

From a technology perspective, you need to implement systems that allow you to operate efficiently as a public company, including enterprise resource planning (ERP), customer relationship management (CRM), budgeting and forecasting, and equity management systems. Timing-wise, ERP is usually the core driver of the change, and successful companies typically have their systems in place early enough that they have time to build and document the surrounding processes, said Scott Schwartz, leader of Armanino's Equity Management Solutions practice.

If you want to go public, you should start acting like a public company 6 to 12 months before your IPO date. Making the needed process and system changes is heavy lifting, but it adds lasting value. “The IPO process is not just a way to get all your internal controls and governance in place, it’s a way to improve efficiency and build a better system to run your business,” Schwartz said. 

Reining in internal stakeholders
One finance chief said that the IPO is like a wedding, with a lot of pomp and show, but being public is like marriage―a lot of continuous, hard work. Ensuring that the whole organization is ready and has the discipline it takes to operate as a public company is a top concern for finance leaders.

In many cases, the founders are the people that need reining in the most.  They may be used to making overly optimistic statements to venture capitalists, for example, but in the public markets, this kind of overpromising can torpedo a stock price.

Holding mock earnings releases, where employees or board members ask point-blank questions about things like missed revenue targets (the finance team can plant some of these questions), is one way to help executives prepare to lead a public company.  You can also set up quarterly calls with investors, to familiarize business leaders with the types of questions this audience is likely to ask.

The sales/acquisition team is another group of internal stakeholders that often needs to be reined in―so they don’t get overly aggressive with contracts, for example, or follow the wrong procedure for insertion orders. One best practice is to hold quarterly meetings with the group, so they know you are going to enforce the controls and processes and audit their work. This is also an opportunity to get together to refine your processes and controls, and improve the business.  “It shouldn’t be finance versus sales, it should be a collaborative effort,” said Schwartz.

Positioning yourself in the market
Market perception is a key external issue for IPO-bound companies, especially if they are trying to redefine how they are valued. A firm may want Wall Street to view it as a software company, for example, even though software only accounts for part of its revenue.

The sooner you can start framing your company’s narrative, the better. “Especially if you’re going to try to start a dialogue with analysts, you want to have a real story to tell, and you want to start crafting it early,” said Jeff Thomas, vice president of listings for the Western region at Nasdaq.

To do this, firms are bringing on internal or outsourced investor relations (IR) staff well in advance of their IPO.  Private companies are raising money from mutual funds and other public investors earlier and earlier in their life cycle, and a dedicated IR staff also helps them satisfy these investors, Thomas added.

You need to determine which key metrics you want to be valued on and put your reporting processes in place early, so you can set the right market expectations from the outset. Metrics are critical to a narrative, and Thomas said that in the past 5 to 10 years, firms have been using more non-financial performance measures. Netflix, for example, talks about customer lifetime value calculations and churn.

As you develop an IR strategy, keep your chief marketing officer looped in to the conversation, as well. The marketing team can tell your company’s story and use the IPO to build brand awareness with your partners and customers.  

Creating robust forecasts
When you make the jump to the public market, you have to withstand more stringent scrutiny and be able to create a predicable model that is easy for Wall Street to understand. Participants said that involving your sales/acquisition group in the forecasting process can help these efforts. Educate the sales team about how you’re building a bottoms-up view, and present your findings to them each quarter. This keeps the sales reps informed about what’s going on in the business, shows them how the finance team adds value, and gives them an incentive to pass on information to you.

One participant, who works with sales finance, sits in on the sales reps’ weekly call. Although he has to take some of their deal projections with a grain of salt, he uses the information to add background and color for IR efforts. 

Technology obviously plays a key role in improving your forecasting. Timing-wise, one controller said it took about nine months for her finance team to get comfortable when they made the switch from Excel to a forecasting tool.

Liquidity and employee retention
In the current market, many companies are taking additional rounds of funding and staying private longer, which can cause employees to get restless.  To hang on to good people, firms are looking at ways to offer them liquidity, such as doing tender offers. In 2015 NASDAQ Private Market ran 40 private company tender offers, over half of which were company buybacks, said Thomas.

Participants cautioned that you need to limit the percentage of vested equity employees can sell. In a typical program, companies allow employees to sell 10% to 20% of their vested shares, to keep their interests aligned. Another thing to consider is the overall impact of these retention strategies.  From an accounting standpoint, doing multiple repurchases can change your stock option charge from an expense to a liability, for example.

You also have to think about 409A issues. In general, quarterly valuations are reasonable if you are 12 to 18 months away from your IPO, but if you’re doing a liquidity offering, the best practice is to do a valuation right before the offering and another one right after.

The IPO is just the beginning
Although the IPO date is a focal point, IPO readiness is really about preparing for what comes next. That first quarter―when your timing is different, your auditors are more stringent, and you have to file a 10-Q or maybe a 10-K―is when the real race starts.

“You need to think about the IPO process not as about going from today to the IPO,” said Schwartz, “but as about going from today to acting as a public company.”

Learn more about how Armanino can help you with IPO readiness.

May 03, 2016

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