With IPOs, timing is everything, and many action items should be considered well in advance of engaging an investment bank. McDermott Will & Schulte’s Craig Garvey maps financial preparedness tasks that require the most lead time, from preparing whitepapers to support accounting conclusions during SEC review to adopting the reporting cadence dictated by commission rules.
Are you considering whether an IPO is right for your company or one of your high-performing portfolio companies? Alternatively, are you evaluating a sale or a crossover round?
These questions are front of mind for executives and private equity leaders as private-equity firms currently own about 29,000 portfolio companies worth an estimated $3.6 trillion, of which approximately 50% of such companies have been owned for five years or more, according to Bain & Co. There have been a number of recent successful IPOs, including Circle Internet, Ategrity Specialty, Chime Financial and Slide Financial, all of which have traded above their IPO price.
With a volatile macroeconomic environment driving lagging global IPO volumes (at lowest levels since 2016 according to LSEG Data & Analytics), these examples are important and positive indicators, as any exit decision depends on timing, fund obligations, market conditions and the expected IPO valuation. When it comes to exits, many companies choose a dual path, exploring both an IPO and sale exit concurrently.
If you are asking yourself these questions and think an IPO makes sense, you are about to embark on an exciting time in a company’s lifecycle. With IPOs, timing is everything, and many action items should be considered in advance of engaging an investment bank. Use this primer to develop your game plan regarding the pre-IPO preparedness process and actions you can and should be taking right now so you are not caught by surprise when it’s gametime.
Pre-IPO preparedness tasks fall into three principal buckets: financial preparedness, business preparedness and legal preparedness.
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Read moreDetailsFinancial preparedness
Preparing financial statements, financial modeling and forecasting will likely be the processes requiring the most lead time in an IPO effort.
Financial statements
Private companies produce annual reports audited in accordance with GAAP principles. Public companies, however, need to present financial statements presented and audited in accordance with the standards set forth by the Public Company Accounting Oversight Board (PCAOB). This “uplift” process to meet PCAOB standards can be burdensome and time-consuming.
During the uplift, a company must consider and reconsider numerous issues, such as segment reporting, application of public accounting codifications and auditor independence. Prepare a whitepaper to support your accounting conclusions. Whitepapers often serve as persuasive support during the SEC review process.
Depending on a number of factors, the company will need to include either two or three years of PCAOB-compliant audited financial statements with its initial registration statement submitted with the SEC. And for marketing purposes, do not be surprised when the investment banks demand a supplemental presentation of historic quarterly financial information.
The number of quarters presented is subject to discussion. Prepare to show quarterly financial information covering at least the four quarters of the most recently completed fiscal year and the fiscal quarters completed in the current fiscal year. Quarterly information should be reviewed by auditors, allowing them to provide “comfort” acceptable to the underwriting banks as part of the diligence process.
Prior to going public, management and its accountants should adopt the reporting cadence dictated by SEC rules. These timelines may be significantly shorter than the company’s private company financial preparation cadence. Practicing meeting deadlines can help identify bottlenecks and issues in the quarterly roll-up and close processes and avoid painful and embarrassing delays once public. Reporting in accordance with PCAOB standards and reporting on the SEC timeline will require a robust accounting and public reporting function. Evaluate the company’s accounting team early and determine whether additional members will need to be onboarded.
As part of financial readiness, take specific notice of any recent corporate acquisitions or divestitures. Such transactions may, for example, require acquired company financial statements or a recast of financial statements to reflect discontinued operations. These categories of transactions and other material events may require Article 11 pro forma financial statements to be included in the registration statement filed with the SEC. Pro forma financial statements are complicated and take time.
Relatedly, consider whether these corporate transactions create headwinds or tailwinds with respect to the narrative discussion of financial trends and results. Headwinds and tailwinds resulting from corporate activities often complicate a company’s ability to discuss and explain its financial results. Another practical consideration is that investors often demand to see actual historical results reflecting corporate integrations and divestitures for a sustained period, rather than just a pro forma look.
Modeling & forecasting
A company contemplating an IPO will need to build a two-year forward-looking model and practice forecasting. The model will serve as a critical item for analyst meetings. After completing the model, pre-IPO financial results should be compared to the models and forecasts to unpack issues and unforeseen considerations.
A company’s ability to model and forecast accurately is critical to establishing credibility with analysts and investors, an essential requirement with these constituents. The company will likely give guidance as a public company, so it is preferable to practice before the lights are bright. A failure to model and guide accurately is often damaging for public companies, causing price volatility and litigation exposure. Evaluate the company’s finance and financial planning and analysis functions early and consider whether additional personnel are needed.
Business preparedness
Write the company’s growth story. Investors have numerous investment options. It is imperative that a company positions itself as interesting and different. Articulate how an investment in the company provides a unique opportunity to invest in a slice of the market not previously accessible. Understand and substantiate the company’s tangible addressable market and its runway for growth. Explain the company’s current market position and its strengths, while also presenting investors with its strategies for achieving continued growth.
Study the company’s public company peers (or the best comparable companies) and understand how they communicate their respective stories. Understand the different non-GAAP measures peers use (such as, EBITDA and free cash flow) and the key performance indicators specific to the company’s industry (such as, recurring revenue, number of customers/patients and gross dollar retention). The measures disclosed are driven by two things: how management and the board evaluate the business and what analysts and investors demand to know as part of their investment thesis. Think critically about the measures that best present the company’s story and be ready to explain nuances and noise specific to the business. Plan to continue to report these metrics post-IPO.
Legal and compliance preparedness
As a public company, financial results and certain corporate events are public, and a company’s share price responds to news in real time. As such, the company will be subject to greater legal and compliance scrutiny. Take a deep dive into the company’s compliance programs. Are these programs ready? Does the company need to set up additional oversight, programs and procedures? Does the company have proper personnel internally or has it identified service providers to help with the ramp-up process?
With an IPO, participating investment banks and the company are exposed to litigation risk for any material misstatements or omissions in offering materials. Banks require a robust diligence process, including a review of legal documentation and auditor comfort on financial information; a number of diligence calls with management, auditors, legal teams and customers; and supporting documentation for certain factual assertions made in offering materials.
The internal legal team should start organizing contracts, board materials and other important correspondence, all of which will be requested and posted to a datasite. Internal legal should take account of any obligations or requirements in its contracts that are triggered by an IPO, such as investor rights, director nomination rights, liquidity rights, consent rights and registration rights. Look for circumstances where an IPO could trigger a “change of control.” For background, generally, up to 20% of a company is owned by the investing public upon completion of an IPO, with the remainder retained by the pre-IPO investors.
Craig M. Garvey is a partner in the Chicago office of McDermott, Will & Schulte. He has extensive experience providing counsel to publicly traded companies and leading various capital markets transactions for public and private companies, including the portfolio companies of prominent private equity funds. He also has significant experience with initial public offerings (IPOs), secondary offerings, high yield and investment grade debt offerings, liability management transactions, transactions involving special purpose acquisition companies (SPACs), restructurings and bankruptcies, and tender and exchange offers. 
