SMA President David Calusdian recently sat down with two partners at accounting advisory firm CFGI, including Shawn Assad, Managing Partner of the firm’s Washington, DC office, and April Coleman, leader of the firm’s Capital Markets Advisory team, to discuss the critical steps that pre-IPO companies should keep in mind ahead of an initial public offering.
David: When do you typically get involved with a pre-IPO company, and how much time before the filing of an S-1 should a company start working with an advisor like CFGI?
Shawn: For most businesses it’s a good idea to start preparing for an IPO at least 12 months before filing a registration statement with the SEC, which allows us to do an operational diagnostic to assess the current state of people, processes and technology, and understand where changes need to be made to support growth and life as a public company. In most cases, it is necessary for companies to update or expand their accounting and finance functions in order to operate effectively as a public company. This can include making sure they have the right general ledger or enterprise resource planning (ERP) systems and other automated systems, the right number of accounting employees with the right level of experience and expertise, and also ensuring that they have the right processes in place to ensure they are able to close their books accurately and timely. And it involves preparation for an audit uplift to PCAOB standards, which may necessitate having formally documented accounting position papers across a variety of topics. In most cases, there are some gaps that need to be addressed.
April: It does depend on the company, industry and development stage. In Boston and in certain other markets, we support a lot of IPOs for early-stage life sciences companies. They may have only a handful of employees, their finance function might be focused on the basics, and in some cases, they may be primarily focused on cash transactions. In those situations, we are able to quickly assess the needs, pull together a team and help the Company through an audit uplift and the IPO on short notice. I call these projects “triage IPOs.” We are able to help the company move quickly and get smoothly through the audits, without sacrificing quality.
David: A triage IPO?
April: Essentially, coming in and doing a quick inventory of people, processes and technology; assessing audit status and readiness and using CFGI’s bandwidth and expertise to supplement a client’s team in order to meet the audit and filing deadlines of the IPO and beyond, when the company is subject to public company accounting and reporting requirements. For example, let’s say we identify eight topics on which the auditors will want formal accounting memos. We’ll put eight people with the right experience and expertise on those memos and complete all of that work, and others on audit support and financial reporting, as needed, so that all of the work is done in parallel. In this way, we are able to help our clients through audits and get them ready to file in a couple of months. This allows companies to take advantage of a market window, even if they have not spent six months or a year preparing for an IPO. And we can continue to augment their team until they have hired additional talent to take the work back in-house.
Shawn: If a company is planning to pursue an IPO, we’re trying to understand if there were any disagreements on any technical accounting topics between them and the auditors, or if we believe the conclusions reached by the company might put them at risk for comments from the SEC. We sometimes need to resurface these issues and make sure the conclusions are correct and agreed on by both the company and the audit firm. In the context of an IPO, any prior disagreements or judgment areas are a big deal and it’s important to get them right and make sure the company is aligned with auditors and the SEC.
April: The auditors require that formal level of documentation because they need to consult with their national offices when performing a PCAOB audit in connection with an IPO. Where they may have just looked at the accounting, the journal entries, talked through the conclusions and signed off on less formal documentation in the past, they will require formal documentation that they can put in front of the national office reviewers for anything that’s complex or highly judgmental. An IPO is a high-risk engagement for the audit firms, in terms of the level of scrutiny.
Shawn: Operational excellence comes from three things: your systems, your processes, and your people. We look at your people and their experience relative to your size and industry and see what may be needed. If you don’t have the right systems, how can you be compliant when you become a public company? You need to make sure that your ERP system can accurately capture and process data to allow your team to produce accurate financial statements on time. And, of course, you need to have appropriate and effective processes in place. Are they automated? Are they manual? How can we be more efficient, ensure accuracy and increase the speed of the financial close? Those are the three big buckets.
David: Let’s talk about people. How long before an IPO should a company hire a professional CFO? Must that person have public company experience?
April: That’s another one that depends on the company, industry and maturity of the business. I have supported companies that did not have a CFO, or that had a contractor from a professional services firm in the CFO seat through the IPO process. It really depends on the industry and size and complexity of the business. As for public company or IPO experience, that’s certainly helpful, but I don’t think it’s absolutely necessary. Also, I don’t think there’s a timeframe for when they have to hire, but the person in the CFO role needs to be able to articulate the company’s story, their go-to-market strategy, how they’re going to be successful, how they plan to use the IPO proceeds, etc. Moreover, they need to be able to speak knowledgeably about the company’s performance versus guidance once they are public. The person has to really know the business and be seasoned and articulate; someone who can have that conversation with investors and analysts.
David: What are some of the most common mistakes you see in S-1s?
April: One sticking point can be the number of reportable segments. One company we know of had a prolonged argument with the SEC about their conclusion on reportable segments. It was a long back-and-forth process. The company ultimately prevailed but by the time the SEC accepted their position, certain things happened in the marketplace that resulted in an IPO no longer being a compelling exit, and the offering was shelved. Another potential sticking point is confidential treatment. Sometimes companies want to redact too much information and the SEC objects. I’ve seen companies get stuck because, in the normal course of business, they entered into agreements with third parties that had very stringent and punitive confidentiality clauses. The SEC requires you to disclose material contracts and the company can sometimes be in a tough spot. They must either get the SEC to agree to some compromise that everyone can be happy with, or they have to go and negotiate with the third party, either of which can really slow things down.
Another problem can result from doing an acquisition during the IPO process. A significant acquisition can trigger the requirement to have pre-acquisition, standalone audited financials of the acquired business in the S-1. The company might have to pause the IPO while they arrange for the audits. Another one is when companies want to keep issuing equity-based awards throughout the IPO process. Companies need to suspend grants at a certain point in order to avoid cheap stock comments from the SEC, which will typically come during the road show. It’s pretty bad timing and can result in delayed pricing and the commencement of trading.
Shawn: Another area that can result in comments from the SEC is when companies use the S-1 like marketing material, “We are the best, we are the greatest, we are number one.” The SEC is going to ask how you are able to support such statements and will insist on fair and balanced disclosure of the good news and the bad, so that it is not misleading.
David: What else should pre-IPO companies be aware of as they start going through the process?
April: There are certain accounting (general ledger) systems and equity management systems that are widely used by privately held companies that will not support or be appropriate for public companies, and in some cases will result in the company being assessed with material weaknesses in their internal controls over financial reporting. It is important to upgrade certain systems either before the IPO or soon after to ensure the company is ready for compliance with the Sarbanes-Oxley Act and other reporting and listing requirements.
David: Any other red flags that companies should keep in mind?
April: One thing that comes to mind is, sometimes a client has loans to or from management. Companies need a plan to get those off the balance sheet prior to going public. We sometimes see overly complicated equity compensation schemes, or companies that allow practices like extending loans to executives to exercise their stock options, or that allow option holders to exercise the awards before they vest. These types of things tend to be unattractive to underwriters, and ultimately investors.
David: Anything else that would be helpful for people to know?
April: Most importantly, the company needs to be ready. They need to be at the right stage of development. They could have a great story and a great management team and still not be ready. But if you have a sufficient history, good growth trends or a clear path to commercialization or profitability, and a good story for investors, those are the things that will put you in good standing. And of course, there are elements beyond your control, like a favorable market. The window needs to be open. Investors need to be looking for places to put their money, and I think they are right now. Being ready for an IPO will put companies with a good story in a position to take advantage of a window opening in the market.
About CFGI:
Today’s rapidly changing operational and regulatory environment presents a unique set of challenges for CFOs, controllers and their teams. The need to adapt to uncertainty and complexity can strain limited resources. This can also present significant – and often costly – challenges when required skill sets, experience and operational expertise are not available.
Founded in 2000 by former Big 4 professionals, CFGI is an established industry leader with the resources to successfully navigate today’s complex accounting, reporting, tax and compliance landscape. An assemblage of top-flight professionals with in-depth public accounting expertise, CFGI is able to fulfill a variety of client needs without the restrictions of auditor independence. With a foundation of knowledge amassed while serving a variety of industries, CFGI is able to guide companies through a wide range of routine and complex business scenarios. The resulting partnership is an innovative resource with the power to address your most crucial accounting, finance and operational challenges. For more information about CFGI, please visit, www.CFGI.com, or contact Shawn Assad at sassad@cfgi.com or April Coleman at acoleman@cfgi.com.
About SMA’s IPO Investor Relations Practice
Sharon Merrill Advisors helps companies make the right first impression with the investment community. We’ll set a professional investor relations foundation in place, ready management for investor engagement and help you act like a public company well before you ring the bell on day one. We offer IPO program management; IR messaging and materials development; IR infrastructure creation; capital markets coaching; IPO readiness coaching; mock earnings and Q&A training; and executive presence coaching.
For more information about our IPO Investor Relations Advisory practice visit our IPO practice website here, or contact us.
