Written by Part 2 of 5 of How to Have a Successful IPO and Beyond
Having a comprehensive financial foundation in advance of an IPO success should go without saying, but it goes deeper. Not only is it important to keep in mind that a piece-by-piece approach to deploying financial software can prove costly over time. We generally do an annual review of our finance function and make sure it is scale-ready and that all internal controls are buttoned up. If there is a major platform upgrade, this has to be done well in advance. And remember a migration to Netsuite or Intaact generally takes a lot longer than the 6 months promised by the vendor/implementation specialist.
Also, be aware that regulatory requirements will prohibit you from changing any financial systems during the IPO process and for one year thereafter. Without a system in place that gives key stakeholders appropriate and real-time access to critical data, the journey gets tougher and you can potentially get flagged for internal control issues (we’ve seen this a lot). Start backwards from the target date and add 6 months or so for cushion.
Companies looking to IPO should be prepared to provide three years of audited financial data. Investors will want to see the detailed financials as they will build their own financial models. The buy-side will have your forecasts and they will do their own scenario analysis and then compare all your numbers with relative comparison companies (comps). The last thing you want them to worry about is the accuracy of these numbers.
Investors will want to see the growth and efficiency numbers such as ARR, RPO, and Fbillings growth, so make sure to define these non-GAAP items. Here’s a quick table:
All the info from your international subsidiaries and branches will tie in together with the appropriate inter-company elimination to detail how this works and show confidence that your financial infrastructure has the necessary controls to manage these quarterly processes as well as the flexibility to accommodate growth in the future. There will be a section to fill out in your filings for Significant Accounting Policies so be prepared with the data.
Internal Controls
High-growth companies typically underinvest in G&A and their finance organization. Consequently, they may lack well-defined processes, sufficient staffing, and a comprehensive enterprise resource planning (ERP) system. When these companies file S-1 or S-4 registration statements, they typically reveal material weaknesses as highlighted by the Audit Analytics on Sarbanes-Oxley Act (SOX). The American Accounting Association also warns of Material Weaknesses in Internal Controls. Material Weakness Warning
Fight for the Budget to Get it Done Right
Companies encounter challenges when establishing effective financial reporting systems due to a shortage of personnel and the lack of budget in G&A, particularly in accounting roles responsible for crucial transaction components. The independent auditor’s support materials are subject to stringent standards set by the Public Company Accounting Oversight Board (PCAOB so use their guide to make sure things are set up correctly with internal controls.
The Basic Step-by-Step Guide to Help You Establish an Effective Internal Control System
- Risk Assessment: Identify and assess the potential risks specific to your SAAS company. This could include risks related to data security, revenue recognition, customer support, compliance, and more.
- Control Environment: Establish a strong control environment that emphasizes integrity, ethics, and accountability. This includes setting the tone from the top management, promoting a culture of Compliance for Finance, and ensuring that employees understand their responsibilities.
- Segregation of Duties: Separate key duties among different individuals to prevent any single person from having too much control over a critical process. For example, separate responsibilities for authorization, recording, and reconciliation of transactions.
- Access Controls: Implement strict access controls to ensure that only authorized personnel can access sensitive systems and data. This includes using strong passwords, multi-factor authentication, and limiting access based on roles.
- Financial Reporting: Define clear procedures for recording and reporting financial transactions accurately. This involves maintaining proper documentation, conducting regular reconciliations, and reviewing financial statements for accuracy.
- Revenue Recognition: Develop policies for recognizing revenue in compliance with accounting standards (e.g., ASC 606). Given the subscription-based nature of SAAS, accurate revenue recognition is critical.
- Contract Management: Establish controls for reviewing and approving customer contracts. Ensure that terms are accurately reflected in the system and that the revenue recognition aligns with the terms of the contract.
- Data Security and Privacy: Implement strong data security measures to protect customer data and sensitive company information. Comply with relevant data protection regulations (e.g., GDPR, CCPA) and conduct regular security audits.
- Monitoring and Testing: Continuously monitor and test the effectiveness of your internal controls. This can include periodic internal audits, self-assessments, and regular reviews of control procedures.
- Training and Communication: Provide training to employees about the importance of internal controls and their roles in maintaining them. Regularly communicate control policies, updates, and changes to ensure everyone is informed.
- Incident Response: Develop a plan to address and respond to control breaches, security incidents, or other unexpected events. This plan should include steps for containment, investigation, resolution, and communication.
- Continuous Improvement: Regularly assess the effectiveness of your internal control system and make improvements as needed. Solicit feedback from employees, auditors, and other stakeholders to identify areas for enhancement.
- External Audits: Engage external auditors to conduct independent assessments of your internal controls. Their expertise can provide an objective evaluation of your control environment and identify potential weaknesses.
- Documentation: Maintain thorough documentation of all internal control procedures, assessments, and changes made over time. This documentation serves as a valuable resource for audits and future improvements.
Learning from Past Mistakes: Companies with Internal Control Issues
Several recent examples serve as cautionary tales for the importance of strong internal controls before an IPO. One such case is Wirecard, a German payment processing and financial services company that collapsed amid allegations of a massive financial scandal. The company claimed to have billions of dollars in cash reserves that did not exist, revealing significant gaps in its internal controls and financial reporting processes. Wirecard had a lot of issues even before going public. Not that your company is Wirecard, but once again investor relations are sceptical and will shoot first and not even ask questions later.
Another example is Nikola Corporation, an electric truck startup, which faced accusations of misleading investors about its technology and capabilities. Weak internal controls allowed for exaggerated claims to be made, leading to investor scepticism and regulatory investigations.
Strong Forecasting (FP&A)
Missing the Quarter or The Positive Surprise
The FP&A team develops the comprehensive financial plan, communicates performance drivers, and supports IPO-related activities and the role becomes increasingly important post-IPO. Providing the right guidance to investors on the earnings call is so critical and all the nitty gritty details leading up to the forecast come together from the FP&A team. The FP&A team is the most important finance partner, offering decision support through data analysis and scenario planning.
We’ve seen FP&A teams of 2 to a dozen all with different roles and responsibilities and the size depends on how complex your business is. From the investor’s point of view, they will closely track the absolute and percentage of your top and bottom line achievement so be mindful of the criticality of the guidance you provide and how it gets extrapolated.
Clean Data For Proper Sausage Making
“Is this number correct” it’s the last thing you want to think about as you prepare financial statements. Effective data governance is crucial, ensuring accurate finances which leads to accurate projections. Clean, consistent data is essential for analytics and reporting, with data analytics specialists aiding in pattern identification for advanced insights. Technological tools are important, with planning tools needing to handle growth, offer scenario analysis, integrate with systems, and create user-friendly dashboards.
The internal processes for our financial team include budgeting, forecasting, and consolidated reporting, aimed at aligning targets, tracking performance, and adapting projections. The methodology varies, starting top-down and shifting to bottom-up approaches, with robust financial modelling being pivotal for IPO readiness.
The Crucial Significance of Robust Financial Foundations Prior to an IPO
Meticulous attention to its financial health becomes paramount. While having an organized financial framework is essential for any business, it becomes even more critical when transitioning to a publicly traded entity. This phase marks the transformation from a Series D, E, company where the focus is often on growth and innovation, to a stage where transparency, accountability, and regulatory compliance take centre stage.
Comprehensive Financial Infrastructure
Building a comprehensive financial foundation prior to an IPO extends far beyond crunching numbers. Deploying financial software piecemeal can lead to inefficiencies and unnecessary costs. Additionally, decision-makers must grasp the importance of regulatory constraints that prohibit altering financial systems during and after the IPO process.
Real-time access to critical data is indispensable for key stakeholders as it allows for informed decision-making. Without it, navigating the complexities of being a publicly traded company becomes even more daunting. A well-structured financial system ensures that financial data flows seamlessly and is readily accessible to those who need it, enhancing the agility and responsiveness necessary in the fast-paced world of publicly traded companies.
Investor Confidence and Regulatory Compliance: The IPO Imperatives
Prior to IPOs, companies must build a story to tell and furnish potential investors with three years of audited financial data. This requirement underscores the need for transparency and accuracy in financial reporting. Read enough S-1s and you see all the details required in terms of financial metrics, the management section, the risks and the disclosures.
Once again, investors want to see if they can forward project consistent revenue and earnings streams. These elements provide assurance of the company’s stability and potential for growth, which are central to attracting investment.
Furthermore, a robust financial infrastructure encompasses more than just financial statements. It extends to processes that touch revenue generation, headcount management, and major expenditures both capex and opex and their appropriate ratios.
A Solid Financial Foundation: A Must
Preparing for an IPO demands a holistic transformation of a company’s financial ecosystem, from internal controls to forecasting accuracy and regulatory compliance. It seems daunting so start early. Establish a comprehensive financial foundation, and build and scale a team so that you can bolster investor confidence, enhance transparency, and position your company for sustainable growth as a publicly traded entity.
In Part 3, we dive into “Preparing For IPO Financial Reporting“.
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