Four ways pre-IPO companies can get their financial house in order
Uber’s first full quarterly report came with surprising disclosures that the IRS and other tax authorities are investigating its transfer pricing arrangements from 2013 and 2014. That’s the sort of landmine no company needs, especially with the extra scrutiny a newly public company inevitably gets.
Transfer pricing is seen by many industry experts “as a relatively risky strategy” and has even gotten giants like Apple and Amazon in trouble. Given the potential benefits, however, it’s not surprising that Uber would want to push the envelope. That said, cutting $141 million of unrealized tax benefits suggests they were doing more than pushing the envelope.
We don’t know exactly what happened in Uber’s case, but a fair number of nonpublic companies have shoddy or nonexistent processes around sign-offs and reviews, and as a result have plenty of skeletons hiding in their financials. That’s why it’s essential for companies contemplating going public to get their financial house in order well before that bell is rung.
For companies dealing with the Securities and Exchange Commission’s requirements for the first time, the process can be time consuming, burdensome and result in significant inaccuracies, which have disastrous consequences. Early planning for an IPO is essential for avoiding many of those unpleasant surprises, and also helps with establishing best practices for future reporting and compliance.
Based on my experience as an auditor at Ernst & Young, and working with CFOs and controllers of companies at all stages of the IPO process, here are four tips to help your finance team make a smoother journey.
1. Get ahead of it. Twelve to 36 months before a planned IPO, companies need to modernize, automate their accounting systems, and keep an eye on compliance. Going public increases the need for speed and accuracy in your accounting — especially in your closing process — and outdated and inflexible financial systems, coupled with manual processes, make it nearly impossible to hit all those hard deadlines. Older systems may lack the necessary capabilities required for consistent, accurate financial reporting. Those older systems may make scaling your finance operations post-IPO nearly impossible.
Besides updating your current system, you may need to invest in other specialty software to help with the accounting and additional voluminous disclosures needed for the latest FASB and IFRS standards for lease accounting and revenue recognition. Excel alone just won’t cut it anymore.
You’ll need a team, technology and processes that ensure the delivery of accurate financials every quarter. According to a guide from Ernst & Young, companies should “begin the IPO readiness process early enough so that your pre-listed company acts and operates like a public company at least a year before the IPO.” With a long enough runway, you can perform trial runs of investor roadshows, IR presentations and “file without filing.” This may uncover essential issues you’ll need to resolve before you go public.
Since your company likely has smaller accounting and finance teams than most public companies, that additional reporting burden will be shared across fewer people. This makes automation a must and provides an incentive to really look at all your processes and eliminate the bottlenecks.
2. Avoid triggering red flags. There are several areas that have historically raised red flags with the Securities Exchange Commission, including company reorganizations done partially for creating advantageous tax positions. Uber’s difficulties with transfer pricing, and Walmart’s recent settlement with the SEC after years of investigations into their policies regarding international “facilitation payments” (aka bribes), show that there are a lot of ways to get in trouble with the SEC.
According to a midyear report on SEC enforcement activities so far in 2019, the second most common problem was Issuer Reporting and Disclosure, an area that was number three for all of 2018. Issuer reporting and disclosure problems include things like revenue recognition, faulty valuations and impairment decisions, missing or inadequate disclosures, and good old fashioned misleading of investors, which got Elon Musk of Tesla and Elizabeth Holmes of Theranos in trouble.
3. Stay on top of key performance indicators. Pre-IPO companies have to disclose information about past business performance to help provide investor guidance on future performance. The KPIs you select should adhere to a consistent and accurate model. Ernst & Young recommends outperforming competitors: “Investors base their IPO investment decisions on financial factors, especially debt to equity ratios, EPS growth, sales growth, ROE, profitability and EBITDA growth.”
For tech companies, research from McKinsey shows that top-line increases are more important than net profit. Revenue growth represents the momentum of a company, and while other metrics — users, subscribers, bookings, merchandise value — corroborate revenue growth, revenue is especially important to investors because the other metrics aren’t audited.
Investors also like to see predictable revenue streams. This means that any changes to a business model may need time to develop a stable, recurring revenue stream.
Another thing that investors look for is enough cash on the balance sheet to fund the company to the breakeven point. If the company isn’t yet profitable, showing a clear path to profitability is always a plus.
4. Accuracy of quarterly reporting and audits. Companies that aren’t spending enough time on evaluating risks may find their organizations subject to issuing a restatement of their quarterly results, or if they’re private, they may have their IPOs delayed in order to get their financial house in order. Uber is likely going to have to do some restatements once the IRS gets through with them, if not before.
Mistakes or errors can kill a CFO’s career, or even worse, send him or her to jail. That’s what happened to the former CFO of Bankrate, who was sentenced to a decade in jail for playing fast and loose with expense accruals. Even saying something in public that isn’t quite accurate can get you in trouble, as Elon Musk and Tesla found out the hard way, to the tune of $40 million in penalties. Keep in mind that the SEC has a zero tolerance level for errors or missing information.
Adopting a cloud-based ERP system is a start. Automating many processes is essential so you can get away from error-prone manual processes and get the books closed faster. Saving time by leveraging technology also gives you time to think strategically about those numbers.
Getting to a successful IPO is an amazing milestone, and something that only a tiny fraction of startups ultimately achieve. Now maybe it’s because I’m an accounting geek, but I think the best part of making a company IPO-ready is the opportunity to build a best-of-breed, lean and efficient accounting function that gives your company a strategic advantage in insights and business intelligence.