Analysis

IPO Brings Discipline to Growing Firms

While a successful IPO can generate financial benefits for a company and its investors, the true advantages are likely to come from the long-term discipline the process instills on the entity's infrastructure.

Speakers at an IPO readiness panel sponsored by Workiva in New York City said a public offering is an important event in a company’s lifecycle, but the transaction should be viewed as a relatively small part of the company’s preparations for its post-IPO operations.

“You need a very robust history of not missing your [forecast results] as well as robust sales pipeline tracking,” said James Disney, a managing director in Credit Suisse’s technology investing group. “You need internal discipline, and probably the shortest way you can do that is to work with your bankers and lawyers to identify the operational, financial and legal requirements and to understand what’s required as a public company.”

The IPO market is recovering this year from a steep falloff in transactions last year, with 66 deals completed at mid-year. This marks an increase from the 42 deals at the middle of 2016, but is still lower than the 104 transactions half-way through 2015, which was the final year in a three-run of IPO market growth.

The financial benefits of a public offering, and the traditional motivations for companies to go public, include raising capital for company operations, to fund acquisitions and to provide liquidity for early stage employees who’ve received a percentage of their compensation in company shares.

Achieving those benefits, however, requires able to demonstrate not only financial performance but also a strong reporting and compliance infrastructure. For instance, although securities regulations require annual results in offerings documents, bankers and large investors want to see at least eight quarters’ worth of performance results to gain confidence in the company’s ability to meet projections and their disclosure requirements reliably.

“If you can produce eight quarters of results, there’s no reason [Sarbanes-Oxley compliance] isn’t happening simultaneously,” said Megan Baier, a partner with legal firm Wilson Sonsini Goodrich & Rosati. “There are some higher-level control environment considerations, but a lot of the core of what SOX should be about is how you’re operating day to day, how you’re closing your books, and what are those functions you have in place to make sure your information’s accurate and complete.”

Gaeton Biscardi, a partner at accounting and financial reporting consulting firm Genova Group, said auditors are placing the controls of pre-IPO private companies under stricter scrutiny, in part as a result of regulatory concerns about firms that have disclosed material weaknesses in their controls shortly after going public.

“There’s a high probability that those control deficiencies existed at the time of the IPO and were looked past by the auditors,” Biscardi said. “There’s some sensitivity by the auditors who are now saying, ‘it’s good we caught something before it went out.’ Although they aren’t giving you an audit opinion on the controls, they’re asking questions and identifying potential weaknesses.”

Another important consideration for pre-IPO companies is early adoption of the revised accounting standards for revenue, leases and credit losses. Biscardi said with the new standards taking effect annually over the next three years, a growing number of pre-IPO companies are choosing to adopt the new standards early rather than having to transition shortly after going public.

More Companies Remaining Private

While the financial benefits of an IPO remain compelling, companies have more flexibility to remain private as new financing options emerge. For example, Baier said the Nasdaq stock exchange and other platforms are enabling employees to tender shares to investors.

“We’ve seen a strong uptick of those offers in the past six to 12 months, so as one alternative to going public, people are starting to leverage that option more to provide liquidity,” Baier said.

Adding to the ability of companies to remain private is a 2012 amendment to securities regulations that increased the number of shareholders that required a public offering from 500 to 2000. This larger number allows companies, especially high value technology companies, to delay a public offering and the associated scrutiny.

“It’s easier to stay private longer, so you don’t need to rush,” Disney said. “If you make a mistake in the public markets, especially in the first two years, then you’re toast.”