An initial public offering (IPO) is a demanding process and a pivotal point for any company. The two most important questions to ask yourself before taking your company public are: “why are we going public?” and “are we prepared?”

Every company is unique and has different reasons and motivations as to why an IPO is the right path. Whether your motivation is to raise capital, improve investor liquidity, or strengthen equity, you must determine if an IPO is the right path for you.

Advantages and disadvantages of going public

First, it’s crucial to understand the advantages and drawbacks, as well as the alternatives to going public.

Advantages

• Access to capital markets
• Increased brand awareness
• Stronger position for acquisitions
• Attract quality employees
• Increase ability for future financing

Disadvantages

• Financial Reporting timelines
• Increased exposure and transparency
• Loss of equity ownership
• Increased operating expenses
• Pressure from investors

It would be advisable to assess the alternatives to an IPO. The alternatives include obtaining bank loans, private placements, partnerships, reverse mergers, and venture capital financing. After careful consideration of “is an IPO the right path?”, the next step is determining if you are ready to go public.

Considerations before taking your company public

Are You Prepared? Do You Have Experienced Individuals on Your Team?

Your accounting and financial reporting team, whether internal or outsourced, should have extensive expertise with the reporting requirements of the Securities Exchange Commission (SEC). The reporting requirements of privately held companies can vary significantly from publicly held companies. Those requirements depend on the nature of the company’s business and the complexities of the company’s transactions. Not only should you assess the capacity of your accounting team members, but you must also assess other areas/team members including the effectiveness of the company’s internal controls, members of governance, proficiency in tax law, legal counsel experience, and investor relations. An IPO is no easy feat, so you want to ensure you have the right people helping you through this process.

Time Considerations

You will need to present two years of audited annual financial statements in an IPO, assuming the company will be filing as an Emerging Growth Company (EGC) or a Smaller Reporting Company (SRC). Otherwise, you will need to present three years of audited financial statements. Audits of financial statements take time so it is important to be cognizant of the fact that the financial statements must meet age requirements, or they go “stale.” Financial statements are “stale” if the time between the latest balance sheet presented and the date of the IPO filing is more than 134 days. Awareness of this timeline can help avoid any potential delays in the filing.

Accounting Considerations

If your company has never been through an audit process, it might be advantageous to perform a “Test Run” before initiating the IPO process. A “Test Run” will help you determine if the company can perform a financial close and complete an audit before the required SEC filing deadlines. This will help gauge any timeline issues and help locate areas of financial reporting weaknesses or complexities that can potentially cause delays in an IPO process.

Common areas of complex accounting include but are not limited to:

• Debt agreements
• Equity agreements
  Share-based compensation
• Revenue recognition
• Fair value of financial instruments including derivatives
• Warrant liabilities
• Embedded conversion features

What to review before taking your company public

Review Debt Agreements

The accounting treatment for debt instruments can be complex. Not only due to the terms and features of the agreement itself but the ability to understand the accounting guidance. Debt instruments can come in various types, each including unique features which can be accounted for differently. Some common types of debt include convertible debt, perpetual debt, share-settled debt, and indexed debt. This can include terms that may not be entirely clear on how to account for in the guidance. One important feature that is often present in debt agreements is embedded derivatives. A contract itself may not be a derivative. However, it may contain embedded features required to be bifurcated and recognized separately from the contract. Debt instruments require careful assesment for any terms that vary the amount or timing of settlement. Typically, you would see embedded derivatives when a contract has conversion terms, redemptions, or certain contingencies.

Just as important as the terms of an agreement, modifications and restructurings are as well, and no less complex. Anytime after the issuance of debt, if the company modifies or exchanges with the same lender, an assessment will have to be done to determine whether this change was a troubled debt restructuring. If not, an extinguishment or modification is necessary.

Review Equity Contracts

The form of equity interest can vary based on your company type. Generally, however, you will see equity in the form of common and preferred shares. Just like debt, equity contracts will vary based on unique terms each contract contains. Common shares tend to be perpetual in nature and include voting and dividend rights, and residual interest in a liquidation. Whereas preferred shares can fall into different categories based on if they are perpetual or redeemable, and if they are convertible or not. In addition, the guidance may require certain types of shares of stock to be recognized as liabilities or, in some cases, assets. Furthermore, SEC registrants may need to classify certain types of redeemable equity instruments as temporary equity, as it is outside the classification of an asset or liability.

Review Your Revenue Recognition Policy

Depending on the nature of your company, your revenue recognition policy might not be too complex. Regardless of the complexity of the policy, the SEC heavily weighs their attention in this area. Attention to detail is crucial to reduce the chance of receiving comments from the SEC. Some topics that warrant further consideration are bill and hold agreements, upfront fees, collaboration agreements, reseller arrangements, and presentation of gross vs. net. Articulating your company’s revenue policy within the financial statement’s disclosures has become increasingly important. Be sure to understand your contractual performance obligations, determination of the transaction price, if variable consideration exists, how the transaction price is allocated, and when/how is the performance obligation(s) satisfied.

Beginning your IPO journey

Potential Need for a Valuation Specialist

Depending on the financial instruments issued by your company, a valuation specialist may be necessary. If a review of your company’s debt agreements determines that derivatives exist, or if you have equity contracts, like stock options, warrants, and forward equity contracts, a valuation specialist will most likely be necessary. The SEC expects companies to disclose all significant estimates and methodologies used. Using a third-party valuation service will help ease difficulties around these disclosures, as well as the computation of share-based compensation and any potential violations under Section 409A.

RRBB Is Here to Help

In today’s ever-changing regulatory environment, it is becoming increasingly difficult for the management of public companies to keep up, requiring the need for talented professionals who understand the complex rules associated with regulatory compliance. Whether your company is looking for an outsourced accounting team to help with bookkeeping, preparation of financial statements and SEC documents, or a Public Company Accounting Oversight Board (PCAOB) registered audit firm, RRBB has the capacity to assist you. Over the years, RRBB has assumed many different roles to support various companies in their IPO journey. Contact our RRBB accountants and advisors for more information on taking your company public. For a printable copy of this article, please click here.

By: Stephen McSweeney, Audit Supervisor