The journey from a private entity to life as a listed company requires you to be prepared for a shift in regulatory demands and public scrutiny. As part of the IPO process, this shift requires complex changes to your financial management and accounting systems.
Knowing what to do and the timing of each step is critical. There are a number of indicators that should be considered to ensure you are ready for a successful IPO. In this insight Kevin Frohbus, Partner, IFRS & Corporate Reporting at BDO Sydney, discusses four key red flags that may indicate whether or not your financial reporting and accounting systems are ready to support either an IPO process or subsequent and ongoing reporting obligations as a listed company.
1. There is no system to support the capitalisation of development expenditure
Many start-ups and early life-stage companies are growing quickly, are hungry for cash and need to improve their net asset position to raise new finance. The irony is, at this critical stage, most companies are keen also to capitalise their expenditure on development activities, but they don’t have the underlying policy and cost management system to support this outcome.
An early indicator that the company’s financial reporting systems aren’t ready to cope with an IPO is when the pre-listing auditor insists that the company write off all previously capitalised development expenditure, sighting the lack of a robust capitalisation and cost management system. When looking to maintain asset value and when considering an IPO, it is prudent for a company to speak to an IFRS and Corporate Reporting specialist who can assist to develop and document a Cost Capitalisation Policy. Ideally this policy should be intricately aligned with project development milestones and the company’s cost management system.
2. Financial statements do not yet include any value-driven narrative information
Following on from the capitalisation of development expenditure, robustness of financial statements is critical. As part of the ILAR process, the financial statements will almost certainly require some form of restatement to previously reported amounts and disclosures. This may include recognising previously unaccounted contractual rights and obligations, or including such information as segment and financial risk management information. Critically, this must be completed at the early-stage of the IPO process.
Many companies aiming for an IPO in the current economic environment have only previously generated special purpose financial statements, or financial reports under “reduced disclosure” regimes. An early indicator is that these financial statements don’t even include basic credit, price and interest rate risk disclosures to which the company is exposed, and control procedures to manage them. Preparing one year’s worth of Tier 1 financial statements is strongly encouraged before undertaking an IPO.
3. Liberal use of IPO shares as currency
Many companies that are cash starved in their final days before IPO will liberally promise to issue their employees, or even their suppliers, with IPO shares on listing. This creates complexity in that the value of those awards or promises are accounted for as an expense to reflect the timing of the service, not the issuing of the eventually IPO shares. In almost all instances, the grant value will be expensed before the IPO, not at the time the IPO shares are used to settle the outstanding obligation. An early indicator that the company’s financial reporting systems aren’t ready to cope is that the company isn’t able to generate a comprehensive list/register of share-based awards, nor have any accounting entry been made in the pre-IPO financial statements for the grant value of these awards.
4. The valuer engaged is out of their depth
Almost all IPOs require a series of complex valuations, ranging from embedded conversion features in convertible notes, to the valuation of adviser and employee share awards, including performance shares and ESOP. An early indicator that an IPO may be at risk is that the company hasn’t established a relationship with a reputable valuer who is able to identify the precise valuation approach for each type of transaction, and gather unobservable inputs into valuations to be prepared to support the accounting before the financial statements are submitted to an ILAR process. Unexpected valuations almost always reduce the company’s historically reported profit numbers. A capable valuer that is appointed before an IPO process will be able to advise on the relevant valuation impacts on financial reporting before key transactions are executed.
If you are considering an IPO, it’s important to understand both pre-transaction and ongoing financial reporting requirements. The BDO IFRS Health Check is a simple way to assess the current state of your financial reporting and accounting systems before embarking on an IPO journey. For more information, contact one of BDO’s IFRS and Corporate Reporting advisers.