Going Public Part III: Mitigating Financial Reporting & Accounting Issues Before Filing

Common Financial Reporting & Accounting Issues Found In the IPO Process

While you’re still a pre-IPO company, you need to be aware of all the financial reporting and accounting requirements public companies need to meet. That way you can adjust and set up the right framework and information ahead of filing.

Taking the time to do this is important. Oftentimes, these reporting standards are new for your business, and there’s a learning gap for your team to understand the SEC’s regulatory process. Once you’re underway, a lot of delays can come from the SEC comment phase, which can get in the way of filing for an IPO during favorable market conditions.

Working through the items below to adjust your accounting solutions and financial reporting quality will help filing go a lot more smoothly.

Financial Reporting Issues or Necessary Additions

1. Segment Reporting

Segment reporting is the practice of breaking out your company’s financial data by division, subsidiary, or whatever kinds of segmentation you may have. Breaking data apart like this gives investors a transparent and accurate idea of your performance, helping them make better-informed decisions.

Segment reporting isn’t a requirement for private companies, but it is for public ones. As a result, your team may not be familiar with setting up or maintaining this type of reporting.

What constitutes a segment?

  • If you have segments with similar services, processes, or products (to name a few examples) they can be reported together as one segment.
  • If you have a component that holds at least 10% of profit or loss, assets, or revenues, it must be reported as a segment.
  • If your existing segment makes up less than 75% of total revenue, you should add more segments to meet that threshold.

Once you’ve defined your segments you’ll need to put together detailed financial statements for each one. You can find more details on segment reporting requirements in ASC Topic 280.

2. Non-GAAP Measures (NGMs) & KPIs

These measures and KPIs add a helpful layer of detail on top of your financial statement KPIs. Oftentimes, they’re used to show details that aren’t easily conveyed or shown in financial statements.

The purpose of these is to help analysts and the SEC understand your company better. They’re a big help for getting the right valuation during your IPO. However, when executed well your NGMs and KPIs can also help show your company in a positive light to the investment community.

So how should you determine the right financial and operational metrics to show your past performance and support what you’re forecasting?

A few tips we recommend keeping in mind are to:

  • Make sure the metrics represent your organization’s objectives, goals, and strategy.
  • Choose ones that will work both before and after the IPO process (They need to be consistent).
  • Consider your industry and comparable peers to guide your choice.
    • EBITDA
    • Adjusted EBITDA
    • Adjusted net income
    • Free cash flows

3. CD&A (Compensation Discussion & Analysis)

This is a statement that details the compensation approach of your organization and is part of a proxy statement. It should touch on factors that are behind your policies and decisions such as how award levels are set and how each of those pieces fits your organization’s holistic compensation objectives.

The goal here is to give your investors following this information the perspective and numbers they’re interested in learning more about.

4. Breakdown of Risk Factors

Regulation S-K requires you to disclose all known and significant factors that hold risk or speculation. These factors are included in the non-financial component of your registration statement.

The aspects you include should be specific to your organization and depicted clearly. Make sure you provide enough detail for the significant risks reported and try to avoid using risks that are too general and could apply to anyone in your industry.

5. Business Combinations or Consolidations

Another financial reporting issue you’ll need to consider is how you’ve identified and recorded business combinations or consolidations. US GAAP requires thorough identification of all tangible and intangible assets. Plus ASC 805 has strict requirements for this type of activity.

You also may need to include pro forma financial information (which we cover further down below). As you look at your history, consider any significant acquisitions or mergers that happened three fiscal years before you fill in Form S-1 to start the registration process.

6. Related Party Transactions

Another SEC requirement, you’ll need to disclose any details about this type of transaction that transpired in the past three fiscal years. If any transaction involves a director, executive officer, or stockholder with a 5% stake and more than $120,000 it must be disclosed.

7. Pro Forma Financial Information

A pro forma statement gives investors an idea of how significant transactions might affect the business’s future performance and forecasting. Transitions like mergers or acquisitions (see the business combinations in number five) will come into play here.

Note that these adjustments provided in this documentation before you file assume that the business combination is completed at the start of the most recent fiscal year provided. Find more detail on putting together pro forma financial information at the SEC site.

8. MD&A (Management’s Discussion & Analysis) Disclosure

It’s critical that your leadership can explain the nuanced factors that contributed to business performance. This is an SEC requirement (although they did simplify MD&A requirements in 2020) and must be provided alongside your financial statements.

Aside from analyzing company performance, your MD&A should also cover compliance, risks, and future goals as well as plans. Make sure what you share is relevant to your company and accurate when compared with the financial statements you provide. It should also acknowledge other risks outside your company that exist in your business environment.

Other Technical Accounting Issues & Factors to Consider

9. Employee Notes Receivable

Oftentimes these are expenses an employee owes back to your company, whether it’s for personal travel expenses or damaged equipment. The money could have also been provided for employee relocation.

As you dive into this, make sure that you’re up to date on Section 402 of the Sarbanes-Oxley, as it clearly bans a publicly traded company from offering personal loans to directors or officers. As a result of this, even private companies have slowed down on issuing loans to employees.

However, if you have any existing ones or are considering any, make sure to involve legal counsel in your process. Doing so can help you figure out what’s prohibited and correct those scenarios before going public. (You may be able to find solutions like having executives repay those loans before the contract is mature.) Resolving your employee notes receivable will prevent them from becoming an obstacle during filing.

10. ASC 606 (Revenue Recognition)

The intent behind this is to standardize the way in which businesses approach accounting for revenue recognition. You’re required to recognize revenue when you have a contract with a customer for promised goods or services. The amount you provide should line up with the total amount you expect to receive as a return.

11. Earnings Per Share (EPS)

These aren’t required for private companies, so this is another new aspect for your team that may cause some accounting issues. However, this calculation helps value stock and show how profitable your business is, which is why it’s important in the IPO process.

You can calculate this in two ways:

  1. Earnings per share = net income after tax ÷ total number of outstanding shares
  2. Weighted earnings per share = (net income after tax – total dividends) ÷ total number of outstanding shares

Note that if what you’re declaring is above your earnings for the last year, the SEC assumes those earnings will be paid with proceeds from the IPO. So you may need to show pro forma earnings per share in your income statement.

12. Goodwill & Intangible Assets

While operating as a private company, you’ve had the option to amortize goodwill, something public companies don’t do. So if you opted to do this in the past, you’ll have a little more work ahead resolving financial reporting issues around this on your balance sheet before filing.

The SEC will look at this piece critically and commonly challenges companies on how they determine reporting units. That’s because if those units are set too high, it means avoiding a goodwill impairment charge. So make sure your team takes time working on finding the right accounting solution.

13. Classifying Liability vs. Equity

How you determine liability vs. equity can have a huge impact on your balance sheet and other areas of presentation and measurement of your company. Because of those implications, the SEC will also probe deeply into this area of your financial reporting. So you’ll need to carefully figure out if the securities you issue are liabilities, permanent equity, or temporary equity.

Try sorting through these three questions to determine that classification:

  • Which accounting unit is appropriate to use?
  • Does the instrument involve an obligation to pay cash, other assets, or equity shares?
  • Is there a conditional or unconditional obligation involved?

Once you undergo filing for an IPO, some of these determinations may shift in the process of transitioning. But it’s important to have them ready before you start filing.

Next Steps to Take In Filing for an IPO

Preparing to file requires a lot of work between fixing accounting errors and working to ensure the quality of your financial statements is up to par. This can put a lot of pressure on your internal team, especially since they may have less experience with all the regulatory requirements for public companies.

Working with an experienced IPO readiness advisory team can help in two ways:

  • It takes the stress of doing the extra work of identifying accounting problems and solutions off of your internal team.
  • It provides support and peace of mind that you’re compliant ahead of filing, so you have a smoother experience.

Getting an outside perspective can help you determine if you’re truly ready and in the right place to get started. At Centri, we’ve helped plenty of companies prepare to file. We also have the expertise and technical accounting knowledge to help you anticipate how to prepare for the SEC’s scrutiny.

Plus, our experience advising both private and public companies means we have a keen understanding of where you’re at and what steps you’ll need to take in order to meet your goal.

About Centri Business Consulting, LLC

Centri Business Consulting provides the highest quality advisory consulting services to its clients by being reliable and responsive to their needs. Centri provides companies with the expertise they need to meet their reporting demands. Centri specializes in financial reportinginternal controlstechnical accounting researchvaluationmergers & acquisitions, and tax, CFO and HR advisory services for companies of various sizes and industries. From complex technical accounting transactions to monthly financial reporting, our professionals can offer any organization the specialized expertise and multilayered skillsets to ensure the project is completed timely and accurately.

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