Groundwork before an IPO

By Aman Bhargava – Director, Financial Reporting Advisory Services
Grant Thornton India LLP

In the era of increasing challenges for growth, the progress and sustainability of any company is dependent on its ability to expand into markets, face competition through continuous innovation and produce quality competitive products. The financial strength of any company and its reputation are clearly sacrosanct. Arguably, no other action signals the 'coming of age' of a company and addresses these critical aspects, as emphatically as an Initial Public Offering ('IPO').

The transition of a company from a private enterprise to a public one is a long-term project that requires a strong focus on many decision points and relevant considerations. The key to a successful listing and life as a public company lies in prior preparation and meticulous planning at every stage of the process. While the actual process and schedule may vary somewhat based on a number of factors such as the jurisdiction, the exchange and the state of preparedness of the company; some of the critical areas of consideration prior to an IPO are:

I. Building a compelling equity story:

The first step is setting out the basic Equity Story. The key is to have a compelling and credible growth story featuring the long term vision of the business. It is important for the company to have a comprehensive business plan covering the following aspects:

• sector and competitive landscape detailing the market opportunity
• current stage of business, nature of the business and operations
• business drivers
• track record of management team
• financial and operating history
• sustainable growth opportunities – short term and long term
• requirement and use of funds.
  

Typically the company should work on building a projected financial model of a 3-5 year window, i.e. the business plan. This model would help guide the management to understand the growth parameters, test the robustness of the business plan through sensitivity analysis and also arrive at a proposed valuation of the business.

During the planning phase, the company should periodically, re-examine the business plan along with the advisors to fine-tune the 'Equity Story' or in order to showcase a strong, credible and saleable investment opportunity. Additionally, the management team along with the advisors should also evaluate proposition enhancers such as business restructuring and acquisitions.

II. Building the team:

When assessing the readiness of a company for an IPO, it is vital to gauge whether the right resources are in place. Internally it is important to build a separate IPO team, right at the conception stage, focusing on the process to maintain the momentum without disrupting the normal course of business. It is also important to evaluate the skill sets of the core management team to ensure that within the senior management team and the board there is sufficient experience and a credible track record pertaining to the sector, operations, strategic planning, financial reporting, internal control and other aspects of a public listing.

It may also be necessary to re-look at the compensation structures across the company to ensure that the rewards are aligned with strategic objectives. Companies in consultation with remuneration consultants should consider granting equity options to the key management team.

Apart from the Company’s internal resources, the team would typically consist of the company's trusted IPO advisor, an underwriter, an accounting and taxation expert, legal counsels, auditors, investor/public relations firm, registrar, financial printers and other experts such as industry specialists and management consultants.

III. Financial Reporting:

Each exchange and/or regulator has its own set of reporting requirements. For the purposes of an IPO, the stock exchange/regulators require a number of years of historical data, sometimes up to five years of using a consistent accounting standard. Further, additional audited information, including pro-forma, may sometimes be required such as those for recent or planned significant acquisitions, equity investments etc.

The financial reporting for a public company is not just limited to the IPO, but is an on-going requirement; i.e. quarterly, half-yearly and at a minimum annually. Furthermore, the time lines for external reporting are generally more stringent for public companies than that of private companies.

It is also important that an integrated financial reporting process be followed as ultimately; management internal reporting and performance measures as well as external financial reporting information flow; from the same data set. For example, IFRS requires disclosures for segments that closely aligns as to how the business is managed.

The company may also need to consider how peers in its industry group report and the kind of metrics they use to communicate with stakeholders. Analysts and stakeholders may expect, and will often measure performance against these parameters. This may require upgrades/ changes to certain internal processes and/or IT systems.

From the above, it is important to understand that though IPO may require significant one-off efforts from a financial reporting perspective, it is equally necessary to build, test and perhaps conduct a ‘dry run’ for the previous year. This is done in order to sustain the transformation into a public company.

IV. Corporate Governance:

Good corporate governance creates transparency and trust between the board and shareholders which helps in the creation, enhancement and protection of value for the stakeholders. Corporate governance principles vary across jurisdiction and exchange, but the broad framework of the various codes revolves around certain key facets such as: Board composition, accountability, responsibility, transparency, internal and external communication, corporate culture, reporting, risk management, remuneration and rights and responsibilities of shareholders.

Even though different regulators have varying requirements regarding composition of Board, in general the requirements are for a mix of executive as well as independent directors with experience ranging from functional, sector and/or public company experience.

Achieving the desired composition of directors usually is a time consuming process due to an increasingly limited pool of talent as well as the increased risks and liabilities associated with public company regulatory corporate governance requirements.

Resulting from the recent accounting scandals and the financial crisis, good corporate governance has gained significant importance with the regulator and investor community. It is imperative for the company to develop risk management capabilities in order to operate as a public company. These could include putting in place various checks and balances to enable the board review of functional and operational efficiencies, company strategy and timely periodic reporting to the business stakeholders.

In effect, corporate governance can be summed up as the responsibility and accountability of the management and the board for their actions and transparency through a timely and a high standard of reporting. Companies often underestimate the time and challenges involved in identifying and putting in place the appropriate checks and balances in order to function as a listed company.

V. Internal Controls & Systems:

The importance of internal systems and controls in the functioning of a public company cannot be understated. A private company may design (and implement) its internal controls and systems with the sole objective of organisational efficiency. Therefore, even though internal controls and systems may often exist, they may not be defined clearly or tested on a regular basis and may be inadequate from the perspective of the new stakeholders such as regulators, market, board of directors etc.

A number of regulators in various jurisdictions may explicitly require design and regular testing of operating effectiveness of various controls, for example: Sarbanes Oxley (SOX) in the United States requires auditor and management attestation of the internal controls over financial reporting. For any public company, irrespective of specific regulatory requirements, a robust internal systems and controls function is necessary on an on-going basis with the objective of managing and monitoring various risks, including those of fraud.

The design, implementation and embedding of the effective internal systems and controls is not an exercise which can be done overnight (and is of little value if rushed/not tested properly prior to the listing). Additionally, it requires careful planning and integration into the working of the business.

VI. Capital & Legal Structure:

Investors generally prefer companies with a simple capital structure and adequate protection against dilution post an IPO. The Company should work with its advisors to put a capital structure in place which will not deter investors from investing in the proposition.

It may be required to reorganise the company’s group structure prior to an IPO to ensure that all key assets of the group, material contracts and intellectual property are held within the listing structure to ensure the company has all it needs for daily functioning of the business. Where any major contracts have change of control clauses, the positions should be reviewed. Additionally, the management may choose to carve out parts of the business which may help in enhancing the transaction value.

Under the public scanner, the management should avoid entering into any transactions which may be perceived negatively by the market. They would need to ensure that any internal transactions with related parties which are entered into, are fair and reasonable to the minority shareholders and are carried out at an arm’s length.

Changes may be necessary in the holding structure, for example when raising funds outside India, to optimise the tax position of the group. The tax advisor may suggest an alternate appropriate holding company structure to facilitate the listing keeping in mind minimisation of tax incidence, the regulatory framework and specific requirements of the company.

Many of the above activities may involve incorporation of companies, re-entering of contracts and other legal matters. It is essential that any re-structuring matters are looked into well in advance as it would have a direct impact on the financial reporting of the company.

Summary:

For any company venturing on the listing journey, it is important to understand that the IPO itself is a milestone. There is a ‘New Normal’ which the company must be adjusted to, immediately post the IPO event of life as a public entity.

Therefore, while there are significant activities and efforts involved in meeting the requirements of the IPO; equal consideration needs to be given to the long term sustainability and viability as well as increased scrutiny and perception by the market. It is therefore highly recommended to conduct a detailed IPO diagnostic, build an implementation time line and execution strategy.

The diagnostic is essentially a comprehensive assessment of the gaps between the current organisation state and the requirements to list as well as to sustain life as a public company. The IPO diagnostic itself may take only a few weeks, many companies find that the resulting efforts of implementation may take up to 6-18 months to address.