Preparing a Successful IPO in 2018

Globally, 2017 was the biggest year for IPOs since 2007, both in terms of the number of deals (1,624 IPOs) and proceeds raised ($188.8 billion), with 49 percent and 40 percent increases, respectively, compared with 2016. In the United States, there were 174 IPOs raising $39.5 billion in 2017, which is an increase of 55 percent in volume and 84 percent in proceeds raised compared to 2016. [1] Biotech IPOs also had a good year, with 40 IPOs raising approximately $4 billion in 2017 versus 28 IPOs raising approximately $2 billion in 2016. [2] WSGR represented Denali Therapeutics Inc. (NASDAQ:DNLI) in the landmark biotech IPO of 2017, which raised approximately $250 million in December 2017. [3] Because of the momentum caused by Denali and others, we are encountering optimism from investment bankers and clients about the healthcare and biotech IPO market in 2018, and we have anecdotally seen more companies start the IPO process or contemplate an IPO in late 2017 and early 2018.

Completing an IPO is an enormous milestone for any company. Along with the excitement, liquidity, and attention, IPOs also bring the responsibility of Securities and Exchange Commission (SEC) reporting, increased regulatory burden and tougher public scrutiny. In order to prepare for these additional challenges, there are certain action items that we advise our clients to undertake before the IPO process begins. As it often takes time to implement these action items, we encourage clients to start early. These action items are important for any company, but are especially crucial for healthcare and biotech companies because, compared with their counterparts in other industries, they tend to be earlier stage and, in some cases, pre-revenue, which means they likely have less infrastructure to deal with these challenges. Below are three main areas of focus to prepare for a successful IPO in 2018.

1. Build Up Your Financial and Reporting Team and Resources

The most important part of IPO preparedness is ensuring that you have sufficient internal financial resources. The chief financial officer (CFO) is the most important member of the finance team and the most important company representative during the IPO process. If you are contemplating an IPO and do not have a CFO with public company experience (or who is up for the challenge of learning on the job), hiring such a CFO should be your highest priority. This is important not only operationally, but also from a marketing perspective, as new investors will be looking for a CFO they can trust to run a public company, and other members of management and the board will be looking to the CFO to make sure the company’s financial performance is accurately reflected in order to communicate with investors and limit liability.

Particularly for companies with revenue, your second priority should be to consider hiring a controller, with a strong preference for someone with public company experience. An experienced controller can help ensure that you have the processes in place to meet public company reporting timelines and maintain internal accounting and control standards, which would enable the CFO to focus on higher-level matters. Other hires in the finance department may be necessary depending on the size and complexity of your accounting and finance functions, but these two are the most important.

For many of our healthcare and biotech clients, the CFO and/or the controller handle all SEC reporting matters, but for larger companies—or to fill a gap in public company experience on your financial team—you may want to consider hiring a SEC reporting manager. This individual is responsible for coordinating with your legal, accounting, and investor relations teams with respect to quarterly and annual reporting, XBRL, Section 16 filings, and other accounting and reporting matters, which frees up your CFO and/or controller to focus on their respective non-reporting functions on a daily basis.

A third position that can take a lot of lead time to fill is the Audit Committee Chair. Board members with financial experience are in high demand, and it is important to find someone whose style is compatible with the rest of the board. The SEC requires that every public company’s audit committee contains at least one “audit committee financial expert,” and, while it is not necessary that this individual becomes the Audit Committee Chair, it is typically preferable. We often see companies focus on finding their Audit Committee Chair before they even build out the finance management team below the CFO.

As the challenges facing your company grow, both due to internal growth and new regulatory and reporting burdens as a public company, your financial organization may need to upgrade from (in many cases) Microsoft Excel spreadsheets to a more scalable and efficient financial reporting technology solution. As you plan your SEC reporting and accounting processes, you should ask your auditors what they see as standard for a company of your size in your industry.

2. Assemble Your IPO Team

In addition to your internal hiring, you will need to evaluate and eventually choose a large external team to support you through the IPO process and as a public company, which should include the following:

• Law Firm. Your lawyers will guide you through the IPO process and can make assembling the rest of the external team easier, so you should engage a law firm as early in the process as possible. It is of utmost importance to hire a law firm with significant IPO experience because an experienced IPO lawyer can keep the timeline moving forward by anticipating next steps and can help you avoid numerous potential pitfalls. As a result, this may be an appropriate time for you to upgrade from your prior counsel. An experienced IPO lawyer will know first-hand what similarly situated companies have done in the various situations you will face, which is especially crucial for the unique challenges that face healthcare and biotech companies.
• Auditors. It is at least as important, if not more important, to identify the right auditors to use for the financial statements in the S-1 and going forward as a public company. The big four audit firms are the obvious choices, but our clients have had good experiences with other audit firms as well. When choosing an auditor (and choosing whether or not your current auditor needs to be replaced), the key is to find one that: (i) your target investors will respect and trust, (ii) has geographical and/or industry expertise, if applicable to you, and (iii) is committed to your timeline. Auditors can also be a tremendous resource for advice on establishing or upgrading your internal controls and processes. Depending on how quickly after the IPO organizational meeting (org meeting) you want to make your first confidential submission, you may need to engage your auditors well before you engage any other external team members.
• Underwriters. Depending on your market (or sub-market), your choice of underwriters can have a huge impact on your IPO and subsequent trading. Similar to auditors, you should find underwriters that: (i) have relationships with your target investors to sell the offering, (ii) have analysts who are knowledgeable about the industry in which you operate and can write credible reports, (iii) have geographical and/or industry expertise, (iv) have the financial resources to be able to stabilize trading following the IPO, and (v) are committed to your timeline and share your vision as to how to present the company to potential investors. The analyst coverage provided by the underwriters in your syndicate may make a big difference in the institutional ownership of your stock and the overall market interest in your business and is oftentimes the critical factor in choosing underwriters, especially in life sciences. Another area where it is important to be aligned with your underwriters on is valuation. If your lead underwriter does not share your idea of valuation, you may be setting yourself up for a confrontation later in the process when it is too late to change horses. [4]
• Stock Exchange. Although it may not seem like it, the stock exchange you choose is a service provider like your lawyer or auditor and is part of your external team. In addition to providing the exchange on which your stock is traded, they can help you by expediting their review when the timeline gets tight and often also commit resources to marketing matters or handle the investor relations portion of your website. [5]
• Investor Relations. An investor relations firm can help you field questions from investors, issue press releases, revise your website, and comply with various investor information requirements that will be applicable to you when your stock begins trading. In most cases, we recommend that our IPO clients engage an investor relations firm during the IPO process in order to ensure that the firm is onboarded before trading begins.
• Financial Printers. During the IPO process, your financial printer of choice will help assemble and submit your filings and will help process changes that are made to those filings during the IPO process. They also print the preliminary prospectuses that are delivered during your roadshow and the final prospectuses that are delivered once you begin trading. This sounds simple enough, but to keep the machine running smoothly you need to choose an experienced printer that is focused on customer service. [6]
• Other Consultants. Depending on the needs of the company, you may need to engage one or more additional consultants before or during the IPO process. For example, for healthcare and biotech companies with limited finance personnel, it may make sense to hire a financial consultant to help prepare financials and with disclosure in the S-1. If your regulatory path is not yet certain, you may need to hire a regulatory consultant to help ensure your disclosure adequately reflects the risks in your business and matches realistic expectations regarding timeline and categorization. Consultants such as these can be engaged on an ad hoc basis and are not necessary for every company.

3. Create Public Company Infrastructure

Hiring internally and engaging external providers are important parts of the process, but it is just as important for you to gather your internal documentation, evaluate your internal process, and make necessary changes before and during the IPO process. There are many things to consider, but some key items you should address are the following:

1. Policies. Early in the IPO process, you should have your counsel create forms of the various policies you will need in order to operate as a public company, such as communications policies, insider trading policies, committee charters, whistleblower policies, codes of conduct, etc. Although only certain of these are required by rules or regulations, there are several others that are considered best practices and can be an effective defense against any future claims regarding inadequate corporate governance. Review these forms of policies to understand them and think about (i) who would best fill each role within them and (ii) how they will actually be implemented. Take steps toward implementation during the IPO process so you are not overwhelmed on the first day of trading. Most importantly, make sure that any policies that are adopted are actually followed—it is better not to have a policy at all than to have one and not follow it.
2. Financial and Accounting Operations. Leading up to the IPO, start and maintain the processes you will need in order to timely report your financials as a public company. Some clients even hold mock quarterly conference calls and practice closing the books according to accelerated timelines in order to prepare for being a public company. Discuss internal controls, Sarbanes-Oxley (SOX) compliance, and best practices internally and with your auditors. The importance of these steps is inversely proportional to the level of prior public company experience in your finance and accounting team.
3. Executive Compensation. If the company has not already done so, begin obtaining regular quarterly 409A valuations in order to establish the practice and defend the fair value of the equity awards you have granted leading up to the IPO. If equity awards are granted at less than fair value in the 12-18 months prior to an IPO, it may raise a “cheap stock” issue with the SEC or, even worse, cause the SEC to ask whether the board has fulfilled its fiduciary duties to stockholders in pricing options. If the SEC determines that “cheap stock” was granted, then the company will need to take an accounting charge for the difference between the grant price and the fair value of that equity and in more serious cases it could lead to additional disclosure on option granting practices or delay effectiveness, if the SEC is uncomfortable with the price at which options were granted. Proper valuation at frequent intervals or in conjunction with major events (financings, acquisitions, etc.) on at least a quarterly basis 12-18 months prior to an IPO and adequate disclosure in the S-1 can minimize risk. In addition, make sure that there are no outstanding loans from the company to directors or officers prior to filing the S-1 in order to comply with Sarbanes-Oxley Section 402.
4. Documentation. Using a sample diligence request list provided by your counsel, begin compiling your diligence items in a data room (or locally in folders until you engage a data room provider) well in advance of the org meeting. This does two things: (i) it ensures that these documents are already organized and ready to upload when diligence needs to begin and (ii) it can reveal areas of weakness in your prior documentation that you can address before the IPO. Besides material agreements (licenses, manufacturing agreements, and the like), of particular importance are the company’s foundational documents and documents related to the issuance of equity or debt.
5. Communication. Make sure your external communications (your website, your social media, press releases, etc.) do not contain any statements that you cannot prove or that are not accompanied by appropriate disclaimers. It is important that your website and communications match the statements made in the S-1 in all material respects. Finally, ask your counsel for publicity guidelines that you can review and convey to your employees so they do not run afoul of SEC rules regarding communications during the IPO process.
6. Board of Directors. This is not an action item for every company, but you should take some time to evaluate your current board. In order to establish a majority of independent directors or round out your areas of expertise, such as to add a financial expert to a science-heavy board, it may be in the company’s best interest to add to or replace certain of your board members. In some cases, venture capital directors may need to rotate off of the board because their partnerships will not let them sit on public company boards. In other cases, you may have a vestigial early investor on the board, and the IPO is a natural time for them to move on. The CEO should take an active role, working with existing board members, to determine how many directors will be leaving, how many new directors need to be appointed, and the skillsets required by the directors to fill the board and committee roles. These can be difficult conversations to have, and good board members can be difficult to find, so starting early is important.
7. Your Story. Before the first line of your S-1 is written, you should have an idea of how you want to tell your story. This will come in part from past presentations to investors and preliminary discussions with your underwriters, but special care should be given to the addressable market, how you compare to competitors, the unique way you solve an unmet need, what key metrics you use to evaluate your performance, and how you intend to use the IPO proceeds.

Conclusion

The mere exercise of preparing for an IPO can be a catalyst for a lot of positive change at a growing company. Many of our clients contemplating an IPO still have startup infrastructures, and major upgrades are necessary in order to operate like a large private company or a public company. Collecting diligence materials can illuminate missing documentation or faulty processes, thinking about accounting disclosure can refine how you recognize revenue, and the act of outlining your business section can refine the way you think about your business. In order to have a smooth IPO and avoid delays while managing risk, we recommend focusing on these three main areas prior to or early in the IPO process.

Endnotes

1http://www.ey.com/Publication/vwLUAssets/ey-global-ipo-trends-q4-2017-de/$FILE/ey-global-ipo-trends-q4-2017.pdf(go back)

2https://www.fiercebiotech.com/biotech/biotech-ipos-roared-back-2017-but-what-will-next-year-bring(go back)

3http://investors.denalitherapeutics.com/node/6366/pdf(go back)

4Sometimes underwriters provide a necessary reality check on valuation, so it may not be an argument that is in your best interest to “win.” Just make sure you have these conversations early so there are no surprises later in the process.(go back)

5Our clients often reserve a ticker symbol early in the process, but do not submit an application to an exchange until drafting has begun.(go back)

6There are some traditional options and more modern, software-based solutions to choose from. We are happy to discuss the differences to help you make an informed decision.(go back)