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Audit Advice for Companies on the Path to Public Life

Audit Advice for Companies on the Path to Public Life

Unpacking the Audit Process for CFOs of Pre-IPO Companies

Going public brings a whole new level of audit scrutiny to your business. Lack of preparation can materially delay your IPO timeline, or worse, cause headaches for your company post-IPO. 

For CFOs of companies two or even three years out from a planned IPO, there are steps you can take now to help prepare and smooth the transition over to public company auditing standards. This includes performing an internal business assessment, building out your in-house finance and accounting team, choosing an audit partner, uplifting to PCAOB audit standards, and quarterizing your financials.

To help demystify the private-to-public company audit process, we recently convened CFOs in The Circle for a conversation led by four experienced leaders in this space: Tim Zanni, independent board member, and former 32-year KPMG veteran;  Karen Wu, Controller at Clari; Anirudh Badia, Chief Accounting Officer at Hippo Insurance; and David Oppenheimer, Audit Committee Chair at Quotient and former CFO of Udemy.

Here’s were the key takeaways from that conversation:

Before You Start an Audit, Perform an Internal Business Assessment

Rushing into an audit is the quickest way to derail the whole process, said Tim Zanni:

“When you’re going public, an audit is a regulatory transaction, not a business transaction like it is when you’re a private company. I don’t know of a single situation where an audit wasn’t a significant gating issue to the timing of an IPO transaction.” 

Before assembling the critical elements needed for the audit process, CFOs should take a step back and perform an internal business assessment to ensure the foundational elements of the company’s finances and accounting are sound.

The first of those foundational elements is revenue recognition. It is critical for CFOs to know what the business’ revenue is and how it’s accounted for, said Anirudh Badia:

“It will change your past, present, and future if your revenue’s wrong. That may be the basis for which you created your past results, presented results during your fundraising, and the forecast on which you’re planning to IPO.”

Equity is the other big area to account for, said Badia. Ensuring your stock-based compensation aligns with your 409A and that everything is reconciled accurately.

Inventory must be properly valued and on the books, especially if there are multiple entities within an organization.

Finally, consider your company size and whether that classifies your business as an emerging growth company (EGC) or smaller reporting company (SRC) under SEC guidelines. If classified as an SRC, you only have to provide audited financial statements for two fiscal years. This means you could file to go public confidentially with only one year of audited financials, providing the second year of financials is provided by the actual IPO date.  

Investigating all of these areas at the outset is important for minimizing delays once your audit firm is onboarded, said Badia. “You don’t want to start doing the audit only for the audit firm to come back and say, ‘these are the issues you need to go and fix’ because you will waste your resources, time, and energy of your team.”

Building Out Your In-House Accounting Organization

As both a former CFO and Audit Committee Chair, David Oppenheimer emphasized that building out your core accounting team, including hiring a highly skilled controller, is a crucial first step for the CFO. 

 “Getting that core accounting team in place is absolutely critical. The ability to make sure you are capable of doing GAAP accounting and revenue recognition in the right period and methodology is the number one item that will always slow you down. You need those team members that can keep and close the books, know how to operate your accounting systems, and then report out of those systems.”

Oppenheimer cautioned CFOs not to get so focused on only GAAP accounting that they ignore cash flow and non-GAAP metrics. Therefore, it is important to have members of your accounting team that are comfortable pivoting between monitoring sources and uses of cash while creating your GAAP financial statements and preparing for an audit.  If that capability doesn’t exist in-house, you can leverage outside smaller accounting firms and consultants.

Depending on the size and needs of the company, CFOs might also consider hiring a Chief Accounting Officer (CAO). A CAO is a Section 16 Officer that takes on much of the day-to-day accounting practices from the CFO, including closing the books, overseeing the company’s ledger and financial accounts, regulatory reporting, and more. Most importantly, that person is responsible for building out the accounting organization, structure, processes, and controls.   This is a role that is typically filled leading into a public listing, thereby freeing the CFO up to focus on capital markets and long-term financial strategy. 

Badia advised CFOs to hire when they find the best candidates, not necessarily when the role is open, whether it’s a CAO, controller, or supporting accounting team members. “It’s very difficult to find talent. If I know somebody who’s the right fit for a position I’m planning to hire after six months, I’m going to hire that person right now.”

Clari Controller Karen Wu called out that as you make changes to your accounting infrastructure, it’s important to maintain alignment between accounting, finance, and everyone else in the IPO working group:

“As you progress along with audits, some of your original accounting methodologies or estimates might need to be updated, and that can impact financial modeling and estimates. Keep your cross-functional teams in the loop on these changes because we want to avoid surprises, especially on the financial modeling as that impacts guidance and forecasts.”

Uplift to PCAOB Audit Standards

Under SOX compliance, public companies are subject to PCAOB audits, which are different and often more rigorous than the AICPA audit standards most private companies are used to. In addition to lower materiality thresholds and expanded footnote disclosures, PCAOB audits bring much closer scrutiny to a company’s financial statements and the financial controls governing them.

While your audit partners will guide much of the work of getting you PCAOB-compliant, companies can take a few important steps to be more prepared.

First, ask your audit partners upfront what documentation they need around the business’ financial controls and processes. That controls establishment can be done even pre-S1, said Wu. “It’s really important to establish expectations with your auditors upfront so that you’re not having to eventually go back and redo everything, in a different format, or at a different level of precision.”

Second, while an audit firm won’t issue a PCAOB opinion to a private company, you can ask a firm to do some investigative work into the business’s top “high-risk” areas of the business (sort of a hybrid PCAOB-AICP opinion). This can help you identify potential stress areas that might get flagged in future audits: revenue, equity, or collaborative agreements through joint ventures, for instance. As you uncover complexities and weaknesses, focus on having “the right people with the right skills performing the controls” around those areas, added Zanni.

It’s also important to keep in mind that PCAOB audit standards can change over time, even for audits with the same firm. “Things that may have been signed off on in the past will get another review, or you may have a new partner at the firm that is taking a fresh look at things,” said Oppenheimer.

Finally, Wu emphasized that if an error is found during a hybrid or a PCAOB audit, the first thing you should do is think through it from the mentality and mindset of the auditors. “How do you build a story around an error and how do you build a fence around the magnitude of the error? It’s really important to articulate the company’s thought process to the auditors. It is strongly recommended that you have someone that have experience at one of the ‘Big Four’ audit firms on your team, if you don’t already have an internal control function stood up.”

Quarterizing Financials

Another area of PCAOB compliance that catches many private company CFOs off guard is moving from annualized to quarterized financial statements. Companies might choose to show historical financial performance over several quarters to demonstrate growth to investors in their IPO prospectus.

Two things to keep in mind here, according to Wu:

  1. Auditors will want to see comparative quarterly results before the number you actually put in your S-1 to perform a PCAOB-level review. 
  2. Each quarterly statement will follow the 10-Q standard (in terms of adjustments and disclosure required) in order for auditors to issue a comfort letter. 

Knowing both of these requirements, Wu advised starting the quarterization process sooner rather than later (8-12 months out from the S-1 ideally), as you won’t want to be dealing with digging into the history along with all of the other SOX and PCAOB compliance work.

Choosing an Audit Partner and Firm

When choosing your external audit team, remember that you need to have a relationship with both the partner and the firm, said Zanni. “You’re going to have conflicts with your audit partner and team. It’s just natural. But if you have a relationship with the rest of the firm,  whether it’s the local managing partner, the SEC partner, or the person in charge of the IPO desk, you can have conversations with them about client service. I think it’s important if you have a conflict regarding service with a partner that’s irreconcilable, you can have a productive conversation with the firm.”

In terms of actual firm selection, Badia recommended leveraging your audit committee for perspectives and referrals. Ultimately auditors are reportable to the audit committee, so it’s important they have that input and visibility. Oppenheimer added that most audit committee chairs have direct experience with multiple audit firms and can help navigate issues you might be having with them. Finally, Oppenheimer cautioned that if you choose not to go with a Big 4 firm, doing so because of cost isn’t a good reason.

As you look to scale yourself and your business on the path to IPO readiness, apply to join The Circle and join a private leadership community where you can give and get insights, ideas, support, and answers.

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