IPO Insights: Preparing for an IPO

The process of conducting an initial public offering (“IPO”), from initial planning to the first sale of shares to the public, is lengthier than many expect. Companies considering an IPO as part of their liquidity strategy should begin initial IPO planning 18 to 36 months before they plan to go public — well ahead of the completion of the IPO.

In preparing for an IPO, the first six to eight drafting sessions of the S-1 Registration Statement are often focused on the description of the company’s business — its markets, its offerings and its competitive strengths and growth strategies. While important messaging points to solidify, careful consideration should also be given during such time to the overview of the company’s MD&A (Management’s Discussion and Analysis of Financial Condition and Results of Operations), which includes a description of the company’s key financial and business drivers, as well as known trends and uncertainties. These elements of the MD&A are crucial to an investor’s understanding of the company and its prospects.

The SEC has stated that: “MD&A should be a discussion and analysis of a company’s business as seen through the eyes of those who manage that business. Management has a unique perspective on its business that only it can present.”

The MD&A is a key area of focus for the SEC, with comments to the section often being some of the most significant and challenging for companies to respond to during the Registration Statement review period. The SEC staff will seek to identify any gaps in disclosure and reduce any ambiguity in the MD&A. Below, we highlight certain considerations to keep in mind while preparing the MD&A overview.

Key Business Drivers

Before drafting the MD&A, management should identify the fundamental drivers of the company’s business and the key levers that influence the company’s financial performance. How does management evaluate the company’s business? What factors drive revenue growth, costs and profitability? What information is presented to the company’s board when reviewing results? Management should consider key drivers today, as well as drivers it expects to be significant in the future.

The MD&A overview is not intended to discuss accounting policies or revenue recognition principles. Rather, it should resemble the type of briefing a new director may receive to understand the key drivers behind the company’s business. It should be a narrative version of management’s internal reporting dashboard. A thoughtful discussion of these key operating levers forms the foundation of the MD&A.

Known Trends and Uncertainties

The SEC staff also typically focuses its attention on the disclosure of known trends and uncertainties in the MD&A overview. The objective is to thoughtfully consider the broader macroeconomic and industry trends that pose challenges to the business — often thought of as the trends/uncertainties that keep management awake at night. The MD&A should articulate how management thinks about these trends and uncertainties and strategically navigates them. For instance, currently many SaaS companies are considering AI’s potential for disrupting traditional SaaS models and reducing the demand for conventional SaaS solutions. This has resulted in many companies considering and disclosing how they may invest in AI and how AI is or may be used in their business. AI companies, on the other hand, are navigating uncertainties around the adoption of AI, securing sufficient power capacity to operate and improving their costs of capital. Other trends and uncertainties may include disclosure around cybersecurity threats becoming more frequent and sophisticated, prompting companies to invest additional resources in monitoring and response plans. Other companies have disclosed trends and uncertainties around inflation, interest rates and supply chain disruptions, which may impact costs and soften customer demand. In drafting the MD&A overview, a company should evaluate whether any of the significant trends or uncertainties that management is closely monitoring, has identified in risk factors or discussed with the company’s board should be disclosed.

Key Metrics

Finally, it’s important to consider how investors evaluate the company. Most companies provide information to investors about their business and financial models through the disclosure of “Key Metrics” or “Key Performance Indicators” (KPIs). Key Metrics and KPIs provide a description of important data, such as operating or financial metrics, beyond GAAP financial statements. Key Metrics reported during an IPO are critical to helping analysts build their valuation models and will continue to be reported in the company’s post-IPO public filings. Often Key Metrics are measures management is already focused on—Adjusted EBITDA, Monthly or Annual Recurring Revenue, user growth or other volume metrics. Management should consider whether it will be comfortable updating and providing its Key Metrics and KPIs quarterly once the company is public. Once investors have been provided with the measures, the general expectation is that they continue to receive it regularly.

Investors sometimes focus on measures that the private company management team hasn’t calculated historically or thought about with rigor. For instance, with respect to SaaS companies, one measure of customer retention, often titled “monthly recurring revenue retention rate,” is used by management to help show the visibility management has into future results. But, there are many ways the retention rate can be calculated, so it can be hard to know if this retention rate gives a valid picture of the company’s business. What if it’s distorted during hyper-growth or what if it overstates the downside in a time of slowing growth? Companies should consider whether another measure, such as backlog, may be more effective.

Companies should be cautious and consider the implications of disclosing specific measures, as some may expose confidential or competitively sensitive data. Some internal metrics used by management may reveal too much, making it easier to reverse engineer pricing or margins. Management should consider how metrics are likely to be perceived and whether there are comparable metrics that could help investors evaluate the business without potentially harming the company competitively.

Conclusion

All of these disclosure discussions take time, data and careful thought. To ensure your MD&A is well drafted and provides a solid reflection of your company, it is important to have early discussions with the underwriters about how to present the company’s business drivers, Key Metrics and KPIs, and to carefully consider the risks and benefits of disclosing them. Putting time and thought into the MD&A earlier in the pre-IPO process will help in many ways, including encouraging the team to think about the analyst model that will need to be built, as well as framing the discussions the company will have during the roadshow and in earnings calls. The overview and key metrics discussion is the company’s opportunity to help set the terms upon which the company’s performance will be measured for years to come.

For more information, visit Orrick’s “Are You IPO Ready?” resource center.