When thinking about taking a company public, entrepreneurs should prepare for the extensive due diligence review of their company that will be performed by the IPO lawyers and the underwriters in connection with the offering. As forewarned is forearmed, this brief overview of the due diligence process can help minimize the amount of diligence-related work necessary once the IPO process officially kicks off.
Due diligence involves a top-to-bottom review of virtually every area affecting the IPOing company. The primary objectives of this review are to:
- Aid the company, its underwriters and their respective counsel in drafting the registration statement and prospectus, by:
- Providing information which securities law requires be disclosed or that may be of importance to investors
- Verifying the accuracy of such information
- Minimizing potential liability (or criminal sanctions) for the offering participants in case of material misstatements or omissions in the offering documents
- Identify any issues the company needs to address, including, for example, any necessary changes to ownership structures, shareholder agreements, employment arrangements and the like.
The level and type of due diligence review for an IPO will depend on factors such as the nature of the company’s business, industry and risk profile, as well as the jurisdictions where the securities will be offered. Some common elements of IPO due diligence include:
- The company producing documents in response to a comprehensive due diligence request list which underwriters’ counsel prepares
- The company’s auditors preparing and delivering a comfort letter to the underwriters containing certain assurances about the financial information contained in the offering documents
- When required, the company’s chief financial officer delivering to underwriters a certificate to provide “management comfort” on specified financial information in the offering documents that falls outside the scope of the auditor’s comfort letter
- The company producing materials in response to underwriters’ requests for documentation of data included in the registration statement and prospectus that the company’s auditors have not provided comfort on, or that have not been otherwise vetted through the diligence process (also referred to as back-up requests)
- Underwriters or their counsel conducting interviews with the company’s management, auditors, and potentially other third parties (such as the company’s advisors, customers, suppliers and/or collaborators)
- Executive officers, directors and certain principal security holders of the company completing questionnaires for the company and the underwriters
- Underwriters or their counsel conducting other types of financial and business due diligence, which may include, for example, a review of budgets, projections, historical financial information or competitive conditions, or site visits to the company’s facilities
The bulk of the due diligence work is conducted prior to the first confidential submission or filing of the registration statement, followed by updates through the closing of the IPO.
For company management, the most labor-intensive part of the due diligence process is typically collecting and assembling the relevant materials in response to the due diligence request list and back-up requests. In order to streamline this process, often a company will make many of these materials available to the project team in an electronic data room.
No matter how well-organized a company is in advance of the IPO, inevitably due diligence work must continue after the IPO officially kicks off. However, a company can take certain steps in advance of an IPO to minimize the amount of diligence work involved during the busy period between the organizational meeting and the first confidential submission or filing of the registration statement. These steps include:
- Designating a point person or persons at the company to lead the document collection and organization process
- Asking the company’s legal counsel for an IPO due diligence request list so the company can start collecting and organizing responsive materials in advance of receiving a similar list from underwriters’ counsel
- Cataloguing any reports or other sources for any data the company may want to include in the registration statement and prospectus (other than financial data that can be tied to the company’s books and records and comforted by the company’s auditors), such as industry statistics, market share or similar data
- Working with the company’s auditors to ensure the company’s financials will meet the Securities and Exchange Commission’s financial statement requirements, including, for example, by addressing topics such as financial statements for recent significant acquisitions, financial statements for certain significant subsidiaries, segment treatment and the like
A thorough due diligence process is necessary to a successful IPO. While the amount of work will be considerable, entrepreneurs who go in with their eyes open and starting preparation early can minimize the related stress.