Apr 19 ‘24
26 min read
IPOs are complex. There are over 27 million private American companies, and only around 250 go public each year. Additionally, only 20% of IPOs eventually survive.
While risky, an initial public offering may be worth trying if your business is ready strategically and financially. The only way to know that is to conduct comprehensive IPO due diligence. This article explores the following aspects of the IPO due diligence process:
- Business aspects IPO due due diligence involves
- Typical due diligence procedures
- Public offering readiness steps
- IPO due diligence checklist
- Common mistakes during IPO due diligence
Understanding the due diligence in IPO
IPO due diligence (DD) investigates a company’s capabilities and sustainability for going public.
Underwriters typically conduct due diligence and collaborate tightly with IPO targets. Due diligence may begin three to six months before the IPO. It achieves the following goals:
- Understand IPO readiness status and develop readiness steps.
- Collect and verify information required for the company to meet the securities law requirements and get listed on stock exchanges.
- Identify any issues the company may have with IPO compliance and minimize pos-listing liabilities.
- Determine the offering price, number of shares available, and types of securities offered
Due diligence on IPO: 6 areas to investigate
IPO due diligence evaluates private companies against reporting, accounting, and regulatory standards for public companies. The investigation of the company may touch on the following areas.
| Investigation area | Significance |
| Corporate governance |
🔸 Pre-IPO companies adjust their governance structures to meet public listing standards. Board structures and policies may require significant organizational changes. |
| Financial information and accounting methods |
🔸 Companies must consider whether they have sufficient resources to sustain ongoing post-IPO costs, like regulatory fees and compliance expenditures. 🔸 Accounting practices and financial records must meet standards for public companies. |
| Business model |
🔸 Companies need relevant profit margins, growth opportunities, and market positioning data to attract potential investors. As per Deloitte research, 80% of companies need to develop forecast models for the IPO process. |
| Internal controls |
🔸 A company that intends to go public needs to improve internal controls to meet listing standards. Control documentation may be revised and restructured. |
| Legal matters |
🔸 The legal structure must meet the regulatory compliance requirements of public companies. Contracts, obligations, intellectual property, licensing, and other aspects must be issue-free. |
| IPO readiness |
🔸 Pre-IPO companies evaluate themselves to understand IPO readiness, identify issues, and address risks. |
How are IPO due diligence investigations made?
IPO targets, investment banks, legal advisors, and other parties use the following methods to conduct IPO due diligence:
- Documentation exchanges. The target company collaborates internally to collect relevant data and exchange documentation with investment banks and other advisors.
- Documentation reviews. Thorough due diligence findings help pre-IPO companies develop action plans, prepare business functions, and address issues.
- Financial audits and forecasts. IPO targets and underwriters determine financial metrics and develop growth projections to support and validate price offerings and meet listing requirements.
- On-site inspections. Internal inspection teams conduct physical checks to actualize and verify findings.
- Follow-ups and resolutions. IPO targets and advisors collaborate closely to address issues, consult on IPO roadmaps, and address readiness issues.
Pre-IPO readiness: 7 important steps
The Big Four firms recommend private companies follow these seven steps in the pre-IPO process:
- Understand business environment
- Develop business strategy
- Research capital markets
- Evaluate your governance structure
- Evaluate internal controls
- Consider operational readiness
- Contact underwriters
Understand business environment
You need to know whether your business can compete with comparable public companies in your market. Pre-IPO due diligence should focus on the following aspects:
- Competitive landscape. Gather information on competitors to understand their value drivers, weaknesses, advantages, and market shares.
- Risk assessment. Understand your market position and identify your value drivers, weaknesses, and competitive advantages.
- Market dynamics. Understand market trends and investor expectations. Compare this data against your business model and value drivers.
- Regulatory environment. Screen regulatory requirements for public companies and understand challenges and trends.
Develop business strategy
It’s critical to consider your business future as a public company, which means developing or at least drafting a business strategy for the post-IPO state of your business:
- Understand business objectives. Develop business objectives and KPIs, such as target revenue and market shares, while considering your business landscape as a public company.
- Identify business growth tools. Consider market and product expansion opportunities, customer acquisition, and other tools for achieving strategic objectives.
- Consider M&A opportunities. Explore strategic partnerships, joint ventures, and mergers & acquisitions as part of your growth strategy and explore M&A compliance requirements for public companies.
Research capital markets
Listing your public company on the right capital markets will maximize stock growth opportunities. Consider the following aspects of stock exchanges:
- Market position. An established exchange with a significant investor base will help your business attract inventors and grow stock valuation.
- Listing requirements. Consider listing rules and associated costs to plan your financials and avoid unexpected charges. For instance, the New York Stock Exchange charges a one-time $295,000 listing fee for a class of common shares.
- Trading volume and liquidity. The high trading volume demonstrates investor interest and contributes to stock performance.
- Expansion opportunities. Ensure international investors can easily trade securities on the exchanges of your choice, and consider their global reach.
Evaluate your governance structure
Check if your organizational structure meets public offering regulations. Also, understand whether the leadership qualities of your current board of directors and C-suite meet the anticipated challenges of becoming a public entity. Evaluate the following aspects of your governance structure:
- Board of Directors. Ensure the board members have relevant skills and experiences to supervise a public company and introduce changes if necessary. Establish a board of directors if you don’t have one. Ensure its composition meets listing requirements.
- Corporate transparency. Evaluate your disclosure practices regarding executive compensation, material risks, transactions, etc.
- Investor relations. Develop strategies to communicate and build trust with future shareholders. Consider voting rights, disclosure procedures, and engagement in business relations.
Evaluate internal controls
As much as 80% (Deloitte) of companies need to improve internal controls before initiating the public offering process. Consider the following aspects to achieve the utmost financial transparency:
- Record keeping. Consider standardized record-keeping templates and secure document management solutions. Many private companies have complex financial records that may be inapplicable to public reporting.
- Financial reporting. Evaluate your financial reporting procedures for compliance with accounting standards. Consider the FASB standards for public companies and adjust financial reporting controls accordingly.
- Management reporting. Evaluate gaps in your management reporting procedures and consider audit software to capture and log real-time business performance.
- Tax planning. Identify the most efficient tax structure, optimize tax records, and address tax issues.
- Information management systems. Use data rooms with audit trails and robust security measures to execute internal controls and gather due diligence materials.
| Check how a quality data room for an IPO protects confidential information and streamlines IPO workflows. |
Consider operational readiness
Over 80% (Deloitte) of companies planning an IPO require additional resources for the listing process and business continuity as public companies. It’s crucial to assess your capabilities:
- Financial capabilities. Consider whether your business can support the IPO process, including underwriting fees, accounting costs, exchange listing fees, and miscellaneous costs. Over 43% of public companies say financial reporting costs were higher than expected.
- Financing needs. Consider debt refinancing, working capital requirements, and other financing needs to support the process. Consider potential financing sources and capital allocation plans.
- Talent. Assemble a strong management team to support the IPO process. Make necessary changes for the successful listing.
Draft your IPO strategy
All pre-IPO businesses develop IPO strategies with timelines, KPIs, and supporting evidence:
- IPO timeline. Outline the steps of your public offering process, from the initial meeting to drafting sessions, SEC filings, the IPO roadshow, and the final listing. IPOs take from four to six months to complete.
- Equity story. It contains business KPIs, value drivers, peer reviews & comparisons, and other elements convincing investors to purchase your stock.
Contact underwriters
Contact investment banks, lawyers, and other parties to execute the IPO process from preparations and due diligence to the final listing. You can see the list of parties involved in taking a company public.
| IPO advisor | Function |
| Investment banks (underwriters) |
🔸 Facilitate IPO preparation 🔸 Perform due diligence 🔸 Purchase stock from the companies and resell them to investors |
| Accountants |
🔸 Prepare financial statements for financial disclosures and other IPO-supporting documents |
| Attorneys |
🔸 Prepare listing documents and manage regulatory filings |
| The U.S. Securities and Exchange Commission (SEC) |
🔸 Approves the IPO process |
IPO due diligence checklist
The following IPO due diligence checklist provides a general idea of the business areas and compliance documents under review.
| IPO due diligence area | Sample IPO due diligence request list |
| Corporate governance |
☐ Articles of incorporation |
| The company’s financials and accounting practices |
☐ Audited financial statements for the past 3-5 years |
| The company’s business model |
☐ Market analysis |
| Internal controls |
☐ Internal control policies and procedures |
| Legal matters |
☐ List of intellectual property |
| Contracts and agreements |
☐ Licenses and permits |
| IPO readiness |
☐ Underwriting agreements |
| 🔸Pro tip: Use a comprehensive tax due diligence checklist to minimize legal scrutiny after going public |
3 mistakes to avoid during due diligence for IPO
Here are the three common IPO due diligence mistakes:
- Incorrect valuation
- Overreliance on investment banks
- Overreliance on the right timing
Incorrect valuation
A company seeking to go public naturally wants to benefit from high valuations. It may create discrepancies between IPO prices and aftermarket performance. As much as 70% of tech IPOs in 2020-2023 traded below the IPO price.
Such companies may earn bad reputations and lose investor confidence. Fortunately, some sound due diligence practices help companies achieve more accurate share pricing:
- Analyze comparable public companies. Consider the stock performance of comparable public companies. Post-IPO stock corrections may give you an idea of the market value.
- Check secondary markets. Analyze shares of comparable private and public companies traded between investors to gauge a more realistic market value.
- Engage with investors. Set up a data room for investors, organize presentations, and collect feedback to understand market prices.
Over-reliance on investment banks
Investment banks generate fees proportionally to IPO valuations. Based on our experience, it may incentivize underwriters to push unreasonably high IPO valuations, resulting in poor stock performance post-listing and major investor concerns.
Investment banks may also undervalue company stock to create artificial growth in the aftermarket. You can take these steps to reduce the risks of overreliance on investment banks:
- Hire multiple advisors. It will help you leverage broader perspectives. Thus, IPO deals between $25 to $99 million have an average of four investment banks (PwC).
- Conduct independent due diligence. Engage internal teams to validate valuation findings and possibly negotiate a more realistic listing price.
Over-reliance on the right timing
IPO markets are cyclic, with bearish and bullish periods replacing each other. Startups aim at favorable IPO windows to catch positive market dynamics and attract more investors. Contrarily, unfavorable market conditions and low investor confidence in the stock market may negatively impact newly listed public companies.
However, the last 20+ years of IPO activity indicate that reliance on the market timing may be detrimental if companies underestimate other IPO success factors. Market conditions are generally beyond companies’ control and should not be decisive factors. Our observations show that successful IPO companies focus on the following:
- Financial health. Demonstrate consistent profitability and revenue growth to become a favorable investment target.
- Inherent business value. Be competitive, ensure business scalability, and pursue innovation.
- Regulatory readiness. Standardize and streamline financial reporting controls to be ready for smooth and painless due diligence.
The bottom line
- IPO due diligence helps companies bring their governance structures, internal controls, business models, legal matters, and financial records up to listing standards.
- A business should understand the competitive environment, improve internal controls, standardize financial records, and prepare an IPO strategy to initiate the IPO process.
- The most common IPO pitfalls are incorrect valuations and overreliance on investment banks and market conditions.