September 01, 2017
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The following piece was written by Barrett Daniels, the CEO and co-founder of Nextstep Advisory Services. He’s worked on more than a fistful of IPOs that you know by name. 

For most companies, the IPO process is painful. Not because IPOs are technically challenging or overly complex, but because a lot of additional hard work is required and it’s not a situation people often find themselves in.

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Unfortunately, there are no secrets for making an IPO painless. Every IPO is arduous, but there is one effective way to make an IPO less painful: listen to your auditors.

Make It Stop

One of the primary goals of every IPO is to finish as quickly as possible. There are several reasons for this. The two most important are to ensure you get out before an IPO window shuts, and, of course, to make the pain stop.

Unfortunately, this is not easy to do. The IPO process is slow and cumbersome. Even in the best of circumstances, it takes several months and often considerably more to go through the motions. Therefore, every day matters, bringing us to two absolute truths that you learn from operating in the IPO world long enough:

  • IPO Truth #1. The long pole in the tent of every IPO is the financial statement audit.
  • IPO Truth #2. Fighting with your auditors and the SEC never makes an IPO go faster.

I felt compelled to discuss the topic of how to approach an IPO audit after reading an Axios article last week on Uber’s financial performance:

Uber is no longer reporting unadjusted net revenue to its investors, due to new guidance from the SEC.

It is unclear if Uber is currently working on an IPO officially. The company just hired its replacement CEO, and the world’s largest unicorn is still chugging along without a COO and CFO.

However, the new CEO also just stated an IPO is at least 18 months away, and the Axios comment indicates that the ridesharing company has, at least, discussed its revenue recognition with the SEC as part of a pre-clearance discussion. Pre-clearance of technical issues is a very common pre-IPO move and 18 months isn’t all that far away. Therefore, let’s assume Uber is in the IPO process.

Revenue And The SEC

Uber previously recognized revenue from its UberX services on a net basis (net of driver costs), while recognizing revenue from its UberPool services on a more aggressive gross basis. Without getting into the accounting weeds around gross versus net revenue recognition, these services seem very similar from an accounting point of view.

Therefore, what Uber was doing with its Pool revenue seemed aggressive. That’s notable as discussions with the SEC concerning gross versus net revenue accounting are known to go something like this:

  1. If the conclusion is aggressive, you definitely lose.
  2. If the conclusion is a tiny bit aggressive, you definitely lose.
  3. If the conclusion is on the fence, you still lose.

Companies in the IPO process understandably love gross revenue, but the SEC doesn’t; therefore, it would not be at all surprising to see the UberPool accounting position get overturned by the SEC. To be fair, the accounting guidance around this issue is convoluted, making it easy for a reader to get to their preferred conclusion.

The main point here, however, is that this is just not a good issue to fight with the SEC. A good IPO audit partner will know that.

Of course, an audit partner can only do so much — management needs to be smart and trust the advice of IPO experts to determine what battles are winnable.

Unfortunately, not trusting an IPO expert is not all that uncommon.

Many CEOs and founders of these exciting IPO companies have probably been told “no” by experts for years. If the company is a true disruptor, like Uber, then this is likely the case. Therefore, breaking the old rules may appear to be a standard part of the process.

But fighting with the SEC is different; the SEC can’t be bullied.

This also goes beyond gross versus net revenue conclusions. Battling the SEC on any issue is often challenging, and that’s not a dig. SEC regulators are just doing their job, and they get ridiculous questions all the time. So, even in the best of circumstances, and even if a company’s intentions are pure, the process of trying to convince the SEC to agree with a conclusion that isn’t black and white can be brutal and is almost always time-consuming. It is also important to note that the SEC is loaded with smart people who understand nuance. That means the SEC, for the most part, is adept at seeing right through bullshit. Said another way: the SEC knows what it is doing and is generally very good at it.

Again, a good IPO audit partner will steer you clear of these unnecessary and time-consuming conversations.

Be Smart

If you have been smart, done your homework, and hired a good IPO audit partner from a reputable firm, they are probably not going to lead you down the wrong path. That means, as a founder, you should listen. And don’t just listen in regards gross versus net revenue either.

Listen to all of it.

Understandably, this is not always easy to do as several accounting rules do not make sense in every circumstance . (A set of rules meant to cover every company in the world is going to have some issues.) But IPO audit partners, the smart ones at least, have to say “no” sometimes, even when pressed by a prized IPO client.

That’s because the SEC doesn’t give a damn about anything except getting to the right answer. If the book says a position is wrong, then the SEC also believes the position is wrong — simple as that. So just listen to your IPO audit partner because, at the end of the day, all he or she wants to do is get the right answers, avoid hassles with the SEC, get the IPO over with, and not piss off everyone too much.

IPOs are difficult enough. As a founder, don’t make them more difficult than they need to be.

iStockPhoto / sanjeri