IPO readiness: financial reporting pitfalls to avoid

A key document to be included in your investment circular, whether an admission document (AIM) or prospectus (main market), is your historical financial information (HFI). This is the track record of your financial position and financial performance presented to prospective investors within your published investment circular, alongside the narrative disclosures.

If you're a UK company, or have a UK parent and are looking at a UK quotation, your HFI must be prepared under UK-international accounting standards (IFRS) and typically cover a three-year period. The rules differ on what financial information you need to present, for example, if you have a recent history of acquisitions, or are listing a combination of separate businesses (complex financial history), or you don’t have three years of trading. 

From the outset, it's essential to know what to include in your HFI – which will be subject to a public ‘true and fair’ opinion from your reporting accountant – and what you'll need to support it. The UK regulatory landscape is evolving and reporting accountants will likely perform top-up audit work on your HFI, which can present practical issues leading to significant delays in the process if you're not adequately prepared.

The specific facts and circumstances of your business will determine what guidance you need, so seek advice early to ensure you know exactly what to include in the transaction perimeter for your HFI.

Key financial reporting considerations ahead of an IPO

1 Consider conversion to IFRS

Once you've established the transaction perimeter of your HFI (complex financial histories can have accounting conventions specific to HFIs), your next step may be a conversion to IFRS.

If you already present audited financial statements under IFRS (usually, but subject to exceptions, with unmodified audit opinions), you may be able to bypass the HFI process altogether and simply reproduce these IFRS financial statements, and the related audit opinions, in your investment circular. If this applies to you then you should discuss and agree this with your advisers early as it can save you a considerable amount of time and expense in your IPO process.

If you don’t already report under IFRS then the first step is to undertake an IFRS conversion impact assessment. This will highlight the material areas of difference between your local GAAP and IFRS. 

Many accounting frameworks are now broadly converged with IFRS but there can still be material areas of difference. Typically we see differences relating to the revenue recognition model applied, lease accounting, amortisation of goodwill and the capitalisation of development costs. These areas can have a material impact on your HFI and your forward-looking information. Since these form an important part of building your equity story to the markets, it's vital to your credibility to understand any differences early on.

2 Anticipate areas of challenge

Your reporting accountant will give a refreshed true and fair opinion under SIR 2000 (Standard of Investment Reporting) on your HFI for the purposes of your investment circular. This is unless you have and can reproduce pre-existing compliant IFRS financial statements and accompanying audit opinions.

While SIR 2000 allows your reporting accountant to obtain audit evidence from the work of your current and previous auditors, the reporting accountant will often be working to a lower materiality level and with a higher risk lens of a listed company. As a result, they'll likely need to perform top-up audit procedures to reach their required level of assurance. They may also have higher expectations from you, requiring external valuations and accounting position papers. This is even more likely if you've had to undertake an IFRS conversion as this will form part of their opinion and won't have been previously audited.

It may be the first time you're undertaking an impairment review under IAS 36. Your reporting accountant will be looking for listed company benchmarks and comparators for the discount rates you apply.

If your finance agreements contain embedded derivatives that must be separated, and fair-valued under IFRS 9, they'll expect to see some external support for any material valuations (or sometimes immaterial to prove the negative).

Any accounting judgements you've made, for example a debt or equity classification of a financial instrument, is likely to need an accounting position paper. These papers are increasingly becoming a standard request.

Being aware of the potential areas of challenge in advance and preparing appropriate solutions can save you time and expense when you're in the middle of an IPO process.

3 Assess capacity for HFI preparation

Never underestimate how long preparing your HFI will take and how much bandwidth – already limited during an IPO – it will consume. Your HFI will be subject to ‘listed company level’ scrutiny by your reporting accountant, who'll expect to see best-practice disclosures and compliance.

If you can outsource the production of your HFI to a suitably experienced third party, we'd always recommend this. 

4 Review treatment of items prone to common errors

We often identify accounting errors in the draft HFI, when we're acting as the reporting accountant, even if those prior periods have been previously audited. Some common errors to consider for your own HFI track record include the following:

Share-based payments (IFRS 2)

• Use of tax valuations, particularly for Enterprise Management Incentive schemes
• Good and bad leaver provisions in the 'articles of association' not being considered for creating a service condition or any impact on the accounting as cash or equity settled
• No accounting for deferred tax assets or social security obligations
• Straight-line rather than graded vesting

Capitalisation of internally generated intangible assets (IAS 38)

• Mandatory capitalisation requirement ignored
• Capitalisation when costs can't be appropriately supported
• Capitalisation of costs which relate to the fulfilment of performance obligations under IFRS 15

Debt versus equity (IAS 32)

• Preference shares inappropriately classified as equity
• Clauses in agreements missed that mean the instrument fails ‘fixed for fixed’ and can't be equity for accounting purposes

Loans (IFRS 9)

• Embedded derivatives, eg, early prepayment clauses
• Exit clauses in linked agreements (often seen in private equity-backed businesses)

Next steps: how to prepare for your IPO 

Addressing financial reporting and other considerations early will help you be better prepared on your IPO journey. Resolving accounting issues late in the day can impact the IPO timetable and result in increased costs. This is particularly frustrating if, during the IPO process, it's identified that material adjustments are required for non-cash items which potential investors or analysts may add back anyway.

Our IPO readiness team have significant experience in supporting companies to prepare for financial reporting requirements before, during and after an IPO.

For more insight and guidance, contact Pinkesh Patel or Ashleigh Ryninks.