For companies with an eye on the public markets, effectively communicating your story is the key to a successful IPO. While lots of ink is spilled on the qualitative narrative of the story, there is a quantitative angle that ironically sometime goes underappreciated. Sometimes, it simply is all about the numbers! Your financial model anchors the narrative of your equity story and reveals how investors and analysts should view your business: Historical financial statements in your S1 reflect your past performance, and your financial projections tell the market how you expect to perform in the future.
Of course, most future shareholders will build their own financial model of your business, but components of their model are going to be informed by the financial model that you share with the investment banks you selected to underwrite the IPO. The financial model indicates both the growth rate of the business and the durability of that projected growth — i.e., whether that growth can and will be sustained over the long term. It will also indicate your view of your path to profitability, if you are still a pre-profit business. Ultimately, public equity investors use the financial model to determine if a company checks all their boxes and is a worthwhile investment.
With that in mind, private companies on the road to an IPO need think carefully about and work diligently to develop a “public-ready” financial model that will support their ambitions. Here’s what to consider when developing that public-ready financial model.
1. Begin With the Right People, Processes, and Systems in Place
Creating an accurate and reliable finance model starts with three key factors:
- Right teams: The IPO process overall requires a company to have a skilled and experienced team in place. Within that team, you must identify the right people to develop and maintain the financial model, since it plays such an important role. Generally, the CFO will quarterback the process, with several other internal and external stakeholders involved: IPO advisors, banking partners, auditors, internal counsel and analysts.
- Right systems: To create a financial model, you must have a reliable accounting system, as well as budgeting and planning software systems. These systems will allow you to track KPIs and accurately forecast bookings, revenue, and other critical metrics of the business.
- Right processes: Beyond having the right software, you also need to establish processes to ensure that you generate the right information in a timely manner. For instance, you should have a process in place for rolling up forecasts from different business divisions to the CFO so he or she can translate and apply them to the business overall.
2. Understand How Different Versions of the Finance Model Serve Different Purposes
Over the process of going public, companies will develop several different versions of their financial model. It’s essential to understand how these fit together and how to sustain and talk about each model.
- The internal model is the “base-case,” long-term plan for the business. This is the model that you would share with your board of directors, and within this model, you can demonstrate best- and worst-case scenarios.
- A banker model is used for the banker bake-off process. This forecast allows bankers to provide a realistic view of how you would be valued in the public markets.
- The Street model is what you share with research analysts, who then use it to build their own models (referred to as analyst models), which are ultimately what get published and used to generate consensus stock price estimates.
- Buy-side models are built by investors, and they are typically more aggressive than the Street model.
Companies that have their eye on the public markets should begin maintaining multiple financial models well before the IPO.
3. Choose the Right KPIs to Tell Your Story (and Report Them at the Right Frequency)
Key performance indicators (KPIs) help orient the investment community by allowing them to compare your business with similar companies, including your direct competitors, and track and forecast your business into the future.
KPIs can also be an important messaging tool. Especially for companies in certain industries, such as SaaS, the income statement doesn’t always tell the whole story. Companies can use other leading metrics, such as total and/or current deferred revenue, remaining performance obligations (RPO), calculated billings, current bookings, and annual recurring revenue (ARR), to demonstrate growth.
The exact metrics you use to tell your company story will depend on your industry and business type. Consumption-based models may lean more toward metrics like customer count, net dollar retention, and gross revenue retention. Software companies may look at payback period, customer lifetime value (LTV), and customer acquisition cost (CAC), whereas a restaurant company might use KPIs such as new unit opening, new unit growth rate and same store sales (comp store sales).
Generally, if your competitors are already public, and they share a particular metric on a regular basis, your company will be expected to follow suit and report the same metrics. However, if there’s something that your company does differently, or you’re the first in your sector to go public, don’t be afraid to share the metrics that you believe best reflect your business.
It is important to note that once you choose to provide certain metrics to investors (including what you decide to provide during the IPO process), it is very hard to discontinue doing so in the future. Therefore, it is important to be very thoughtful in selecting metrics that will allow investors to properly assess the company’s performance and future prospects, but not box-in management down the road by having to report on numbers that may be problematic.
Beyond selecting the right metrics, companies should consider how frequently to report on these numbers. Generally, KPIs fall into one of three buckets: one-time disclosure, annual disclosure, or quarterly disclosure.
4. Balance GAAP and Non-GAAP Metrics Reasonably
While all public companies are required to use generally accepted accounting principles (GAAP), companies may also choose to report non-GAAP financial metrics. Especially for tech companies, stock-based compensation (SBC) is usually the biggest adjustment between GAAP and non-GAAP. In addition, companies may adjust for factors such as depreciation, amortization, legal expenses, restructuring expenses, and acquisition-related expenses.
These are all reasonable and acceptable adjustments. However, it’s important to remember that investors will likely question your financials if any of your adjusted metrics are significantly out of line compared to your peers. For example, if you report SBC that is way outside of your competitors’ range, investors will want to investigate, because they may fear that high SBC will eventually lead to dilution down the road.
Financials are not one-size-fits all, and every industry is different in terms of what is acceptable and not acceptable. In general, however, investors will not look favorably on any attempts to adjust out real expenses to make profitability appear higher. The loss of credibility with investors is not worth the risk of trying to marginally increase profit.
If your company is considering an IPO, start the process of creating a financial model now. Begin identifying and tracking KPIs, see how you compare to your publicly traded peers, and maintain multiple financial models. As you continue toward the public markets, investors will see that you have spent ample time preparing, and you will more easily be able to build credibility early in the process.
For additional insight into building a public-ready financial model, listen to the full replay of the Baird’s IPO Reboot Series webinar.
