9 minute read 4 Jan 2021
EY - Bridge-crossing-under-construction

What happens when great minds don’t think alike?

Authors
Ken Englund

EY US North America Technology Sector Consulting Services Principal

Focused on helping technology, consumer electronics, internet, social commerce and software companies solve critical business issues.

Jackie Kelley

US-West IPO and Strategic Transactions Leader

IPO and strategic transaction advisor. Growth-focused leader. C-suite sounding board. Featured source in The Wall Street Journal, Forbes and other news outlets.

Kevin Lavin

Partner, TMT Sector, Ernst & Young LLP

Experienced advisor and executive. Passionate and inclusive leader. Driven to bring people together to design better solutions.

Hardik Rathod

Senior Manager, Business Consulting, Ernst & Young LLP

Leader in transforming controls and internal audit functions for new and existing technology, media platforms and SaaS companies. World traveler. Works to connect and bridge cultural gaps.

Sanjay Khunti

Principal, Technology Sector Consulting Services, Ernst & Young LLP

Helps companies on their IPO journey transform from early-stage private to mature publicly traded companies. Works across the technology, consumer products, health care and life sciences sectors.

9 minute read 4 Jan 2021
Related topics IPO TMT Technology

Platform-based companies must manage their fast growth with regular, close engagement between engineering, finance and other business functions.

In brief

  • Companies focused on the needs of the engineering team can innovate quickly, but this model presents challenges when a fast-growing company approaches an IPO.
  • Pre-IPO, companies must align and balance priorities and resources across finance, engineering and operations. Active, transparent communication is also vital.
  • Post-IPO, companies must maintain a fast-growth mindset, while complying with new public company requirements. Robust processes, systems and controls to support timely, accurate reporting of financial results, forecasts, metrics and disclosures are critical.

Traditional monolithic IT architectures are giving way to microservice-based platform environments that are more modular and agile. Platform environments are primarily found in the technology sector, although non-tech businesses are adapting them.

For these companies, the platform is the primary revenue-generating mechanism and houses the most valuable data. That naturally results in an organization geared primarily to the needs of the engineering team in terms of headcount, investments and decision-making influence.

It’s a robust model for technical innovation, especially as a company is growing rapidly, but presents challenges when a fast-growing company approaches an initial public offering (IPO). Pre-IPO companies — and those that go public — have a broad set of financial, regulatory and operational requirements that must be harmonized with the pivotal work of engineering.

When priorities around technical innovation and public company readiness are not aligned, the resulting miscommunication and strategic disconnects jeopardize IPO timelines and IPO and post-IPO valuations.

  • Well-prepared companies take advantage of active tech IPO market

    Through December 10, 2020, 64 tech IPOs have come to market, a record-breaking number of tech IPOs in nearly two decades. In September alone, 16 tech IPOs launched, raising nearly $10 billion, the largest amount since 2014.

    So, what’s driving the strong performance?

    Despite an initial interruption, COVID-19 and the quarantine culture have been advantageous to technology companies. Pre-IPO firms continued to bide their time, and by June the markets became favorable again.

    The 2020 market shows the importance of diligent, thorough pre-IPO work. In a tumultuous year, well-prepared tech companies are closing 2020 in an extraordinary way and reaping the proceeds of a favorable market.

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Chapter 1

Five critical pre-IPO challenges

As companies speed toward an IPO, they must also find ways to harmonize their different functions.

Before the IPO, platform-based technology companies must address five critical challenges.

1. Balancing organizational objectives

A year or two out from an IPO, the focus should be on aligning and balancing priorities, resources and controls across finance, engineering and operations. Early, active lines of communication will help both engineering and product teams understand how their respective work affects the accounting, regulatory, compliance and finance teams.

The downstream impact of new products, services, functionality or existing services that are modified must be assessed before taking these actions. Again, teams need to work in harmony.

2. Establishing a common financial reporting “language”

Understanding and reporting key financial data is crucial for a successful IPO, and this responsibility goes far beyond the finance team. Tax, legal, cyber/privacy, sales, operations, IT and engineering must also have a common understanding of the financial reporting information. The company as a whole must be aligned in the terminology as well as the intended use of financial reporting data.

Reporting data that originates, or relies heavily, on front-end or underlying product infrastructure could lack sufficient controls and reliability. Likewise, new products or sales initiatives can complicate accounting evaluations and the capability to produce succinct financial information for investors and analysts.

To mitigate the risk, companies must develop a robust financial reporting and disclosure infrastructure that produces timely, accurate reports for management, regulators, investors and other relevant parties.

A year or two out from an IPO, the focus should be on aligning and balancing priorities, resources and controls across finance, engineering and operations. 

3. Building IT governance

Management must harmonize IT, operations and engineering across policies, processes and talent. The “tone at the top” is critical to successful coordination.

That tone manifests in several ways. There must be a clear delineation of responsibilities and reporting between the engineering and IT functions. Management also has to make judgments about funding priorities (i.e., engineering vs. other infrastructure requirements), which often will require a cost-benefit analysis to balance the focus appropriately.

Finally, management must clearly articulate its priorities and allocation of responsibilities and hold engineering and IT mutually accountable for their work.

4. Deploying internal controls

When IT access is not well-controlled, a company risks inappropriate access or security breaches that threaten the company's financial results and reputation. When IT change management processes are not mature, a company risks unauthorized system changes that impact financial results and operations.

Key staff (a vice president of engineering, for instance) can help bridge the gap between keeping a compliance mindset while building as fast as possible. Proper training and clear ownership of controls around financial information also are important for building a strong controls mindset.

5. Investing in talent and other resources

In parallel to IPO-specific efforts, companies must continue to invest in the business itself during a high-growth period. The right talent is critical. However, companies chronically underestimate the time it takes to acquire high-level talent in competitive markets.

Certain personnel are vital to achieving that crucial cross-organizational balance — such as those who effectively link product and engineering teams to accounting and finance teams.

EY - IPO-readiness-timeline
EY - Construction-of-hover-dam-bridge
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Chapter 2

Five critical post-IPO challenges

New public companies must discard the private mindset and focus on broader regulatory, finance and operational priorities.

After the IPO, platform-based technology companies must continue the fast-growth mindset that got them to market in the first place. That requires continued alignment and close collaboration between the business and engineering. There are five critical ways that this alignment can fall short, especially within the first year or two post-IPO.

1. Insufficient system architecture

It’s vital to have up-to-date enterprise resource planning (ERP) systems and an adequate revenue subledger architecture that can scale with the transactional volume and overall growth of a company post-IPO. Other gaps to look out for include insufficient reporting capabilities and a lack of appropriate systems documentation. Companies must also make sure they have systems that can support production of consistent, reliable KPI data and nonfinancial metrics.

2. Lack of “one source of truth” and effective data management

Data must be complete, accurate and useful to stakeholders. But when data is siloed and/or dispersed across services, that can be a hard target to hit, posing a significant business risk.

Data managers shouldn’t rely solely on SQL queries; they must be able to generate reports that can be understood by less-technical finance personnel. Change management also plays an important role. Managers must make sure that queries are updated when underlying tables are modified.

Because a public company reports quarterly, financial reporting is more crucial and must be more tightly governed than when the company was private. IT must understand financial accounting, reporting, disclosures and controls. If not, master data might be of no use to stakeholders. Additionally, inconsistent master data in different systems can cause data manipulation to occur outside of reporting systems, creating inefficiencies and risks around compliance and data integrity.

When considering master data management, several elements must be in order:

  • Data tag and field definitions must be consistent across the organization
  • Group-specific trial balances must tie to accounting trial balances
  • Governance models must meet stakeholder needs
  • Data dictionaries must be kept up to date as the business grows and changes
  • IT systems of record for data elements must be defined
  • Processes and controls must be in place to make sure data remains aligned between IT systems
3. Lack of understanding of the “golden path” for revenue from initiation to subledger

The “golden path” is the scenario in which revenue flows seamlessly from initiation to recording without any exceptions. Due to the decentralized nature of revenue-related services, achieving this is often an extremely time-intensive discovery exercise.

The constantly evolving SOX environment also plays a role here. Too often, teams that “own” SOX do not communicate well with product and engineering teams. The disconnect means that both SOX leaders and product and engineering teams do not fully understand the financial risks associated with a company’s core product. And as microservices are created and functionality is compartmentalized, the number of applications in-scope for SOX can expand significantly.

Because a public company reports quarterly, financial reporting is more crucial and must be more tightly governed than when the company was private. 

4. Inadequate controls design

The science of compliance is having controls in place and operating them properly. The art of compliance is identifying and designing the controls. To do so, companies must address the following all-too-common challenges.

  • Poor integration between traditional and other approaches

    Poor integration between traditional IT general control (ITGC) approaches and agile and waterfall-based systems can create challenges.

    A microservices architecture enables agile development, allowing the rapid spin-up and deprecation of services. Therefore, SOX scope requires continuous validation. Numerous complexities must also be addressed around development, testing and monitoring of distributed systems.

    A controls design also includes monitoring of application programming interfaces (APIs). Instead of traditional interfaces, APIs are mostly used for service-to-service data transfers. API call-failure monitoring and error resolution may not be easy to prove or test if appropriate tools are not implemented up-front.

  • Inappropriate segregation of duties

    The inappropriate segregation of duties across platforms, corporate applications and businesses with a fluid environment is another potential stumbling block.

    Most engineers in a microservices environment have elevated access so they can quickly make changes to enhance the product. These permissions need to be appropriately managed.

    Other issues arise when there is (1) a lack of automation with deployment workflows and (2) a lack of appropriate access monitoring. Platform system access must be restricted as needed, and a detailed audit trail of system changes is mandatory.

  • Platform-based fraud

    As a company’s visibility grows post-IPO, so do threats. Platform-based theft includes location spoofing, coupon-/discount-related deceit, inappropriate credits and fraudulent cash payments.

    Management must assess platform access, determine what’s appropriate (and what’s not), and perform ongoing fraud assessments to calculate the material impact on a company.

  • Reliance on SOC reports

    Companies that use third parties to manage their controls environment open themselves up to compliance risks.

  • Failure to monitor “emerging growth company” requirements

    Companies that fail to monitor these SEC-related requirements as defined by the Securities Act of 1933 face slippage and/or noncompliance with SOX 404(b) regulations.

5. Technical accounting challenges

Platform companies often rely on custom systems along with a complex IT architecture to process transactions and perform accounting-related activities, especially for revenue. Technical accounting evaluations, including those contained within IT systems, must be completed quickly enough to align with financial reporting processes and timelines. 

This can be difficult because often (1) revenue recognition is complicated with customer, agent and principal considerations, but also, (2) the accounting for these considerations is often embedded in complex scripts and tables contained in the IT systems.

Once public, it’s critical that IT, engineering, finance, accounting and operations work closely together to develop and maintain a robust accounting and reporting process and control environment that meets SEC and regulatory reporting and compliance requirements, forecasting needs and related timelines.

The authors would like to thank EY team members Jake Plumer, Abhay Khera and Monique Christensen for their contributions to the article.

Summary

Pre-IPO companies should perform a readiness assessment to address potential challenges that could disrupt the path to going public. For companies that have already gone public, similar pitfalls — such as a lack of collaboration between business operations and engineering — must be addressed, as well as additional requirements for public companies.

About this article

Authors
Ken Englund

EY US North America Technology Sector Consulting Services Principal

Focused on helping technology, consumer electronics, internet, social commerce and software companies solve critical business issues.

Jackie Kelley

US-West IPO and Strategic Transactions Leader

IPO and strategic transaction advisor. Growth-focused leader. C-suite sounding board. Featured source in The Wall Street Journal, Forbes and other news outlets.

Kevin Lavin

Partner, TMT Sector, Ernst & Young LLP

Experienced advisor and executive. Passionate and inclusive leader. Driven to bring people together to design better solutions.

Hardik Rathod

Senior Manager, Business Consulting, Ernst & Young LLP

Leader in transforming controls and internal audit functions for new and existing technology, media platforms and SaaS companies. World traveler. Works to connect and bridge cultural gaps.

Sanjay Khunti

Principal, Technology Sector Consulting Services, Ernst & Young LLP

Helps companies on their IPO journey transform from early-stage private to mature publicly traded companies. Works across the technology, consumer products, health care and life sciences sectors.

Related topics IPO TMT Technology