Although the initial public offering ('IPO') event itself generally lasts for between four and six months, the process of transforming a business into a public company begins at least a year or two before the IPO, and continues well beyond it. An IPO is a key turning point in the life of a company. As such, it should be seen as a business transformation process rather than simply a one off financial transaction. The IPO is also an opportunity for a business to simplify its structures, formalise business practices and make improvements that will prepare it to face the challenges of operating in the public spotlight. This chapter summarises the principal financial information requirements for a company seeking a Premium Listing and admission to trading on the London Stock Exchange's (the 'Exchange') market for listed securities. The prospectus requirements set out below apply equally to Standard and Premium Listings, but those eligibility requirements under the Listing Rules, and the requirement to appoint a sponsor, only apply to a Premium Listing.

The Financial Service Authority's ('FSA') Prospectus Rules, Listing Rules and Transparency and Disclosure Rules (collectively, the 'Rules') establish a regulatory framework that determines the financial reporting requirements for a listing. In applying the Prospectus Rules, the FSA will take account of guidance issued by the Committee of European Securities Regulators ('CESR guidance').

The most significant requirements arise from:

Prospectus requirements

A company seeking to list on the Main Market must prepare a prospectus presenting detailed information on management and the underlying business. The equity growth story for the business to attract investors must be presented, however, other key information required includes:

• operating and financial review
• current trading and significant changes in the business
• key investment risks
• audited financial record
• unaudited interim financial information*
• indebtedness, funding requirements and capital structure
• statement on the adequacy of working capital
• pro forma financial information*
• profit forecast.*

* only required in certain circumstances

While some of these requirements must have an opinion from a reporting accountant/auditor, not all will lead to disclosure of financial information in the prospectus. They will, however, all need to be based upon financial information.

Listing Rules

These require a company (subject to certain industry-specific exemptions) to have accounts that have been audited without qualification and:

• cover at least three years
• have a final balance sheet that is not more than six months before the date of the prospectus
• show a revenue-earning record that supports at least 75 per cent of the company's business.

The financial information implications of these requirements should be carefully considered and, where necessary, they should be agreed with the FSA at an early stage in the IPO process. It is particularly important if major acquisitions have occurred during the period covered, as they can significantly impact the work required by both the company and the reporting accountants.

Sponsor

The Rules require that any company seeking a Premium Listing of equity securities must appoint a Sponsor. The sponsor will make an assessment of the company's suitability for IPO and the contents of the prospectus. As part of its responsibilities, the sponsor is required to make a declaration to the United Kingdom Listing Authority ('UKLA') which covers among other things:

• the company has established appropriate financial reporting procedures ('FRP')
• that the directors of the company are satisfied at the time of the IPO that the company will be able to meet its future reporting obligations as a listed company
• the directors' basis for the working capital statement. This statement declares that the company will have adequate financial resources for its present requirements, covering at least 12 months from the date of the prospectus. Making this assessment will form an important aspect of the IPO preparation.

The sponsor will usually require the company to commission the reporting accountant to prepare reports covering both of these matters.

The reporting accountant is instructed to prepare a number of reports. These either:

• meet specific regulatory requirements; or
• assist the directors and sponsor in meeting their obligations.

As such, much of their work is based on accepted market practice and therefore results in reports that are not published. The directors bear legal responsibility for the contents of the prospectus and the sponsor faces considerable reputational risk should it prove to be deficient. The due diligence process is designed to mitigate these risks and the work carried out by the reporting accountant is therefore extensive.

Long form report

A private due diligence report on significant aspects of the business – its exact scope will be determined by the company's circumstances.

FRP report

A business should be able to meet its reporting obligations as a public company and therefore consideration of FRP is critical in determining its listing suitability. The report assesses the suitability of the company's reporting procedures, and controls, as a basis for the directors to make judgements on the company's financial position and its prospects.

Accountant's report

The company's historical financial record contained in the prospectus must be reported on. While this can be achieved by audit opinions provided for each set of financial statements included, market practice is for an Accountant's report to be issued on the entire financial track record. This forms part of the prospectus and is equivalent to an audit report, but provides greater flexibility as it does not need to be issued by the same firm that issued a previous audit opinion.

Working capital report

This is a private report that considers the basis for the working capital statement in the prospectus. This includes the company's approach to financial forecasting, its projections underpinning the working capital statement, as well as analysis of the impact of changes in the key assumptions, and the available banking facilities.

Other reports

If a company includes either a profit forecast or pro forma financial information in the prospectus, an Accountant's report on the compilation of information must be included in the prospectus. While companies rarely choose to include a profit forecast, owing to the additional risk, cost and time involved, pro forma financial information is commonly used to illustrate the effect of the IPO, recent transactions or a reorganisation that are not reflected in the historical financial information. When a profit forecast is reported on, it is usual for the reporting accountant to prepare a detailed private report that comments on the preparation of the forecast and the risks to its achievement. The reporting accountant also provides a 'comfort letter' to the directors and sponsor to assist with the verification of other financial information in the prospectus.

The following sections explain what the various reporting entails and how disruption to the company's business and cost can be minimised through appropriate preparation.

This is an integral component of the IPO process. It is established practice in the UK, rather than a legal or regulatory requirement, for the report to be prepared as part of the consideration of the company's suitability to be admitted to a public market. While the report is not made publicly available, it will influence the contents of the prospectus. The long form report is often prepared by the same firm that audits the company's accounts, but the work is performed by personnel who are not part of the audit team. This is owing to the specialist nature of the work and the need to provide a more objective and independent view. The table below illustrates the typical contents of a long form report and some of the issues that it may need to address. These will be raised with the company and sponsor as the work progresses for consideration and/or timely action, as appropriate. The scope of the report is tailored to the requirements of each IPO and is agreed between the reporting accountant, the company and the sponsor. The report's extensive scope requires management to make a significant commitment of time and resources in order to provide the necessary information and explanations. This coincides with competing demands on company resources arising from other aspects of the IPO, and some of the same information will also be required by the other IPO advisers. Cooperation between the various IPO advisers is required to reduce the pressure on the management team.

start planning early and in particular:

• identify information requirements that might not be straightforward, eg GAAP conversions, complex transactions, and related-party and inter-company transactions
• check the quality and consistency of information across all subsidiaries
• assign a project manager to deal with information requests. It may be appropriate to hire additional resource
• establish an electronic data room. This can be particularly beneficial when information is being drawn from many sources and locations and/or different advisers require access to the same information
• start the due diligence in advance of the other IPO work streams. A draft report can be prepared and then updated for current trading later in the IPO process. This reduces pressure on the company's resources and provides a useful basis from which to draft the prospectus.

Failure to make timely disclosure of financial and price-sensitive information can damage a company's reputation and result in fines for both the company and its directors. Significant emphasis is therefore placed on a company's FRP during the IPO process, culminating in the sponsor's declaration to the FSA that the company has established procedures that are fit for purpose. The lack of appropriate FRP can result in postponement and, in some cases, abandoned flotations.

Most companies will need to improve their FRP, as it takes time to identify changes, and to design and implement revised procedures. The key message is that FRP needs to be addressed early with, ideally, an initial gap analysis performed at least 12 months prior to the IPO. This will be particularly important if the company has made acquisitions that need to be integrated. The reporting accountant will normally prepare a private report commenting on the FRP and give an opinion as to whether it considers that the procedures provide the directors with a reasonable basis on which to make judgements concerning the company's financial position and prospects. The focus on prospect management has become increasingly important in recent years.

The work performed would not typically extend to testing the relevant controls or procedures. However, identifying the key performance indicators ('KPIs') is critical. Once these are identified, the reporting accountant will assess whether the procedures are capable of producing information for the KPIs on a timely and reliable basis. An example scope of work for FRP includes, but is not limited to, the following areas:

• high-level financial controls (eg 'tone from the top', risk identification and management, internal audit function, board and its committees)
• design of internal controls
• budgeting and forecasting processes
• treasury management
• accounting policies and procedures
• management reporting framework
• financial statement consolidation and reporting procedures
• IT general controls and application controls for production of key financial information.

Aside from a few specific exemptions (investment, mineral and scientific research-based companies) a company must be able to present financial information covering at least three years.

The separation of a large energy business from its parent, and subsequent IPO onto the Main Market, involved the complex detachment of legal entities, assets, people, systems and shared/ centrally provided services. As the new entity had not previously operated as a standalone business, the design and implementation of new FRP was a priority.

Ernst & Young identified the FRP gaps through an early readiness assessment and the following actions were undertaken:

• A comprehensive separation plan was developed, which was led by a dedicated separation manager.
  • The key areas covered were:
  • – management and people
  • – the scope of central services to be provided by the parent
  • – shared and separated IT systems
  • – contractual agreements
  • – confidentiality considerations
• An action plan was then developed to address the implementation required for new FRP relating to corporate governance, management and statutory reporting, preparation of IFRS management accounts, budgeting and forecasting.

Ernst & Young's readiness assessment and the resulting remediation plan enabled the company to avoid delays and unnecessary cost by ensuring its FRP were appropriate in advance of the IPO. The action plan also highlighted the additional expertise that the company would need to hire in order to implement the new FRP procedures successfully, particularly with regard to International Financial Reporting Standards ('IFRS').

However, there are some additional, potentially onerous, requirements that are considered below.

Reporting

The financial information must be reported on, either by means of an audit report or, more typically, an Accountant's report. The opinion in each of these reports is essentially the same, but an Accountant's report may require additional work. Whichever form of report is used, it should be unqualified. Any audits must have been performed in accordance with auditing standards accepted in an EU member state or equivalent.

Age of historical financial information

The financial information for Premium Listings must be drawn up to date no more than six months before the prospectus date. This could mean that full, audited financial statements are required to an interim date, with comparative information, although the latter can be unaudited. Interim information should be prepared and audited early in the IPO planning process, as failure to do so can cause a delay and incur additional costs. If a company wishes to offer shares in the US to qualified investors under Rule 144A of the US Securities Act and the latest audited financial information is more than 135 days old, the auditors may need to review more recent, unpublished financial information so that they can issue the auditor's comfort letter, required by the underwriters to the offering.

Financial track record and transactions

A minimum of 75 per cent of the company's business must be supported by a revenue-earning track record for the three-year period. The implications are that, even with this track record, a company may still not be eligible for listing, if, for example, its core activity has changed fundamentally during the three-year period or the level of operations has increased exponentially. In such cases, management should discuss the matter with the FSA to determine whether the company will be eligible for listing at the present time. If the company has made a significant acquisition in the three years leading up to the IPO, it may mean that its existing financial information does not reach the 75 per cent threshold. To reach this threshold, additional pre-acquisition financial information for acquired companies will have to be presented separately. This inevitably adds to the work of the finance team and the reporting accountants, particularly when the financial information in question has not previously been audited or was prepared using different accounting policies from those of the company.

Accounting policies

At least the last two years of the financial information must be prepared using the accounting policies that will be used in the first set of audited accounts post-listing. For EU-registered companies preparing consolidated accounts, this will mean accounts prepared under IFRS as adopted by the EU. Non-EU registered companies have greater flexibility, as they can also use certain other approved GAAPs. Companies that do not already prepare accounts under IFRS should give advance consideration to the conversion. This can be very time-consuming and could impact the IPO story if the trading track record changes significantly when looked at through a different accounting lens. Adopting IFRS will necessitate a change in internal reporting and may require new or different internal controls that will also impact the FRP workstream.

The prospectus will include a working capital statement that considers both internal and external financial resources available to the issuer in order to meet its liabilities as they fall due. This statement cannot be qualified, or stated to be subject to assumptions, although the Listing Rules provide potential concessions for certain regulated companies.

The regulators do not want any surprises and want to know that companies can meet their reporting requirements in a timely fashion. Listed companies must be able to respond quickly and effectively to the rigorous information demands of a listing on the Main Market. Companies should:

• conduct an early gap analysis of FRP
• allow time to resolve gaps in key controls and financial information gathering
• embed policies and procedures into the business, including the effect of IFRS
• ensure that FRP are scalable, to support both existing processes and future growth plans.

The directors therefore need to be satisfied that the company has sufficient working capital to finance its business plan and also sufficient margin or headroom to cover a reasonable worst-case scenario.

Projections

To prepare a working capital statement, the company will make unpublished financial projections and identify the key assumptions. The projections take the form of an internally consistent cash flow, profit and loss and balance sheet, on a monthly basis. While the statement only covers 12 months after the proposed date of listing, the projections typically extend to at least 18 months. To prepare the projections, the company needs to:

• perform an analysis of its existing business
• consider the strategy and plans of the business, the related implementation risks and resultant uncertainties
• identify assumptions that address the uncertainties, checking against external evidence
• include capital expenditure and other resource requirements of the business
• identify the financing facilities available and required
• perform sensitivity analysis to identify the impact of changes in key assumptions.

The complexities of a pre-IPO IFRS conversion were heightened for a private equity-backed consumer product business by a significant overseas acquisition made 18 months prior to the float. When asked after the successful IPO what he would have done differently, the company's CFO stated that he would have started much earlier on the preparation of the IFRS historical financial information. His first challenge related to IFRS conversion. Issues arising included:

• accounting for hedges and other financial instruments and, in particular, issues around demonstrating the effectiveness of hedge instruments for accounting purposes and valuations
• fair value accounting and valuations for the intangible assets arising on the acquisitions made during the three years included in the track record
• segmental reporting requirements
• deferred taxation changes.

The second challenge related to the overseas acquisition. The requirement in the Listing Rules for 75 per cent of the business to be supported by a historic revenue-earning record, meant that separate historic financial information had to be included for the overseas acquisition. At the IPO date, this made up more than one-third of the group's business. The acquisition had not previously been subject to a full audit and its accounts were not prepared under IFRS. As a result, significant lead time was required by Ernst & Young to complete this process for the pre-acquisition period.

In addition to preparing the historical financial information under IFRS, the team had to build the new accounting policies into the ongoing management reporting and forecasting processes. This also took significant time and effort to complete, but was essential for the company to operate on the same metrics used by market participants.

Finance facilities

In making a working capital statement, the company may only include facilities to which it has secured access at the time of making the statement. This means that committed bank facilities (for the period they are committed) and the proceeds of an offering (if they are either fully underwritten, or, in the case of a placing, firmly placed) can be taken into account when making the statement. The company should also consider projected compliance with any loan covenants (including under the sensitivity analysis, unless there are mitigating actions) and the borrowing limits in its Articles of Association.

The reporting accountant will then prepare a private report* commenting on the:

• preparation of the projections
• assumptions
• accuracy of the previous forecasting
• availability of financing
• restrictions on cash movements within the group
• sensitivity analysis
• the directors' basis for making the working capital statement.

* There are additional requirements in place for mineral companies that have not been producing on a commercial scale for the previous three years.

Structure

• holding company location
• personal holding structure – 50 per cent tax rate, capital vs income
• rollover/cash out of existing debt and equity structure, including share options
• tax clearances and transaction taxes (eg stamp duty)

Float process

• availability of tax information and in-house tax resources
• project management and coordination of tax structure, tax disclosure for long form, short form, working capital report, funds flows etc
• likely UK GAAP to IFRS adjustments

Tax status

• ensure all tax filings and payments are up to date
• look to resolve any open items with the relevant tax authorities
• review the approach taken to any other areas of tax uncertainty
• tax assets (eg unprovided deferred tax assets)

Post-float

• tax resource requirements
• post-close tax filings and payments
• ongoing tax compliance, planning and reporting
• securing tax upsides
• securing tax assets
• management of structure and optimising tax profile

Ernst & Young carried out a tax readiness review for a large private mining group in order to identify potential tax issues (and opportunities) in preparation for its listing on the Main Market. The determination of the tax residence of the parent company was identified as a key issue.

Key management individuals were personally tax resident in a number of jurisdictions, so the structure was assessed in detail to ascertain what was practical for the group, recognising implementation issues. The most practicable solution was a bespoke tax structure that aligned with the company's commercial strategy.

If this issue had not been identified well in advance of the planned IPO, the potential and significant tax consequences would have, at best, resulted in an additional tax charge; at worst, a delay to the IPO process. In order to ensure that the structure was managed in a way expected of a company with a Premium Listing on the Exchange, new procedures were needed for corporate governance, the physical location of key management activities and the commercial structure of the entity to be listed.

As the design, implementation and management of tax residence were demanding matters, there was a risk that they would occupy significant management time. However, the process went smoothly because the issues had been identified and acted upon early. Consequently, much of the implementation of the tax structuring work had been completed in advance of the IPO and management were not tied up in dealing with these matters during the key IPO execution phase.

Companies seeking admission to the Main Market should consider their tax structure prior to listing, and in particular the location of key management. A structure should be implemented that closely aligns with the commercial and operational management structure of the group to be listed, so it can be effectively managed in the future. It is essential that management understands the effect of the decisions taken about the IPO on future tax rates and the tax position of existing investors. Failure to prepare early may constrain the flexibility of management's decision-making closer to the IPO event and may also create additional burdens on management's time during the challenging later phases of preparation. A range of potential tax implications should be considered in order to determine the future optimal structure.

Overseas companies

Overseas companies thinking of listing in London will need to be aware of the implications of becoming UK tax-resident and how appropriate structuring and good governance can preserve non-resident status. A UK listing does not automatically place the business within the UK tax net if it comes through an overseas holding company. Overseas companies with a free float of less than 50 per cent are not eligible for inclusion in the FTSE UK index series (see chapter 'London: a unique investment opportunity'). Companies in this position therefore tend to use a UK-incorporated company as the listing vehicle. However, a successful challenge by the UK tax authorities on the parent company's tax residence can result in profits of overseas subsidiaries being brought into the UK tax net under existing or future controlled foreign company rules. The UK tax authorities increasingly look at a group's transfer pricing policies as a further way of bringing additional tax income into the UK.

UK tax rates are, at the time of writing, high and careful structuring of remuneration and shareholdings is crucial to protect employees' tax position and avoid incurring higher company costs (eg tax and social security). Appropriate tax structuring though can result in a more effective and motivational reward package. Becoming a listed company also provides opportunities, through shares, to incentivise a much wider group of employees. A range of possible plans are available for executives and all employees, some with specific tax breaks approved by HM Revenue & Customs. The implications of an IPO on employee remuneration and incentives are summarised in the table opposite.

Once the IPO has been completed and the company has been admitted to the Main Market, a listed company will be subject to a number of reporting obligations. These include:

Report and accounts

• audited annual report and accounts must be published within four months of the year-end and include corporate governance disclosures
• unaudited figures must be prepared for the half-year within two months of the half-year end
• interim management statements during each of the first and second halves of the year.

Disclosure of price-sensitive information

• company must make a prompt announcement in connection with any price-sensitive information.

Transaction and document disclosure

• many types of transactions have to be disclosed to the market and some require shareholder approval.

Pay structures in public companies differ significantly to those in private companies and come under a great deal more scrutiny from non-executive directors, external regulators and investor bodies.

Companies planning for an IPO should consider:

• the quantum of pay, bonuses and structure of any share incentive schemes. Salary benchmarking is required to ensure these are in line with comparable listed businesses and market practice
• ensure institutions are comfortable with level of dilution of pre- and post-IPO equity incentives, usually requiring shareholder approval on admission
• early indication and communication to investors of any likely charge going through the income statement
• appropriate performance targets post-IPO
• ensure as far as possible that remuneration and incentives are delivered in the most tax-efficient manner whilst being aware of the attitudes of investors in this regard
• 'lock-in' arrangements are likely to apply to management shareholders, in order to help retain key management, which is key to the value of the business from an investor perspective
• the remuneration committee will set pay design and levels for executives
• current management shareholdings investments and options will be impacted by any restructuring of the group pre-listing and tax advice should be revisited as part of the listing process.

Transactions by Premium Listed companies are subject to 'class tests' that compare the size of the potential target to the listed company's existing business, based on a number of financial measures. A proposed transaction that exceeds the 25 per cent class test would be conditional upon shareholder approval. Additionally, if the 100 per cent threshold is breached, the company enlarged by the acquired entity would need to reapply for listing. The class tests are based on:

• gross assets
• profit before tax
• gross capital
• consideration: market capitalisation.

These requirements could introduce an element of uncertainty into a transaction, potentially affecting the company's competitiveness in an auction process. Additional costs are added with these requirements, including the need to provide a circular to shareholders to enable them to reach a decision. The company would need to appoint a sponsor to provide declarations to the FSA concerning the transaction and reports will also be required from a reporting accountant. A shareholder circular, and approval, is also required for transactions with 'related parties' that exceed 5 per cent of any of the class tests.

As this chapter shows, the work of the reporting accountant is extensive. It has to be performed at a detailed level to satisfy the regulatory requirements and to provide the directors of the company and the sponsor with the comfort they need. Providing all the information mandated by reporting requirements presents an onerous task to management. The burden will be particularly heavy on the finance team, who will already be subject to competing demands from other parties involved in the listing process. The reporting accountant can assist with many aspects where help is required, but are precluded from some for independence reasons, so management should consider employing additional temporary resources. The key message that should come through from this chapter is the need to start this process early. The earlier that management starts to identify the gaps in their company's IPO readiness, the sooner they can address the tasks required to fill them. Those companies that start to behave like a public company before they list, will find their new environment post-IPO very much easier to navigate. For these reasons, it is essential to view an IPO as part of a business transformation process, rather than seeing it as a standalone transaction.

Think and operate like a listed company pre-IPO. Early preparation is everything.