August 19, 2019
By Erin Cahill, Partner, US IPO Services
The number of life sciences companies raising capital through public offerings has been rising steadily for the past few years – from 28 IPOs in 2016 to 67 in 2018, with total proceeds of $8.6 billion in 2018. Life sciences company IPO activity in 2018 represented an almost twofold increase over 2017, according to Dealogic data, with several notable IPOs, including Moderna’s $600 million stock sale, the biggest biotech IPO ever, and Elanco Animal Health’s IPO of $1.5 billion. In fact, life sciences company IPOs represent the most active sector in the overall IPO markets for the last several years.
PwC recently surveyed a sampling of 34 life sciences companies that either have gone public in the previous three years or plan to do so in the next year regarding their finance organization and governance structures and changes to people, processes, technology, and other organizational impacts, in preparation for being a public company. The companies surveyed ranged from specializing in oncology to gene therapy to diagnostics, amongst others, and spanned clinical phases, with nine being pre-clinical and three having reached commercialization. Nine of the 34 companies were generating revenue.
Life sciences companies facing business demands that exceed their ability to raise capital through private sources may find the prospect of an IPO alluring. Valuations, particularly for earlier stage companies that are pre-clinical or in Phase 1, are often comparable to those that have reached commercialization. Early-stage companies are enticing to investors, who often see unlimited commercial potential and growth prospects. However, there are many factors specific to the life sciences industry that companies should consider. Our survey found that life sciences companies most frequently had concerns about increased reporting requirements and heightened regulatory scrutiny.
Before going public, many life sciences companies have a varied investor base, including founders, angel investors who seeded the initial idea and venture capital investors who helped build the organization. Private equity and corporate sponsors invest at different stages of a company’s growth, depending on their appetite for risk and investment goals. All of these stakeholders, as well as senior management, must be committed to the offering.
Life sciences companies generally have a unique set of issues to grapple with when going public: They are earlier in their growth stage, often pre-revenue, have lean teams and are focused on minimizing cash burn. Based on our survey, we identified some key elements that life sciences companies should consider before going public.
Identify your “going public” team
The first step is getting the right people engaged. Identifying qualified experts, both externally and internally, is critical to an IPO’s success. These include lawyers, underwriters, accounting advisors and auditors, among others. Their input can directly impact the success of the IPO and investor confidence going forward.
The decision to outsource or co-source may often be more cost effective for life sciences companies that need additional bandwidth during peak times or technical support for low-volume, highly complex transactions. Nearly 70% of the surveyed companies relied on external experts for technical accounting and legal services, while 50% outsourced payroll and 47% used external investor relations firms. Financial reporting and employee benefits were more likely to be handled in-house, with only 35% and 24% of respondents, respectively, using external providers for these functions.
Another key player on the going public team is the auditor. Companies should look for auditors registered with the Public Company Accounting Oversight Board who have expertise in generally accepted accounting principles and are deeply credentialed in IPOs. This not only helps ensure that financial statements are properly audited and that the company’s financial records are accurate, but the auditing firm often is another key advisor on the company’s path to an IPO and post-IPO. More than 90% of the companies we surveyed said they had retained their auditor for more than two years before their IPO.
While external expertise may be needed, companies must also bolster their internal functions to meet the broader demands of being a public company. Life sciences companies typically maintain a lean finance team, with just enough resources to prepare audited financial statements and forecasts for the board and to answer investors’ questions. Because of increased reporting requirements and stakeholder expectations that come with an IPO, companies must expand their finance teams as a result of going public.
Of the companies we surveyed, only 8% had pre-IPO accounting or financial reporting teams of six or more people. After they went public, 41% had teams of that size. In fact, those who didn’t increase their teams in the IPO process generally indicated they used outside accounting firms before and after the offering. Besides increasing the size of the finance team, companies are also focused on adding individuals with the right public company experience. Key finance positions added in the year leading up to the IPO included the CFO, controller, FP&A manager and SEC reporting manager.
Common area of focus for life sciences companies in preparation for life as a public company
Going public puts increased demands and pressure on a life sciences company’s resources, and it’s important to identify where to focus them. Here are some areas life sciences companies should consider:
1. Accounting: To meet public company reporting timelines, 52% of the companies surveyed closed their books each quarter in 15 days or fewer after their IPO, compared with 27% before the IPO. Beyond the accelerated external reporting requirements for public companies, finance organizations must increase their attention on public company ready policies and processes, accountability and first-time accuracy.
2. Technology: Existing systems and processes may be inadequate for a public company. Accounting systems used by small, private life sciences companies often aren’t suited for meeting reporting and demands in a public company environment. More than 50% of the companies surveyed implemented a new ERP system in preparation for their IPO. Nearly three-fourths cited the need for better functionality and integration as the reason for the change, closely followed by enhanced internal controls capabilities. Besides the ERP, life sciences companies also typically look at systems such as equity administration, payroll and expense reporting to meet public company rigor.
3. Internal controls: The Sarbanes-Oxley Act (SOX) increased the amount of preparation and planning necessary for a successful IPO, requiring certifications of the CEO and CFO in their public filings on financial statement accuracy and compliance with regulatory requirements as well as reporting on the control environment. Almost all the companies surveyed said they had begun SOX implementation efforts before going public.
4. Cybersecurity: Cyber threats and security breaches make headlines with growing frequency. Public companies must ensure their IT systems and other technology are properly protected, and they must determine who is responsible for managing these risks. More than 60% of respondents said they had placed someone in charge of cybersecurity, often led by the IT director.
5. Governance: Public companies face much stricter requirements for board composition and governance practices than private companies do. For example, major stock exchanges require a majority of independent directors for listed companies and require audit committees composed of independent board members, with certain transition provisions up to a year after the IPO. As a result, public companies typically have much larger boards. Our survey found that the minimum number of board members increased post-IPO, with 93% of respondents having at least six people on their boards. Companies should allow time to recruit qualified outside directors before the IPO. Additionally, 92% of the surveyed companies had met the majority independent board requirements and 70% had met the fully independent audit committee requirements at the time of their IPO.
6. Tax planning: With the increased scrutiny of being a public company, many life sciences companies assess their tax planning strategy and relizability of various tax credits such as net operating losses (“NOLs”) and research and development (“R&D”) tax credit carryforwards. Companies that are going public may want to retain a third-party tax advisor to study the impact of these and other issues in advance of the IPO. Of the companies we surveyed who performed tax studies in advance of going public, 79% performed a NOL study and 57% performed a R&D tax credit study.
Life sciences companies face unique challenges, as well as potential benefits, from going public. It’s important to understand these challenges and properly prepare for them to ensure that an IPO is successful and provides a vital source of capital and liquidity for the future. Having an advisor with the right experience and insight is crucial to achieving these objectives.
The findings above are a snapshot of the survey results, for additional details or a deeper discussion on the road to going public, please contact your local Deals IPO partner. Or for more information, explore PwC’s IPO services.