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As part of the IPO process, private companies must perform due diligence to ensure that they’ve met all the requirements for being listed on a public exchange. This ensures that the company follows all registration and disclosure guidelines established by the Securities Act of 1933.
Broadly speaking, IPO due diligence is similar to the due diligence performed in other situations involving large amounts of capital. Just as an investor may research certain aspects of a company before deciding to purchase shares, a company that’s planning an IPO must have an understanding of the various factors that could positively or negatively affect its success.
If you’re interested in IPOs, it’s helpful to know what goes on behind the scenes and how the IPO due diligence process works, given that IPO stocks are considered high-risk securities.
Key Points
• IPO due diligence is a process of researching a private company to make sure it meets the requirements for being listed on a public exchange.
• The due diligence process involves gathering information about the company’s organizational structure, licensing and taxes, board and employee information, financial information, customer/service information, and company property.
• Benefits of IPO due diligence include an opportunity to explore the viability of an IPO for the company and more information for investors on the company and its risks.
• Steps to filing an IPO include SEC review, IPO roadshow, pricing, launch, stabilization, and transition to market.
• Due diligence can help inform investors whether the company complies with all relevant SEC regulations.
IPO Due Diligence Process
During the IPO due diligence process, the IPO underwriters and IPO attorneys will work together to perform the necessary background research to gain a better understanding of the company, its management, and its financials. This involves gathering the following information:
1. Organizational Data
During the first stage of the IPO due diligence process, the underwriters and attorneys gather information about the company’s organizational structure. This may include requesting copies of any or all of the following:
• Articles of incorporation
• A list of the company’s shareholders and committees
• An overview of the number of shares owned per individual shareholder
• Annual business reports for the previous three years
• Company business plans or strategic plans
• A breakdown of the company’s organizational structure, including board members, directors, and employees
The underwriting team may also request a copy of a certificate in good standing from the state’s Secretary of State, along with information on organizational decision-making.
💡 Quick Tip: Access to IPO shares before they trade on public exchanges has usually been available only to large institutional investors. That’s changing now, and some brokerages offer pre-listing IPO investing to qualified investors.
2. Licensing and Taxation
The next step in IPO due diligence involves collecting information about the company’s licensing and taxes. At this stage, the IPO underwriter and/or attorneys may request copies of:
• All business licenses currently issued to the company
• Annual tax returns
• Government licenses and permits held by the company
• Employment tax filings
• Comprehensive reports of the company’s tax filing data
The underwriting team may look back three years or more when analyzing income tax returns and tax filing information.
Recommended: The IPO Process
3. Board and Employee Information
Due diligence can also extend to information about the company’s board of directors, its managers, and its employees. At this phase of IPO due diligence, underwriters and attorney may request:
• A list of all individuals it employees
• Information about employee status, including each employee’s position and salary
• Details regarding employee benefits and bonuses, according to position
• A copy of company policies relating to sick leave or conflict resolution
• Details about employee insurance benefits, including health, disability and life insurance
• Copies of resumes for leading personnel
• Copies of employee audits
With regard to employee audits, underwriters may look back two to three years.
💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.
4. Financial Information
A company’s finances can come under close scrutiny during the IPO due diligence process. When considering financial information, the IPO underwriting and legal team may review:
• Copies of broker or investment banking arrangements
• Company financial statements records, including previous financial audits
• A list of all financial accounts held by the company
• Copies of financial analyst reports
• Information about the company’s inventory holdings
• Details regarding the company’s accounting and amortization methods
• A list of all fixed and variable expenses
The timeframe for which underwriters can review financial information can stretch from the previous three to five years, depending on what they’re examining.
Recommended: How to Read Financial Statements
5. Customer/Service Information
Due diligence also takes into account interactions with customers and service practices. During this step, the underwriting team may request:
• Reports or information about the products and services offered by the company
• Details about consumer complaints filed against the company
• Information about legal approvals for the company’s products and services
• Copies of the company’s trading policies
• Details regarding the company’s marketing strategies as well as copies of marketing materials
The underwriters may also need to see copies of customer supply or service agreements.
6. Company Property
Last but not least, IPO underwriters will examine property holdings owned by the company. This can include reviewing information about:
• Business locations
• Real estate agreements and/or franchise licenses
• Trademarks and copyrights held by the company
• Approved patents held by the company
• Trademark complaints, if applicable
• Official contracts showing the purchase of real estate
The underwriters may also ask for a full inventory of any physical or real property the company owns.
Objective of IPO Due Diligence
During due diligence, the underwriting team is working to gain a full understanding of how the company operates, how it’s structured, how healthy it is financially, and whether there are any potential issues that could be a roadblock to going public. The due diligence process effectively clears the way for the next steps in the IPO process.
The IPO due diligence process ensures that there are no surprises waiting to crop up that could derail a company’s progress. It’s also an opportunity for the underwriting team, the IPO attorneys, and the company itself to assess any potential risk factors that may affect the IPO’s outcome.
Benefits of Due Diligence Process
IPO due diligence has benefits for both the company and investors.
IPO Due Diligence Benefits for the Company
• Due diligence offers an opportunity to explore the viability of an IPO, based on the company’s business model, financials, capital needs, and anticipated demand for its shares.
• Due diligence also allows the company to avoid going afoul of regulatory guidelines, and it can help to identify any issues the company may need to address before going public.
IPO Due Diligence Benefits to Investors
• The due diligence process can reveal more about a company than the information in the initial red herring prospectus. In IPO investing, a red herring refers to the initial prospectus compiled for SEC registration purposes.
• If investors feel confident about the information they have, that could help to fuel the success of the IPO which could mean more capital raised for the company and better returns for those who purchase its shares.
Note that an investor’s eligibility or suitability for trading IPO shares is usually determined by their brokerage firm.
Next Steps in Filing an IPO
Once the underwriting team has completed its due diligence, the company can move on to the next steps involved in how to file an Initial Public Offering (IPO). Again, that includes:
• SEC review
• IPO roadshow
• Pricing
• Launch
• Stabilization
• Transition to market
The SEC review typically takes between 90 and 150 days to complete. At this point, it’s up to the SEC to determine that all regulatory requirements have been met. Usually, the team conducting the review includes one or more attorneys and one or more accountants.
Next, comes the roadshow. During the roadshow, the company presents details about the IPO to potential investors. This step of the IPO process allows the company and underwriters to gauge interest in the offering and attract investors.
IPO pricing usually involves a closer look at the company’s financials, including its valuation and cash flow. Underwriters may also consider valuations for similar competitors when determining the appropriate IPO price.
After setting the IPO price, the underwriters and the company will schedule the IPO launch. Once the IPO launches, investors can purchase shares of the company. The underwriter can take action to stabilize the IPO price for a period of time following the launch. After that, the company transitions to market competition, concluding the IPO process.
The Takeaway
IPO due diligence is an important part of the IPO process. Due diligence ensures that a company about to go public complies with all relevant SEC regulations. Then, it’s up to qualified individual investors to decide whether trading IPO shares suits their goals and risk tolerance.
Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.
FAQ
What is due diligence for an IPO?
Due diligence for an IPO refers to the process of investigating a private company’s financial, legal, operational, and regulatory status to make sure that it meets public listing requirements. Due diligence can also identify any potential risks or problems that could affect the company’s IPO. The goal of due diligence is to verify that the company is ready to go public.
What is IPO compliance?
IPO compliance refers to a company’s compliance with regulatory requirements in order to proceed with an initial public offering. Compliance helps ensure that a company meets financial reporting, adheres to strong governance, and has strong internal controls as required by the Sarbanes-Oxley Act, which was passed in 2002 to help protect investors from corporate fraud.
What are the types of IPO due diligence?
The main types of IPO due diligence include financial, legal, commercial, and operational due diligence. During the due diligence process, IPO underwriters and attorneys will also look at a company’s licensing, tax obligations and history, and board of directors and employees, among other factors. The purpose of due diligence is to verify information in all areas to identify and assess any risks and ensure the company’s readiness for going public.
About the author
Rebecca Lake
Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.
Photo credit: iStock/porcorex
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