As capital markets show signs of renewed activity, IPO hopefuls and M&A candidates are dusting off their financial models, engaging underwriters, and revamping board governance. But there’s one signal that continues to trip up first-time filers: material weaknesses in internal controls over financial reporting (ICFR).

A recent analysis of SEC filings from Q1 2025 reveals a striking trend: S-1 and S-4 filers are significantly more likely to report four or more material weaknesses than their fully public peers.

These disclosures aren’t just compliance checkboxes — they’re red flags for investors, auditors, and potential acquirers. And for companies racing toward the public spotlight, they could mean the difference between a smooth transaction and a costly delay.

The Numbers Tell a Clear Story

In a review of nearly 500 companies that disclosed material weaknesses between January and March 2025, roughly 16% of all filers reported four or more material weaknesses. Among S-1 and S-4 filers, that number jumps to 21%.

This trend is consistent with what we see across the IPO landscape: companies often delay investment in internal controls until the final stages of deal readiness, only to find themselves scrambling under the pressure of auditor scrutiny, compressed timelines, and elevated public expectations.

Our analysis of material weaknesses classified by category is below.

Material Weaknesses

Why Late-Stage Remediation Fails

There are a few reasons this pattern keeps recurring.

  1. Underestimating ICFR Complexity: Private companies tend to operate with lean finance teams, undocumented processes, and minimal formal oversight. When they face PCAOB-audited financials and SEC disclosure requirements for the first time, gaps become painfully visible.
  2. Compressed Timelines: IPO timelines can accelerate quickly based on market windows. This leaves limited time to evaluate, remediate, and test controls, especially when multiple systems and geographies are involved.
  3. Overreliance on Auditors: Some companies assume external auditors will guide the ICFR journey. But auditors are focused on opinion-level assurance, not building or owning the control environment. Management needs to proactively establish and validate effective controls, as they will be required to certify their adequacy long before auditors issue their opinions. Relying solely on auditors’ reviews can result in control gaps or deficiencies surfacing too late, leading to audit delays or valuation impacts down the road.
  4. Remediation-as-a-Checklist Thinking: Trying to “plug” control gaps with temporary workarounds or borrowed documentation rarely satisfies the scrutiny of public company readiness reviews.

The result? First-time filers walk into the most visible financial transaction of their lives carrying internal control baggage that can erode valuation, delay registration, or prompt costly restatements down the line. Furthermore, the cost of reactive remediation typically far exceeds the upfront investment in proactive control preparation.

ICFR as a Pre-IPO Value Lever

The good news: It doesn’t have to be this way. Companies that approach internal controls as a strategic enabler, not a last-minute hurdle, enter the public spotlight with greater confidence, smoother audits, and stronger positioning with investors.

At Stout, we work with pre-IPO and transaction-ready companies to build what we call “SOX-lite” ICFR programs. These frameworks are right-sized, designed to establish control discipline without overengineering. And more importantly, they are built with an eye toward sustainability as the company scales.

What a Successful Pre-IPO ICFR Roadmap Looks Like

Here’s how we recommend approaching internal controls as part of IPO or M&A readiness.

Start with a Risk Assessment

The foundation of any ICFR program is understanding where the risk lies. This includes identifying significant accounts and disclosures; processes that are complex, manual, or judgment-heavy (e.g., revenue recognition, equity, consolidations); and areas with known issues or rapid change (e.g., new systems, acquisitions, turnover)

This risk lens helps scope the ICFR effort and ensures that resources are focused on areas with the greatest potential impact to financial reporting and investor confidence.

Perform a Gap Assessment

Before building anything, assess the current-state control environment. Are key processes (e.g., revenue, equity, close) documented? Who owns control execution and review? Is there evidence of segregation of duties, particularly in system access and journal entry posting? Have any prior control deficiencies gone unaddressed?

This early diagnostic helps avoid late-stage surprises and sets a baseline for remediation planning.

Focus on High-Risk Areas First

Pre-IPO companies don’t need full SOX compliance on day one, but they do need strong foundational controls over revenue recognition, journal entries and adjustments, and IT general controls (user access, change management). They’ll also need strong controls over equity accounting and share-based compensation, as well as entity-level controls, including board and audit committee governance.

Build Repeatable, Documented Processes

Control success isn’t just about “doing the right thing.” It’s about proving it. For example, we work with teams to create tailored control narratives and flowcharts, as well as design walkthroughs and testing templates. We also work to embed controls into close checklists, system workflows, and standard operating procedures.

This approach helps internal and external stakeholders align on expectations before the first Form S-1 hits the wire.

Test Early and Often

Even limited-scope testing can surface issues before they become audit blockers. A pilot testing phase gives finance and operations teams exposure to audit-like rigor in a lower-pressure environment.

For example, we often co-source this work to reduce the burden on internal teams while coaching them through expectations they’ll face in a public company context.

Scale with the Exit in Mind

Whether the goal is IPO or strategic sale, ICFR maturity supports a smoother transition. Buyers are increasingly focused on governance and reporting readiness, and audit firms are under pressure to avoid ICFR sign-off risks.

When we do this work, we’ll help portfolio companies position their controls as value contributors, not liabilities, during diligence.

Examples of Material Weaknesses and Remediation Plan

Type

Industry

Material Weakness

Management’s Remediation Plan

Public Companies

Technology

Management identified a significant weakness in the risk assessment process regarding IT general controls, including those for logical access, segregation of duties, and change management, as well as certain process-level controls impacting our financial reporting processes.
  • Expanding and enhancing the effectiveness of existing IT general controls for access management, segregation of duties, change management, and computer operations
  • Improving documentation of IT controls for systems critical to financial reporting
  • Providing training on the importance and execution of IT general controls for key systems supporting financial reporting
  • Developing enhanced risk assessment procedures and controls to manage IT risks related to crucial financial reporting systems
  • Conducting a thorough analysis of roles and accesses within key financial reporting systems and redesigning them to bolster the control environment
  • Utilizing both internal and external resources to aid in remediation and monitor progress

Public Companies

Healthcare

While preparing the company’s interim financial statements, it was discovered that the disclosure controls and procedures were not effective due to a material weakness. This weakness stemmed from an inability to maintain an adequate control environment over internal control activities ensuring the completeness, accuracy, and timeliness of processing and reporting accruals associated with upfront payments and issue fees in licensing agreements.
  • Management is engaged in implementing and assessing remediation efforts to address the material weakness. The monitoring and review controls over the preparation of financial statements have been enhanced, including designing, documenting, and implementing additional reconciliations, analysis, and review procedures over accruals associated with upfront payments and issue fees in licensing agreements.

Foreign Private Issuers

Pharmaceuticals

Company management did not design and maintain effective internal controls for recording royalty revenue, specifically regarding the assessment and accounting for royalty reduction provisions within the company’s commercial agreements with collaboration partners.
  • Strengthening cross-functional communication to identify, catalogue, evaluate, and assess all royalty reduction provisions in contracts and ongoing application to financial reporting
  • Enhancing procedures designed to allow the timely review of existing and new contracts, as well as contract amendments containing royalty provisions and requiring that appropriate business functions provide a specific approval and periodic internal certification process to facilitate appropriate quarterly accounting including royalty reduction provisions

S1, S4

Investment

These material weaknesses were related to the following:

  • The company did not design and maintain formal accounting policies, processes, and internal controls to analyze, account for, and disclose certain complex transactions, including determining the fair values of convertible notes, SAFE notes, and warrants. These deficiencies resulted in material adjustments to consolidated financial statements.
  • The company did not design and maintain formal accounting policies, procedures, and internal controls, nor did it have the necessary resources to achieve complete, accurate, and timely financial accounting, reporting, and disclosures. This includes issues related to revenue recognition and controls for appropriate segregation of duties within accounting and finance systems. These deficiencies also resulted in material adjustments to the consolidated financial statements.
  • Expanding the accounting and finance functions by hiring additional employees
  • Engaging a third-party firm to assist with debt and equity valuation methods and accounting processes
  • Engaging a third-party firm to assist with complex revenue and other transactions
  • Implementing additional controls related to revenue recognition and the impairment process on an ongoing basis
  • Developing and implementing formal duties, processes, and responsibilities within the company’s accounting and finance systems

 

Final Thoughts

The rising rate of material weakness disclosures in S-1 and S-4 filings is more than a compliance trend. It’s a cautionary tale. Companies waiting until the 11th hour to build their internal control environment often find themselves overcommitted, underprepared, and exposed at the worst possible time.

But for those who invest early — who treat ICFR as a path to credibility, maturity, and strategic execution — the payoff is clear: smoother transactions, stronger governance, and more trust from the market.