This article is the second in a series looking at what a company does or does not need for its accounting (and finance) based off its stage. (You can read Part 1 here.) Companies often invest too much or not enough in their accounting operation.
For the purposes of this article, I’m defining a company seeking a Series A raise as a company looking for its first institutional investor. By this point, the company should have a proof of concept, not just an idea on a deck. Ideally the company already has customers and revenue. Regardless, looking for and then having institutional investors greatly changes the needs and focus of a finance organization.
Before we go further, let’s discuss what an institutional investor is and how it differs from friends and family or a seed round. The largest difference is that an institutional investor is normally investing someone else’s money. Therefore, it has its own processes, metrics and reports since it is accountable to its own investors. Institutional investors will thus need reporting from you and might push you to achieve better financial performance. This then requires you to have the appropriate finance and accounting team to support these needs.
Like early-stage companies, a key financial and accounting issue is cash flow. Making sure you deploy your capital and keeping track of your cash metrics (burn and run rate) are important. But the expectation now is to be more efficient with your cash and show a path to smart growth and profitability.
Cash efficiency can take a lot of forms, and for illustrative purposes, let’s discuss one of the most common: customer acquisition cost (CAC). What’s so interesting about CAC is it requires a number of different data items. You have to keep track of customers and the various spend attached to their acquisition, and possibly apply an allocation methodology. You’ll also need to explain the methodology and its calculation, and reconcile it to your books, records and other reports since CAC is not a pure general ledger ratio. The takeaway is that supporting institutional investors requires more and different skills, capabilities and processes than an early-stage company.
Accounting practices and operations are a lot more serious and important as a company grows. Instead of just managing cash flow, you have three major new focuses: GAAP (generally accepted accounting principles), operations and analytics support.
• GAAP compliance: Being GAAP compliant is more important as a company grows and really depends on your investor base and your future capital plans. If your investor base is not requiring an audit, and you are not planning to raise capital in the near future, strict GAAP compliance is not as important. Remember, the ultimate goal of GAAP is to “ensure a company’s financial statements are complete, consistent, and comparable” for an investor. So, if your current or future targeted investors are going to care about GAAP, you’ll need to, as well. The driving factor then is at what period of time do you need to start caring. A good rule of thumb is to make sure GAAP is reflected in the financial periods that will be audited or reviewed by an outside party (e.g., a CPA firm). The last thing you want to face before a capital raise is a restatement of all your financials.
• Accounting operation needs: Supporting GAAP compliance requires an upgrade in your accounting operation. While you can spend a significant amount of time and resources becoming and remaining GAAP compliant, the following items are the most important to have a handle on:
1. Revenue recognition: especially if you have a subscription service or a combination of hardware and software.
2. Expense matching: usually involves matching the expense to the revenue it generated (e.g., cost of goods sold and commissions).
3. Capitalization table management: so you have a clean record of whom owns how many shares of the company, including all securities that can turn into equity (e.g., options, convertible debt, warrants and SAFE notes).
Odds are you won’t have fintech deployed to manage these processes, so you’ll be keeping track of them manually. For instance, at this stage, revenue waterfalls are usually kept on a spreadsheet. Make sure you are organized and have easy-to-follow spreadsheets and work papers.
• Analytics support: This becomes relevant when you have metrics and reports that require data outside the standard financial reports from the general ledger (e.g., income statement, balance sheet and statement of cash flow). A lot of this function focuses on obtaining operational data, enriching financial data and being able to translate and reconcile both to the accounting data. This is actually much harder than analyzing the data.
Besides a bookkeeper or accountant, you will also need a part-time controller to manage your month close and GAAP compliance. You’ll also need someone who will own the sales operations data and can ensure it’s properly reflected in your general ledger. Unless investors ask for it or you want to run scenario analyses, you probably don’t need a reporting function. However, you’ll probably need some sort of CFO support to help you raise the next round of capital. The level of support required will depend on how much financial reporting and analysis is required.
This article was first published on Forbes Finance Council.
