Accounting Essentials for Three Stages of Your Startup
Every day you face new challenges as a startup founder. It can be tempting to take short cuts or push tasks off for a later date. Accounting is not the area of your business to do this. Developing good accounting habits and bringing in the right experts at the right time will help you grow faster and save you headaches (and possibly heartache) down the road.
Two of our powerhouse CFOs, Alaa Ismail and Sirk Roh, hosted a webinar earlier this year breaking down the essentials of startup accounting. Combined, they have over two decades of experience guiding the financial strategies of Silicon Valley winners. Bookmark this recap, so you have this information as you move through each of the three phases: pre-funding, fundraising, and funded.
Start your business off on the right foot by separating your personal and business expenses. Before you land that seven-figure (or any figure) investment, be sure to take these crucial steps:
- Open a separate bank account
- Apply for a separate business credit card
- Keep detailed records of all revenue
- Keep all receipts and invoices
- Use an external payroll service and HR provider
- Hiring a professional is best to further protect yourself from penalties. There are also online services that may work for you, such as gusto.com or Intuit. Don’t have employees, yet? Research your options, so you’re ready to “turn on the HR lights” when the time comes.
- Create your capitalization table (tracks who has equity in your company)
Creating a tracking system and outsourcing functions like payroll are foundational in this early stage. Change happens quickly, and things can get complicated. Consider pre-funding the calm before the storm. Take advantage of this calm to get your essentials in order.
Even if you are pre-revenue, remember you must file federal taxes, and depending on where you are incorporated, state taxes. You may also have city taxes to contend with. If you haven’t gotten your state and city business licenses yet, this is the time to do so.
Continue diligently tracking your revenue and expenses – refining the systems you created pre-funding. Now that you are fundraising, you will need to be able to talk about your financials. You will need to answer questions about burn rate and financial projections. Investors want to know about your current status and plans for growth. Some tools for telling this story include:
- Elevator pitch – a clear and concise verbal message that explains the problem you solve and the benefit you bring, leaving people wanting to learn more.
- Investor pitch deck – the meat and potatoes of your fundraising tool kit. This standard set of slides goes in depth on your product and why it’s a smart investment.
- Executive summary – a one-pager that highlights your business.
These items spark interest and get the audience to take the next step – a conversation. It takes several meetings with an investor to secure funding. Being able to articulate “the numbers” will increase your chances.
Investors are looking for a return, so your financial projections will be a deciding factor. The two most common projections are:
- Bottom-up forecasts (used for 1-2 years out) and
- Top-down forecasts (used for years 3 and later).
Use statistics that are comparable to other companies in your industry. If it is your first time creating a financial projection, consider hiring a professional. This will add credibility to a potential investor.
Check out this webinar for more info on fundraising.
Congratulations – you’ve secured funding! In addition to the basic business accounting we’ve talked about, you now have reporting requirements. GAAP, generally accepted accounting principles, must be followed. The most appropriate accounting method for venture-backed companies is accrual-based accounting. The IRS prefers this method of recognizing revenue and expenses when they are earned or incurred.
On a monthly basis, your investors will expect an update that includes:
- Income statement
- Balance sheet
- Profit and loss statement
- Statement of cash flows
These four financial documents give you and your investors an accurate perspective of what is happening with your business over time. You may want to include a cash burn chart, as well.
On a quarterly basis, update your financial projections:
- Identify key variables and key revenue assumptions
- Run different scenarios and forecast a three-year plan at the most
Use this document to check the pulse of your company and anticipate changes going forward.
Operationally, it’s important to control who has access to your finances and the ability to move funds. Create a set of checks and balances. For example, one person prints checks and a different person signs them. Set up an approval process as a part of your internal controls. Use online tools, as well as accounting professionals, to control these accounting systems (i.e. accounts payable, accounts receivable, expense reporting, and payroll).
If your company has a stock option plan, the IRS requires a 409A valuation annually or when there is a material event, which can include:
- Equity fundraising
- An event in your industry that causes the market to shift
- Merger or acquisition
Like any service provider, the quality and price of valuation companies varies. As you shop around, look for a credible professional that you feel is looking out for your bottom line and will help you withstand an IRS audit. Double check that they do free revisions in case errors occur (nobody is perfect). Finally, make sure they work quickly, so your employees are not waiting months to find out what their stock options are worth. Build a strong relationship with your valuation provider, as you will go through this process annually.
Check out the entire webinar to hear Ismail and Roh discuss these accounting essentials in greater depth. Feel free to contact us directly if you have any specific questions!
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