Extraordinary growth is the goal for most startups, especially those seeking investment. An in depth knowledge of all phases of capital management is required to get started on this path. This starts when you are first forming a company and continues as partners and other participants join.
We recently sat down with two of our powerhouse CFOs, Alaa Ismail and Sirk Roh at Early Growth Financial Services to ask them about the A-Z’s of getting it right. Alaa Ismail and Sirk Roh have spent over two decades guiding the financial strategies of Silicon Valley winners in the fields of software, hardware and many other industries.
In this webinar they discusses the challenges faced by startups while giving their tips on what to look out for. You can watch the recap at Accounting for Startups and subscribe to our YouTube Channel for more great information like this.
In the pre-funding stage, it is crucial to separate your business expenses from your personal expenses. Open a separate bank account and apply for a separate business credit card and/or debit card. Keep detailed records of all payments collected for goods and services. Keep all receipts and invoices. Use an external payroll service and HR provider to protect yourself from penalties. Hiring a professional is best, but there are also online websites offering these services, such as gusto.com or Intuit. This is a good time to create your capitalization table to track who has equity in your company. It’s helpful to get this started early as it becomes much more complex as time goes on. Remember that you are required to file both state and federal taxes depending on where you are incorporated. Also, be aware of city taxes and business license requirements in your city.
Check out our past webinars for even more information on fundraising. Your fundraising materials should include an executive summary which should explain in a salient, professional way your company’s current status and future plans. An elevator pitch is a verbal message that clearly and concisely explains who you are and what you’re about that leaves people wanting to learn more. A pitch deck is the guts of your fundraising effort. It is the set of slides that you will present to your potential investors that goes into depth about your product and why they should invest in your company. With every one of these items the goal is for the audience to take the next step towards due diligence discussions.
Within your pitch deck you will want to include financial projections. The two most common projections are “bottom-up” and “top-down”. Bottom-up forecasts are used for 1-2 years out, and top-down forecasts are 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, you may want to seek assistance from a professional, as this will help make your presentation more credible to a potential investor.
Once you have funding, there are reporting requirements that you are responsible for. GAAP, generally accepted accounting principles, includes accrual based accounting which recognizes revenue and expenses when they are earned or incurred. The IRS prefers financials to be maintained in accrual basis and it is the most appropriate accounting method for venture-backed companies. At this point in your business, you will want to be able to supply your investors with a monthly income statement, balance sheet, profit and loss statement and a 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. Additionally, you may want to include a cash burn chart.
After you’ve raised your round, it is a good idea to focus on identifying key variables and key revenue assumptions. You will want to run different scenarios and forecast a 3 year plan at the most. Update this document quarterly to see how your company is doing and to help anticipate changes going forward. Operationally, it’s important to control who has access to your financials and the ability to move funds. Create a set of checks and balances. For example, one person prints checks and a different person signs. Set up an approval process as a part of your internal controls. Use online tools, as well as accounting professionals that you contract, to control these accounting systems, such as accounts payable, accounts receivable, expense reporting and payroll. It’s necessary to put good financial controls into place at this time.
If your company has a stock option plan, the IRS requires a 409A valuation annually or when there is a material event. These material events include equity fundraising, an event in your industry that causes the market to shift or a merger or acquisition. Depending on how you obtain your valuation, the cost will vary. When you pick your valuation provider, make sure they are credible and professional, as well as someone who is looking out for your bottom line. Your valuation needs to withstand an IRS audit. It is important to have a good relationship with your valuation company as you’ll need to do a 409A on an annual basis. Double check that your valuation company will do free revisions in case errors occur. Finally, make sure your valuation provider will work in a quick and timely manner so your employees are not waiting months to find out what their stock options are worth.
We recommend viewing our webinar in entirety for more details on these topics we’ve just covered. Feel free to contact us directly if you have any specific questions!