What does Investor-Ready Bookkeeping Mean?
Any technology start-up thinking about raising growth capital needs to ensure their financials are investor-ready. Many founders may think that at the early stages of their company, all they need is simple bookkeeping services. However, setting up proper accounting and bookkeeping systems that can provide investor-ready financials right from the start will go a long way in creating the right foundation for your startup to raise money from investors.
What does it mean to be Investor Ready?
Venture capital investors are inundated by companies looking to raise capital and have no shortage of companies to choose from. So when you are getting ready to pitch an investor, not only do you have to demonstrate why your product or service will be the next big thing, but you will also need to show the investor how you will make money and monetize the opportunity. Not being able to concisely articulate this will decrease your opportunity of getting funded.
One of the more popular business models that have seen a lot of investor activity in the past few years is the SaaS business with its recurring revenue business model. What makes the accounting and bookkeeping for SaaS companies different than traditional businesses is the need to keep track of key factors that drive SaaS performance.
For SaaS companies, investors look at unit economics such as what it costs to acquire a customer (CAC) and what is the expected lifetime value of a customer (LTV).
In general, investors are looking for companies that have LTV/CAC ratio of at least 3:1 or greater. Investors are also very interested in your monthly recurring revenue trends (MRR) and new MRR growth.
Does your current bookkeeper understand these concepts and can they help you get Investor Ready?
Accrual vs. Cash Based Accounting
The concept of cash based accounting is that a transaction gets recorded in your books only when it hits your bank statement i.e. you have paid for an expense or you have collected and deposited cash for a customer sale.
For technology startups, you will need to maintain your books using accrual based accounting. The concept of accrual accounting is that unlike cash accounting, you record a transaction when the goods or services have been performed or received not when you pay or receive cash.
A great example of this is when a SaaS company sells a 12 month subscription of $120 for its software and collects the cash upfront. Under cash accounting, you would record the $120 as revenue when it hits your bank account. Under accrual accounting, you would set up the $120 as a deferred revenue item and then recognize $10/mth in revenue as you provide the service.
So if you are not tracking deferred revenue in your subscription business, then your revenue recognition is probably not in accordance with Generally Accepted Accounting Principals (GAAP) and probably not Investor Ready.
If you look at the financial statements for any publicly traded company, you will see they track their operating expenses by department instead of by expense type. Typical departmental categories include sales, marketing, research and development, general and administration, etc. By doing this, they can keep track of how resources are being allocated across the company. This in turn helps management compare the effectiveness of each department (e.g. by calculate the operating expenses for each department as a percentage of revenue), or make future business decisions (e.g by looking at R&D spend as a percentage of revenue).
So why do most startup companies track their operating expense by category type i.e. salaries, advertising and promotion, meals and entertainment, rent, utilities, office supplies, bank fees etc.?
Most often, when setting up the chart of accounts for a new startup, the bookkeeper uses the default settings in the accounting software which are based on categories. While this approach would be ok for a small business, who never intends to raise any venture capital, it isn’t the right long term approach for a tech startup.
Tech startups who want to be proactive and get their financials Investor Ready should start tracking their financials in line with industry practices. It takes a lot more thought and effort to setup departmental type reporting, but ultimately this is where you will end up.
Whether you are working with an external bookkeeper or have a full time bookkeeper on staff, you should always ask yourself, “Is my current bookkeeper Investor Ready?
If your current bookkeeper is focused more on data entry and your financial statements are not Investor Ready, it may be time to upgrade your bookkeeper. Delaying this will only create a pain point for you in the future and could jeopardize your chances of being successful in your fundraising efforts.
You should always expect more from your bookkeeper.