If there’s one four-letter word on the mind of every investor, it’s “risk.”
While virtually all investment opportunities involve some level of uncertainty, the people and organizations who eventually invest in your company—be they bank lenders, venture capitalists, or your friends and family—are the ones who are confident they have minimized their risk. Sure, they want to feel excited about an opportunity, but what they’re ultimately looking for is a safe bet.
How can you ensure that the company you’ve built poses the least amount of risk to investors possible? The answer is in your books.
Why Do Investors Care About Financial Data?
Good books indicate good business. They’re the objective records you and your investors can turn to for reassurance. Without high-quality financial data, a well-developed pitch has as much value as an incredible street performance or a top-scoring comment on Reddit—it may be interesting or memorable, or even bring an audience to tears, but no one’s going to cut a check for it.
Moreover, when your company’s data looks disorganized, incomplete, or otherwise questionable, it’s a sign they’re being mismanaged, and that’s dangerous for every part of your business. Investors will have a difficult time assessing your liquidity (i.e. your ability to pay off any short-term liabilities) or the value of equity. Even the most audacious angels and venture capitalists need the reassurance of a business’s potential to provide them with worthy returns. And between potential fines, reputational damage, and jail time, the risks of investing based on false or deceptive information are worse than making the decision based on nothing at all.
All of which is to say that if your organization is getting traction and piquing investors’ interest, but you’re having trouble turning those conversations into actual funding, it’s time to take a close look at your financials.
The Costs of Looking for Funding Before Getting Your Books in Order
Your books should be in order well in advance of any discussion with potential investors, and not only because doing so drastically improves your chances of getting funded. If you rush in and assume you can clean things up after you’ve secured funding, you could end up spending that entire investment (and more) on switching to proper accounting.
In fact, at inDinero, we’ve heard stories about organizations paying upwards of $50,000 to fix reporting mistakes and $25 million in enterprise value to address problems that the right bookkeeping and accounting solution could have addressed early on.
Here are some reasons why cleaning up your books post-funding is so costly:
1. Starting from scratch with an accountant delays the process. Waiting to bring on the correct accounting system and expertise can extend the time between hearing a “yes” in the boardroom and hearing cash hit your bank account. A spreadsheet can give your accountant something to work with when putting together a historical picture of your financial performance, but it only goes so far. And if you have nothing, it can take months of time-intensive work (which may be billed hourly) to catch up by mining through all your transactions, bank and credit card statements, and so on. The longer you delay, the bigger the headache, and your investors don’t love waiting—in some cases, lack of a proper system can kill a deal altogether.
2. What you uncover could make or break your business’ image. Losses hiding in your financial statements can throw your pitch off balance. Organizations that use SaaS and subscription-based revenue models are particularly susceptible to misjudging cash flow projections based on sales. These businesses are likely to receive many prepayments and recurring contracts, but if your business plan revolves around revenue from subscriptions and you’re not using accrual accounting, you may be inflating your company’s performance (and valuation) by overreporting deferred revenue, and potential investors will catch on.
3. Your investors expect you to demonstrate your fiduciary duty. It’s worth mentioning that keeping good books is also, at some point, a legal requirement. As a chief executive, you will probably one day (or already do) have a fiduciary duty to your shareholders. Part of that duty is ensuring the accuracy of financial records and statements, typically by keeping books in accordance with Generally Accepted Accounting Principles (GAAP). I’m not just talking about operating a public company; GAAP-compliant books are also important during preferred stock rounds, such as Series A.
4. You could be missing opportunities to save your investors money. With proper accounting, you can proactively claim deductions and credits several magnitudes greater than upfront bookkeeping costs. The R&D Tax Credit, for example, could save your business up to $250,000 in a fiscal year. Beyond taxes, when you keep low-quality books, you lack the capacity to prepare for audits, manage your working capital, structure debt, or optimize your accounts receivable—all opportunities to present your business in a better light to investors.
5. You could be sabotaging your relationship with an eventual buyer. Financial records are particularly important during a merger or acquisition. Why does that matter? Because investors frequently become business buyers. Missing information damages trust and hurts your organization’s value in the eyes of an investor, and may dissuade that investor from ever taking the next step when you’re considering exiting the business. And if you’re thinking about taking advantage of the current M&A market, this isn’t a bridge to cross later, but a competitive necessity now.
The bottom line: your books are the key to your company’s past, present, and future. If you don’t have historical financial data and reporting tools, investors will find it virtually impossible to conceptualize both risk and their other favorite R-word: returns.