Series A funding tests whether a business is just a good idea or if it has what it takes to go the distance. That’s a lot of pressure. Entrepreneurs and early-stage business owners have told us about being almost manic with excitement: sleepless nights, endless agonizing about every detail, presenting everything in the perfect way.
After all, the odds don’t favor most businesses.
Self-reported data suggests that no more than 3% of startups obtain series A funding each year. That leaves a huge margin of startups and small businesses to either keep bootstrapping their dreams or throw in the towel.
Don’t get discouraged, get prepared with GAAP!
At this stage, investors are less interested in a fancy passion plan. They want you to prove big market potential, revenue generation (or potential revenue streams), and that your product has value to your customers. They also want to see how your financials measure up with those of other companies in their portfolio.
If you’ve done some research about GAAP accounting you know that adhering to the guidelines can make your accounting more time consuming. For this reason, businesses typically only use GAAP when they are required to. Series A is one of those must-have milestones, and in fact, we’ve seen investors get cold feet or cancel investments altogether because companies haven’t gone GAAP.
Here are a few reasons why series A investors go to GAAP to satisfy their financial doubts:
Series A Investors Need Reassurance From a Trustworthy, Objective Source
Most investments come with some amount of risk, but even the most aggressive venture capitalists look for opportunities with businesses they understand. Knowing the industry is only the first step. They also want to feel confident in a company’s financial well-being, so they look for information they can verify as unbiased and comprehensive. This is covered by the faithful representation principle and understandability principle, two guiding principles of GAAP.
The understandability principle is, as it sounds, a stipulation that a business’s finances must be easy to understand for the decision makers. This assumes a person has a fair amount of reasonable knowledge of business finances and economics. The faithful representation principle ensures businesses are providing the most credible picture of their company’s current financial state. To adhere to this principle, businesses must show that any figures they report are based on verifiable evidence, not clouded by opinions, and that nothing has been intentionally left out or skewed because of hidden internal motives.
You’ll be up against other companies who are vying for their Series A
Investors and VCs weigh many investment options, so they need a way to accurately compare. GAAP is the go-to measuring stick for outsiders to easily understand your business model and weigh it alongside other investment opportunities as well as their existing portfolio because of one standard guideline in particular:
The comparability and consistency principle states that all businesses that adhere to GAAP must report their finances in the same way as each other and also from one time period to the next. Holding all companies to the same standards and guidelines creates a more level playing field for everyone and makes it easy for investors to find and correlate the exact information they are looking for across their options.
Having financials prepared using GAAP can help investors calculate their risk:
While gambling can be exciting, series A is not the time or place for blind guessing. A few principles of GAAP come together to give outsiders the full view of a company’s current state, and the ability to anticipate future performance. This gives investors exactly what they want: predictability.
First, when preparing a company’s financials to be GAAP compliant, accountants must use the matching principle to correlate all costs and expenses to revenue. This creates a direct picture of profitability and performance so that you and your investors can see how your spending plans and decisions will translate into revenue and profit returns in their pockets.
The second important guiding standard to creating an informative picture of a company’s financials is the relevance principle. This acts as a filter to ensure all information a business discloses to its investors is significant and timely enough to affect the decision making process. This specifically does not mean that a company should overshare information, but instead encourages them to give potential investors what they will need to fully understand the state of the business. For example, information about your current debts is going to have a clear influence on a bank, accelerator, or investor’s decision to invest in you so you should include the details such as your types of debt, amounts you owe, payment schedule, etc.
Similar to the relevance principle, the materiality principle is a second information filter. The word “material” itself is a synonym for relevant but also for important so material information or material weaknesses, by definition, must be important enough to trigger a variance in a company valuation. This standard allows for a threshold to disregard an error in a company’s accounting if it will have little to no impact on their financial statements and perception of company performance. Because the weight of a lapse on a company’s books is entirely relative to its net impact, an accountant or auditors will tread this path differently based on factors such as company size and relevance to performance.
Your business’s financials cannot be professionally audited for series A funding unless you have GAAP:
GAAP is the magna carta of all business accounting in the United States. It is what all financial professionals use when preparing official public accounting records. Likewise, GAAP is also what third-party auditors require when they analyze your company for any misstatements, or deficiencies in your internal financial controls.
All publically traded companies must go through an annual audit when they disclose their financial performance, and this is also a requirement of most series A investors. This can be a lengthy process that involves having financials reviewed by an independent accounting firm. We’ve seen this put an instant halt on businesses looking to get series A, taking anywhere from six to twelve months to complete. Many young companies who lack experience in preparing for this milestone spend a lot of time and energy reworking financial statements, so having an outside expert on accounting for growing businesses (like indinero) is invaluable.
Getting your company’s finances on GAAP is important but there is more to the puzzle. At this point, you can’t simply WOW investors with a fancy concept like you could in earlier seed rounds; you need to back your big dreams up with data. Download our Series A Checklist to know what you need to prepare, so you can show investors and VC’s the right things about your company’s performance.