Congratulations - your startup just raised a Series A! With all that money comes some pretty high expectations from your new venture capital investor - including regular access to your financial statements and reports. If you are a startup CEO who has just raised funding, this post will help you understand the financial information your VC’s will expect to see from you.
How do we know what venture capitalists want to see from their investments? Kruze Consulting’s startup clients have raised over half a billion in funding in the last 12 months, and we’ve helped hundreds of funded startups gear up to deliver financial information to professional venture capitalists. Also, two of us at Kruze have worked in venture, and were the folks who asked our CEOs for financial information on a regular basis, dissecting our portfolio companies’ monthly financials, helping our portfolio companies get ready for the next fundraise and (least fun of all) consolidating all of the portfolio’s data into analysis used for holistic portfolio reviews or to pitch limited partners.
Once you raise from a professional investor, your financial reporting requirements really need to level up. You will need to have the systems to regularly report on the company’s financial position and produce one off reports for your VCs. Just as importantly, your team will need the strategic financial skills to carefully manage your burn, growth, headcount and more - all while being able to figure out which internal projects generate the ROI needed to help your company reach the next stage.
Venture Capitalist Financial Statement Information Rights
Assuming you are a “normal” startup based in the US, you signed an “Investors Rights Agreement” with your professional investor. This agreement likely grants very specific, and also rather open-ended, rights about what financial statements and data you are required to share. Below we will breakdown the common rights and explain a bit on how you’ll need to make sure you are ready to get them put together efficiently (and in a way that shows your investor that you’ve got your act together.)
An important side note: keeping your company’s financial information confidential is pretty important. You don’t want competitors, potential partners, acquirers or others knowing the details of your company’s growth, burn rate or cash balance. Not every person who invests in your startup should receive the same level of information rights as a professional VC. Make sure you are working with a great law firm, and that you are thinking carefully about who you grant these rights to. A well known VC, Mark Suster, has written a thoughtful post on this called “Why You Don’t Want to Give Financial Information to All of Your Investors.” You should probably have visited it during your angel round, actually…
Investor Rights Agreement
Let’s breakdown what we see top tier VCs asking for after they’ve invested in a startup. The “3.1 Delivery of Financial Statements” part of the Investor Rights Agreement provides an easy framework to showcase what and when the investors are going to ask for - and what it means for you as the company founder. The following legal text is taken from the National Venture Capital Associations’ Investor Rights Agreement in their Model Legal Documents. It’s a great resource, and a huge percent of the actual legal documents used in venture deals are based off of these documents. (Another note, we are not attorneys, this is not intended to be legal advice that you use to negotiate your venture deal - hire a great startup law firm!) (Another note, we are ignoring the legal text we that we don’t typically see).
|Legal Language from Section 3.1 of the Investor Rights Agreement||What is the VC asking for?||What we typically see VCs ask for, and when|
|(a) as soon as practicable, but in any event within [ninety - one hundred twenty (90-120)] days after the end of each fiscal year of the Company (i) a balance sheet as of the end of such year, (ii) statements of income and of cash flows for such year[, and a comparison between (x) the actual amounts as of and for such fiscal year and (y) the comparable amounts for the prior year and as included in the Budget (as defined in Subsection 3.1(e)) for such year, with an explanation of any material differences between such amounts and a schedule as to the sources and applications of funds for such year]||
|(b) as soon as practicable, but in any event within forty five (45) days after the end of each of the first three (3) quarters of each fiscal year of the Company, unaudited statements of income and cash flows for such fiscal quarter, and an unaudited balance sheet as of the end of such fiscal quarter, all prepared in accordance with GAAP (except that such financial statements may (i) be subject to normal year-end audit adjustments; and (ii) not contain all notes thereto that may be required in accordance with GAAP);||
|[as soon as practicable, but in any event within thirty (30) days of the end of each month, an unaudited income statement [and statement of cash flows] for such month, and an unaudited balance sheet as of the end of such month, all prepared in accordance with GAAP||
|(e) as soon as practicable, but in any event thirty (30) days before the end of each fiscal year, a budget and business plan for the next fiscal year (collectively, the “Budget”), [approved by the Board of Directors and] prepared on a monthly basis, including balance sheets, income statements, and statements of cash flow for such months and, promptly after prepared, any other budgets or revised budgets prepared by the Company;||
|(g) [such other information relating to the financial condition, business, prospects, or corporate affairs of the Company as any Major Investor may from time to time reasonably request;||
So what does this really mean to you, as the CEO who has just raised a lot of money?
- Your accounting systems and bookkeeping must be strong enough to:
- Deliver reliable financials every month
- Periodically generate specific reports for your investors
- Do accrual accounting that produces GAAP or close to GAAP numbers
- Survive an audit, should they ask for one - this means having your schedules and back up information neatly organized
- Product a capitalization table on demand
- Your strategic finances must be strong enough to:
- Create a budget that your team can follow
- Produce a budget before the end of the year
- Compare your actual performance to your projected
- Explain the difference in your period over period difference
- Know when you are running out of cash, and understand the impact of hiring decisions, margins, and more on your projected cash out position
How does a venture funded company manage finances?
Setting up systems, keeping an eye on money in the bank, generating reliable financials, producing and understand the variance against a budget - how can a startup be expected to do all of this?
There are three proven ways to get your funded startup the financial chops you need to keep investors happy and have the intelligence you need to manage the business.
- In house: Hire up and do it all in house. If you’ve raised a ton of capital this is a somewhat common way to go. You’ll need a senior, experience finance professional. Perhaps a CFO, but more likely a VP of Finance. Someone who has done this either as the number two person at a bigger, fast growing company, or a repeat finance leader from a funded startup. You’ll need a mid-level accountant to keep the books in order. This mid-level person will also likely require a junior account to manage AP/AR, enter items, etc. And you’ll probably want a junior analyst who can assist with projections and one off strategic projects. All in you are looking at over half a million a year in salary. The upside is that you’ll always have that strategic person to help out on important analysis, plus you’ll have the team in house who can assist on important, but not strategic items like negotiating a lease or helping sales reps figure out payment terms of a contract. Plus, you can set any customized or unique accounting procedures that you want, as long as the team has the time to execute against them.
- Hybrid: Hire a VP of finance in house, and outsource the less-strategic accounting to a startup focused accounting firm. We’ve seen this model work very successfully for companies (especially ones in the Bay Area, where the competition for junior talent is intense). The VP gets you all the strategic help you need, while they also manage the outsourced bookkeeping and accounting. Depending on how much you pay that VP, you are likely looking at $200,000 to $300,0000 a year in expenses - a substantial savings, without sacrificing any strategic upside. Eventually your VP will want to hire an analyst in house, but a good outsourced finance partner will have FP&A professionals available to assist on specific projects as needed at a reasonable cost.
- Totally Outsource: Work with a startup focused accounting firm, who will provide your regular reporting. These firms have experienced senior professionals available for one off projects, but can also help bring in a part-time CFO who can help with strategic projects like fundraising. All in costs if you have the part-time CFO should be under $100,000 - and much less if you just use your accounting firm’s senior people for one off projects. You may sacrifice a bit in terms of responsiveness or lose some of the help handling less-finance focused tasks (like reviewing contracts or negotiating with vendors), but you’ll save a ton of burn and keep your investors happy with your reporting.
What not to do:
- Provide shoddy financials to your investors, or show up to board meetings not understanding your company’s recent financial performance. You likely are already pretty good at managing your books, you did just raise a lot of funding after all, but professional investors sophisticated and you need to be ready.
- Keep trying to get by with a low cost CPA or a “robo” bookkeeper. You are no longer in the business of just getting by with your financial reports. You now have legal responsibilities to do a good job preparing your information. We’ve been brought in many times to clean up a company’s financial statements after a VC loses patience (and sometimes faith) in a CEO who sticks with a mediocre accountant for too long.
- Not know your cash out date.
- Fail to produce a budget or fail to analyze how you are performing vs. your budget. Setting up a budget isn’t just best practice, it’s going to be required by your investors. And they’ll want to see how you are producing against your projections. You should want to know this too!
Ready to step your financial game? Reach out to us and we’ll find a time to discuss what we’ve seen work with other funded companies.