Does my startup need an Audit?

Does my startup need an audit?

Probably not. We serve hundreds of VC-backed startups, and only a small handful get financial statement audits. Audits are a tremendous amount of hassle, and most professional venture investors do not want to burden their founders with an audit. Even if you are prepared (and we make sure our clients are!), getting an audit is cumbersome. This is especially true for private companies in their early stages that have small finance teams who are likely already maxed out with their day jobs!

Why might a startup get an audit?

• The number one reason for a startup to get an audit is because the investors ask for it. Check your Investor Rights Agreement (usually in 3.1) for audit rights - read more in our VC information rights piece. Most Series A and B investors do NOT ask for an audit (at least if you’ve got a quality bookkeeper of finance team).
• Your startup is getting ready for an initial public offering (IPO) - you’ll need one in this case. This is a common scenario when raising capital through an IPO, so many experienced finance leaders get the ball rolling a year or two ahead of time so that the process is crisp and perfected by the time a company gets public and has to regularly report out GAAP financial statements to public stockholders. 
• A bank that is offering you a bank loan or line of credit asks for one - note that in many cases, this request is just part of a copy-paste diligence list from the bank, and you can likely get them to waive this if you have solid bookkeeping processes. Regardless of if your bank asks for one, understanding your company’s financial statements is crucial when applying for a bank loan.
• You sell to the government - possible, but rare.
• Your board is worried about your books or other financial shenanigans.

What is a startup audit?

A lot of folks throw around the word “audit” without really knowing that there are 3 types of financial statement services that your CPA can provide: Audit, Review, and Compilation. The AICPA has published a fabulous comparative report on these types of services here. In a nutshell, a CPA can both prepare the financial statements AND provide a Compilation Report, but they must be independent is they are to provide a true Audit Report. Additionally, the CPA issuing the report must be “Audit” certified in order to legally sign off on the report. You can check to see if your CPA can provides here.

Where can I get a startup audit? Who does audit for startups?

Kruze Consulting’s top picks for Startups in the Seed to Series C stage are Deloitte, Armanino, Moss Adams, BPM, BDO, and Frank Rimerman. These startup audit divisions are typically called “emerging growth.” Many of these firms specialize in audits for businesses in various stages, from early-stage startups to more established companies. Depending on your industry, we can advise on the best pick for you. Feel free to email me at vanessa@kruzeconsulting.com   for help. 

How much can I expect to pay for a startup audit?

We’ve seen that most startups audits cost between $20,000 - $50,000. These prices are for SF and NYC based startups that are between Seed to Series C stage, hiring a high quality (but not Big 4) CPA. The cost can vary depending on factors such as the complexity of your company’s financial statements and the specific GAAP accounting rules that apply to your business.

How long does the audit process take?

Between 2 to 4 months. This timeline can vary based on the company’s size, complexity, and how well-prepared the company is for the audit process. Really, how prepared you are and the quality of your financials matters the most. 

When should I get a startup audit?

As a private company, startups are not required to do an annual audit by the IRS or any other governing body. Early-stage companies usually get audits when asked to by their investors, and as we’ve already mentioned, venture capitalists don’t usually start asking for an audit until a company is Series C or later. So you shouldn’t get an audit until your investors ask for one, or if an outside party (like an investment bank that will take you public) says that you need one.

Audits are distracting, expensive and time consuming. As long as founders have faith in their financial records and the company’s financial statements, it’s not worth the effort.

What is the Startup Audit Process?

1. Preparation and Planning

• Initial Meeting: The audit process begins with a meeting between the startup and the audit firm to discuss the scope and objectives of the financial audit, timelines, and any specific areas of concern. This meeting should include the startup’s CFO, finance team, and probably the audit committee. Founders and, on rare occasions, investors may also attend to address specific concerns.
• Documentation Preparation: The company is responsible for preparing all necessary financial documents, such as balance sheets, income statements, cash flow statements, and details of financial transactions. These financial records are vital for a successful audit and must adhere to generally accepted accounting principles (GAAP accounting rules). Proper accounting software can greatly assist in preparing and organizing these documents.

2. Fieldwork

• Transaction Testing: The audit team will test various transactions by examining supporting documents to verify their accuracy and compliance with accounting principles. This includes reviewing sales records, tax documentation, receipts, etc..
• Request for Additional Information: During this phase, auditors may request further documentation or clarification on certain transactions or accounting practices to ensure thorough examination and compliance.
• Internal Controls Evaluation: Auditors assess the effectiveness of the startup’s internal controls over financial reporting, often in consultation with the audit committee to ensure robust oversight. This often involves reviewing systems used for recording financial data and sales transactions. This feedback is crucial for risk management and ensuring the company’s financials are audit ready. 

3. Audit Completion

• Draft Report: The audit team prepares a draft audit report that includes their findings, the audited financial statements, and any necessary disclosures. The draft will be reviewed by the startup’s finance team, management and the audit committee. While it’s a pain, this report often provides valuable insights into the company’s financial health.
• Management Review: The startup’s management reviews the draft to ensure all information is accurate and that they understand any audit adjustments or recommendations. This step is crucial for both public companies and private companies.
• Final Report: After addressing any concerns from the management review, the auditors issue a final audited financial statement, which is then approved by the audit committee.

4. Post-Audit Meeting

• Discussion of Findings: The auditors, along with the audit committee, meet with the startup’s management to discuss the audit findings and any necessary changes or improvements in financial processes or controls. This meeting can provide valuable insights for businesses looking to improve their financial management, and can be a solid step for a startup CFO who really needs to request additional budget or headcount! 
• Audit Committee Reporting: The audit committee presents the final audited financial statements and their findings to the board, ensuring that the board is fully informed on the financial health and audit outcomes.
• Future Planning: Based on the audit outcomes, the startup may need to implement new processes or prepare for subsequent audits, especially if they continue to grow or raise more funding. This planning often involves preparing for future audits and improving financial systems.

What materials are needed for an audit?

Solid bookkeeping and legal record keeping will help make an audit smoother. The auditor will provide a list of materials, but in general this includes documentation like:

• Your financial statements (income statement, cash flow statement, balance sheet).
• The trial balances - and related supporting documentation (expect this to go to the year PRIOR to the audited year, as the auditor will want to make sure they agree with the opening positions/balances).
• Tax returns. Auditors will typically review several years of tax documentation.
• Financing documentation (make sure your lawyer is filing this all away in a shared Box folder so you have easy access). Very important point for VC backed startups undergoing an audit.
• Incorporation documents.
• Employment agreements.

It’s important to note that auditors will usually - actually pretty much always - want to dig into supporting records. This will include payroll records, invoices, bank records, etc. They are looking to prove that the finances are as you say that they are, so make sure you are organized. For us at Kruze, we try to make sure we have all supporting documentation easily organized. It really helps in an audit, especially for private companies, although our companies are more likely to need it due diligence when they get acquired by a major tech company. This level of organization is crucial for both public companies and private companies preparing for potential buyers.

What can I do to prepare for a startup audit?

The best way to prepare for a startup audit is to have diligent documentation process from the start. That means using Quickbooks Online, Brex or Ramp, Bill.com, (or a startup credit card with built in expense management), a high-quality-startup-focused payroll provider, and Box so that you can easily share reports and documents with your audit team. I also recommend setting up an “accounting@yourcompany.com” email box as soon as possible and cc’ing all accounting matters when corresponding with clients or vendors. That way both new accounting and finance staff and audit staff have an easily accessible audit trail…. And don’t need to bother you for more details! This preparation is essential for companies at all stages, from those raising capital to those preparing for an initial public offering.

What to Do if the Auditor Finds a Material Misstatement

If your auditor discovers a material misstatement in your company’s financial statements, it’s crucial to act quickly and transparently. Here are the steps you should take:

1. Don’t panic: It’s very common to find some errors or minor misstatements - when you get your first audit, so confer with the auditors to make sure you understand how big of a deal this is. Small, even decent sized errors aren’t uncommon when a startup gets its first audit, so don’t freak out quite yet.  
2. Understand the issue: Work with your auditor to fully comprehend the nature and extent of the misstatement. It could relate to revenue recognition, tax issues, or other accounting areas.
3. Inform key stakeholders: Let your investors and venture capital partners know quickly. Transparency is key to maintaining trust - it’s much better to be upfront quickly.
4. Assess the impact: Determine how the misstatement affects your financial position. Hopefully, the money in the bank has not been materially misstated (note that we see this problem with a lot of the “automated” bookkeeping services).
5. Develop a correction plan: Work with your finance team and auditor to correct the misstatement and adjust your financial statements accordingly.
6. Review and improve internal controls: Identify what led to the misstatement and implement stronger financial systems and controls to prevent future issues.
7. Consider regulatory implications: Depending on the nature of the misstatement, you may need to inform regulatory bodies, especially if you’re preparing for an initial public offering. And if the root cause is fraud, consult with the board and your law firm.
8. Document everything: Keep detailed records of the misstatement, your response, and all communications with your auditor and stakeholders.
9. Learn from the experience: Use this as an opportunity to strengthen your financial reporting processes and perhaps invest in more robust accounting software.

Remember, while a material misstatement is challenging, how you handle it can demonstrate your company’s integrity and financial management capabilities to your venture capital investors and other stakeholders. It’s an opportunity to show that your business can navigate financial hurdles responsibly.