Article originally published on TechCrunch.com
The party’s over
Until recently, tech startups traditionally enjoyed relative freedom from financial oversight from the venture capitalists who funded them.
As long as these firms could report progress in developing their products and generating some level of earnings from sales and software subscriptions, they could burn through their millions without having to endure close scrutiny of their expenses.
But this laissez-faire era is coming to a close. With inflation, rising interest rates and lower earnings expectations battering technology stocks this year, we may be in the midst of another tech bubble burst similar to the one at the beginning of the century.
In this environment, many of the “pie-in-the-sky” companies that angel investors were flocking to are now struggling to survive. Many VC funds are refocusing their investments on more well-grounded technology companies focused on solving real-world problems.
Passing yearly audits will no longer be enough. Investors now expect these startups to demonstrate greater financial transparency all the time. CEOs who once got away with marketing themselves as visionaries will also need to think and act like accountants.
This means they’ll no longer be able to get away with manually filling in spreadsheets on an ad hoc basis whenever they have a spare moment. They’ll need to have robust bookkeeping processes and tools to track and report expenses and revenue in a more accurate and timely manner. And they need to maintain accurate records of revenue and earnings coming in each month, if not every day.
While most startup CEOs have a basic understanding of accounting principles, many don’t have the training needed to serve in this role, or simply don’t have the time or desire to do so. But with more VC funds wanting to see where every dollar is spent, it is essential CEOs understand how to accurately track and report monthly expenses and revenue.
Step 1: Simplify all non-card payments to one provider
Use one tool to sync your accounting platform with any wire transfers, checks or ACH payments your business needs to make. Online banking services like Relay Bank or Bill.com are useful.
You don’t need multiple ways to pay and want to prevent using anything that prevents payments from instantly showing up in your books. I’ll explain why this is critical further on.
Step 2: Use services that control spending of credit card charges
Many SaaS companies will hold a significant amount of credit card charges. You’ll want to start using a Divvy or Brex card that allows you to segment and issue cards by department and apply spending limits to help enforce monthly or department budgets.
Amex cards are enticing because of the rewards and points, but they make it hard to track employee spending in real time.
Step 3: Record your cost of payroll
Labor costs will almost always account for the biggest share of your monthly expenses. I recently transitioned my firm to Justworks since it can easily generate detailed monthly reports of all-in costs for every employee.
From there, I use Airtable to create a list of the current burn costs for each employee, including salary, healthcare costs, employer taxes and promised year-end bonuses.
It’s important to keep in mind that payroll does not always hit accounting systems in the period it is incurred, so it’s helpful to get the all-in monthly costs to have an accurate picture of monthly burn rates by department.
Also be careful to track PTO days. If any of your employees quit, are fired or get laid off, and you don’t have accurate records of their personal time used, you will be responsible for paying out unused PTO days. For a startup looking to be as efficient as possible with expenses, this can become a surprise added cost if it isn’t properly tracked.
Step 4: Know your prepaid yearly plan charges
As a SaaS business, it’s paramount to understand the difference between your credit card billings and revenue.
For instance, Stripe and Braintree will tell you what was charged to cards, but they will not indicate if some of that money is going to prepaid yearly client subscriptions. You will need your billing system to provide you this detail to fully understand how much revenue is attributed to prepaid plans each month.
Depending on the balance from these prepaid plans, you may want to segment it out to another bank account so it remains separate from your general business bank account. Platforms like Novo and Relay Bank will enable you to create multiple accounts to segment balances in this way.
Doing this prevents you from viewing and using this money to pay bills — those funds should be used for your plans. It is recognized revenue from prepaid customers versus credit card charge revenue.
If you’ve closed a funding round this year, you may want to use a similar strategy and open a fully FDIC-insured bank account for the bulk of those investments. You’ll want to separate these funds from your daily business use account.
Transfer the necessary amount once or twice a month as needed. This will provide added visibility into your burn rate, and how fast funds are leaving your daily business account.
Step 5: Track revenue on a daily basis
One of the most important steps to accurately track your finances is to set up daily emails or weekly reports on revenue. It’s a type of “reconciliation process” for what your sales team is telling you.
You might already be receiving notifications on projected revenue, but that’s not enough to get an accurate picture of your financials. You need to reconcile projected revenue with actual revenue, which means knowing what your daily billing is. Any discrepancies will help you identify if there is misinformation or confusion on the team, or problems with your billing system.
As the CEO, you want to see your bank account balance every day. You don’t want to run your business by balance, but if you’re a tech firm that isn’t yet profitable, you need to keep tabs on your balances.
Step 6: Ensure you get accounting statements about a week after month close
Steps 1-5 are essentially checks a CEO can do against their accounting team. It is essential to the financial future of your business to have a person, department or outsourced firm dedicated to ensuring your books are done accurately every month.
I recommend you ensure you receive all P&L and cash-flow statements within seven to 10 days after the month’s end.
Step 7: Choose the right accounting firm
Look for accounting firms that have client accounting services teams trained to provide bookkeeping services to tech startups, as your bookkeeping challenges may be different from those of the retail clients that are often the bread and butter of such businesses. Companies like Aprio, Pilot and Escalon specialize in managing finances, accounting and tax services for startups and SaaS businesses.
Once you find a firm, ask for a fixed monthly fee arrangement based on the services you want and the different platforms they’ll need to access your financial data. It may cost a little more than an hourly billing arrangement, but at least you’ll know exactly how much you’re paying each month.
You may even want to consider hiring two separate firms — one to handle expense reporting and the other to handle revenue recognition.
In today’s tight economic environment, VCs no longer have the patience to speculate on startups that run on “game-changing ideas” alone. Burning through cash without showing concrete results or demonstrating sound business management is no longer an option.
If you want to improve your firm’s chances of making it to the IPO finish line, you need to start getting your financial house in order right now.