In our last article we explained the differences between private equity and venture capital, along with the various stages of venture capital financing. In this article, we discuss the importance of remaining funding ready and how to accomplish this.
Venture capital companies have an insatiable appetite for cash. It takes capital to invest in the technology, R&D, new product development and staff needed to fund ongoing growth.
This capital is usually raised in stages, starting with the pre-seed and seed stages and progressing through Series A, Series B and onward for as long as capital is needed. Unfortunately, four out of five companies that receive pre-seed and seed funding never make it to Series A. And nine out of 10 companies that receive pre-seed and seed funding don’t achieve a successful exit.
Prepare for Financial Due Diligence and Auditing
The key to making it to the next funding stage is to remain “funding-ready” at all times. This starts with preparing for financial due diligence and auditing during the pre-seed and seed stages. These steps typically include the following:
- Gather formation documents (e.g., articles of incorporation, bylaws, shareholder agreements).
- Identify and build relationships with professional services providers (e.g., CPA, banker, attorney, insurance broker).
- Prepare revenue and gross profits by product offering.
- Obtain audited financial statements for the last two (private company buyer) or three (public company buyer) years.
- Consult with an audit firm about complex accounting requirements (e.g., revenue recognition, leases, stock options, convertible debt).
It’s also critical to adopt financial best practices during the pre-seed and seed funding stages. This starts with building a top-notch financial and accounting system with well-organized financial files. Your system should include monthly reporting and establish strong internal controls over financial reporting while accommodating corporate tax requirements and deadlines. Also invest in an appropriate enterprise resource planning (ERP) system for your needs.
8 Steps to Remain Funding Ready
Here are eight more steps you can take to remain funding ready at all times:
- Implement accurate budgeting and forecasting. These provide the foundation for successful financial management. Investors want to compare current and previous periods so budgets and sales forecasts should be prepared on a monthly, quarterly and annual basis. There should also be common definitions of finance functions across the various time periods.
- Establish sound collection practices. This is especially critical for early-stage venture-backed companies. Statistically speaking, the longer invoices go uncollected, the less like they are to ever be converted to cash. Therefore, early-stage companies should implement policies and procedures designed to ensure prompt collection of accounts receivable.
- Utilize financial metrics, benchmarking and data analytics. Sometimes referred to as key performance indicators, or KPIs, these are quantifiable statistics that help define and measure progress toward key business objectives and other critical success factors. Common financial metrics include debt-to-equity, accounts receivable (AR) and accounts payable (AP) days, days sales outstanding (DSO) and inventory turnover.
These metrics should be benchmarked to previous time periods (e.g., the last month or quarter) or industry standards to spot trends and help reveal potential problems while you can still address them. RMA’s Annual Statement Studies is a good source for industry-specific financial metrics.
- Incorporate cash flow management. Startups can burn through cash quickly, making cash flow management critical. The key is to decide which expenses are essential and will lead to increased market share and growth and which expenses are wasteful. Devise monthly cash flow plans to make sure your business remains liquid at all times.
- Create a formal sales compensation structure. Sales is the main engine that will drive growth so your sales comp plan needs to be structured and formalized no later than the Series B funding stage. Most sales comp plans today include a base salary plus benefits in addition to commissions and bonuses to incent and reward top salespeople for high performance.
- Create a fundraising project plan and investor presentation. At each funding stage, investors will want to see how you plan to raise enough capital to carry the company through to the next stage. Prepare a formal presentation with these details that you can share with investors during your “pitch” meetings.
- Use GAAP accounting and revenue recognition. Series A and Series B investors will expect to see financial statements prepared in accordance with generally accepted accounting principals, or GAAP. At this stage, GAAP reporting should be timely and accurate. The following three major financial statements are required under GAAP:
- The income statement
- The balance sheet
- The cash flow statement
- Prepare for potential international expansion. Depending on your products/services and your industry, Series B and Series C investors may inquire about how your company can tap growth opportunities overseas. So, prepare an international expansion plan that details these opportunities, along with the potential risks and costs of overseas expansion and any statutory international compliance requirements.
Using Finance as a Service (FaaS) to Build an Optimized Finance and Accounting Team
Venture-based startups can build an internal finance and accounting team or outsource this function. Outsourcing using Finance as a Service (FaaS) tends to be far more effective for the majority of pre-seed and seed companies.
Building an optimized finance and accounting team in-house typically takes from 9 to 18 months, but an outsourced FaaS approach can accomplish this in as little as 30 to 90 days and at a fraction of the cost.
Consero can help you build an optimized finance and accounting team using FaaS so you remain funding ready at each stage. Connect with Consero by requesting a complimentary consultation to discuss your situation in more detail.