The GTX Finance Finance Stack

I’ll skip the cute blog anecdotes for this post. Lots to get to, so let’s dive in. Your “finance stack” is the set of tools and services that you use to run the finance organization for your company. I’ve been working with startups for over a decade, and in that time, I’ve used a few very good tools, a few very bad tools and a lot of tools in between that get the job done. But… 

When discussing a topic like the finance stack, it’s good to keep in mind that the landscape for corporate tools is ever-changing, with new products launching frequently. It’s part of my job to ensure that clients have the best stack available, and my experience isn’t worth very much if I’m not staying up to date on new entrants eager to put the market leader on their heels. That said, you won’t see a lot of sexy under-the-radar recommendations in my stack. I can’t claim to know every single product coming onto the market, but I am paying attention. In most cases, the market leader is at the top for a reason. But if you’re reading this and have experience with a tool that blows any of my recommendations out of the water, please let me know!

I have a working relationship with almost all of the providers that I mention below. But outside of networking & goodwill, I have no affiliation or direct financial relationship with any of the recommended services.

As of August 2023*, here are the tools and services that I most often recommend to my clients (and read on for more in depth discussion):

Tools

• Banking

• Mercury - Mercury offers the best banking solution that I have seen for startups. Set up is easy, the platform integrates with everything you’d expect it to integrate with, and the staff are knowledgeable and supportive. They offer $5M in FDIC insurance, and setting up an interest earning Treasury account (via Vanguard or Morgan Stanley) is a breeze. I am aware of some other offerings that provide higher FDIC coverage. But if you think about $100M of FDIC coverage, at $250K per bank, that’s 400 banks! If anything ever were to happen to your provider in that scenario, unraveling it and getting the cash back could be a logistical nightmare. Better in my mind to stash excess funds in treasuries with Morgan Stanley and cross your fingers that the US Government doesn’t collapse…

• SVB - Sooooo, we had a little bit of a scary moment there with SVB didn’t we? I have a lot of thoughts and feelings about the March 2023 SVB bank run. In my opinion, it didn’t need to happen. For years, I have recommended SVB to clients as a great option for early stage startups. They were flexible enough to keep up with the pace of a young company, but also grown-up enough to feel secure about dealing with a “real bank”. As far as I can tell, now operating as a subsidiary of First Citizens Bank, they are still doing just that. Unlike Mercury (which is technically not a bank, but a fintech company), SVB is a lending bank. I’ve worked with them on multiple occasions to provide liquidity to my clients as a bridge to the next round or to cover bases on working capital during high growth periods. My general recommendation these days is to use Mercury as the primary operational bank, and maintain 6-9 months of runway with SVB as both a backup bank and a valuable relationship. 

• Accounting

• Quickbooks Online - Talk about not having a sexy under-the-radar pick. If you decide to go with QBO as your accounting software, there’s going to be a few headaches. But in my experience, QBO offers fewer headaches than its competitors. It’s a little bit trickier to set up than Xero and some of the other more lightweight offerings, but once you’re up and running, the accounting and tool integration features are more than a step ahead of the pack. I’m certainly open to the possibility that a better alternative already exists, so if you're reading this and have an accounting tool that you love, please let me know!

• Netsuite - For companies with a bit of additional complexity, such as inventory intensive operations or providing bespoke enterprise contracts, you may consider adopting Netsuite earlier than some of your cohorts. It can be expensive and requires a pretty intense implementation effort, but if you set it up correctly, it’s an incredibly powerful tool. If you do decide to go this route, tap your network, see what others have paid, and try to find somebody who has a lot of experience with implementations. Netsuite’s pricing model is not what you would call transparent. (Sage Intacct has also been suggested to me as an intermediate alternative between QBO and Netsuite, though I need to do a bit more looking into it before I recommend it myself).

• Strategic Finance/FP&A

• Causal - Here’s an under-the-radar pick for you! One of my client contacts suggested I look into Causal, and I’m so glad I did. This tool has really streamlined and turbocharged my financial models. It’s a spreadsheet based tool that utilizes simple formula language, powerful “helper variables” and links between models to make complex models much more straightforward. From there, building basic dashboards and charts is as easy as a few clicks. It integrates with QBO, gsheets and other apps to make updating actuals a breeze. After scaling the not-too-steep learning curve, I’ve spent much more time strategizing & analyzing for my clients instead of maintaining models. The one drawback that I might mention is that the Casual team is rapidly iterating, so occasionally you may find a bug under a rock somewhere, but I have seen this less and less over time. 

• Google Sheets - As with most finance folks, I used to spend all my time in Excel. But in adding feature after feature over the years (and the fact that I’m doing most of my complicated modeling in Causal these days), the gap between Excel and Google Sheets is now pretty de minimis. Add to that the fact that a GSheet is easier to share and has more integration capabilities than an Excel doc. So while I use Causal for my flagship three statement financial model, I often use GSheets for budgeting and ad-hoc analysis. 

• Accounts Receivable/Payments in

  Once you launch your product, you want to make sure it’s as frictionless as possible for your customers to pay you. The best way to do that is to pick the right tool for your particular situation.

• Stripe - Consumer SaaS. If you have an app or digital product that you are selling en masse to consumers, Stripe should have everything you need to cover your bases on payments. It integrates with everything you need it to integrate with, and the reporting capabilities are great. If your product is a basic monthly subscription, you can use Stripe Subscriptions. Alternatively, if you have a more complicated subscription offering (multiple tiers, terms & prices) you could pair Stripe with a subscription management tool like Chargebee.

• Shopify - Direct to Consumer/Retail. For companies shipping a physical product to customers, you will want to make sure that you have an attractive and intuitive online store, and can track shipments and inventory levels. Shopify is the industry standard provider in this space for good reason. 

• Bill.com - B2B with standard Terms & Conditions. If you have a B2B offering, but what you’re offering is a standard product, with little variation from customer to customer, Bill.com should be a good option. Many, if not most, of your customers will already have a bill.com account, so collecting payments on the platform should be easy. With a QBO integration, accounting should be fully automated. 

• Zoho/Netsuite - Enterprise Contracts. For B2B companies that offer bespoke contracts & terms to each customer, you’ll want something a bit more robust than Bill.com. To be fair, I don’t have a ton of experience in this arena, but I didn’t want to leave this cohort out. In doing some research, it looks like Zoho offers the best ratio of functionality/implementation/price for bespoke invoicing solutions. If you want it to talk to your Salesforce instance, you’ll have to set up a Zapier link, but that’s pretty easy to do. Alternatively, you could just bite the bullet and set up Netsuite. 

• Payroll

  Similar to Payments In, this one depends on your situation. There are three tools that stand out to me, all of which work pretty well and may be tailored to specific situations. 

• Gusto - For companies with straight-ahead employees and contractors. Gusto is probably the easiest payroll tool to set up and use. If your company doesn’t have a lot of edge cases, international issues or unique benefits, Gusto is a safe bet. 

• Justworks - It might be just a bit trickier to set up than Gusto, but I’ve found Justworks to be more flexible when dealing with contractors and international providers. From an accounting perspective, the reporting on Justworks is a bit more intuitive, in my opinion, than Gusto’s reporting features. 

• Rippling - Congrats! You’ve grown to 150+ employees. Time to roll up your sleeves and implement a more scalable tool. Rippling provides enhanced functionality & support for benefits, 401K and compliance. If you find yourself spending more time than you’d like registering with new states for payroll taxes, you may consider supplementing your payroll provider with Middesk.

• Payments ouT

• Bill.com - It just works. It’s easy to set up and integrate with your accounting system. I think there are some improvements to be made in terms of automation, and I know many companies are working on combining OCR with AI tech to optimize the recognition and coding of bills as they come in. But until somebody comes along with a tool that is 5-10x better than Bill.com, the fact that most of your vendors already have a Bill.com account is going to make keeping the lights on with Bill.com easier than any other tool.

• Routable - I haven’t actually worked with Routable before but I think what they are doing is really cool and I’ve had a couple of really illuminating conversations with the founder. I’ve decided to give them a shoutout here in case this may help any founders swimming in payments hell. Routable has developed a product focused on streamlining disbursements at scale. If your company is in the fintech, insurance, or marketplace space, you might want to check them out. 

• Credit cards and expenses

• Ramp - I’m not as close to the credit card & expense reimbursement side of the house as I used to be, but Ramp has everything you need to manage both. 

• Inventory

• Zoho - Zoho inventory is powerful enough to track all of your skus, lots, bills of materials, and FIFO layers. It integrates with QBO and logistics platforms, and will cost you MUCH less than its competitors. 

• Netsuite - For companies that expect to scale quickly, it may be worth setting up Netsuite sooner than later. 

• Sales Taxes

• Avalara or Anrok - I’ve used Avalara in the past, and it works fine. I’ve also heard that Anrok works well. 

• Equity & Cap Table Management

• Carta - Carta’s a great product. In terms of ease of use, reporting, and support, Carta is a tool that I have no qualms about recommending. It costs a little bit more than some of its competitors, but from my perspective, it’s pretty easy to see what you’re paying for. You’ll note that in my diagram, I don’t have Carta integrated into the accounting system. That’s because their integration is currently one way, pulling the financials into Carta. If they added the functionality to push stock based comp and option exercises into QBO, then I’d recommend setting up the link. Until then, Carta sits on its own in my finance stack. 

Services

• The below aren’t necessarily tools, but are basic finance-related services that every startup is going to need at some point. 

• Strategic Finance

• GTX Finance - Did you think I was going to invest all this time in this blog post without a bit of self-promotion?! We have a small team, but we’re really good at what we do, we really care about our clients, and we have a track record of successfully ushering our clients to the next stage in their journey. 

• Accounting

• Kong Basile Consulting - I work with KBC on most of my clients because they hire great accountants. I’ve worked with a number of outsourced accounting firms and outside of specific scenarios, KBC is the one that I always recommend. 

• Income Taxes

• Baker Tilly - I’ve worked with Alan Chinn & his team for many years now. They are incredibly knowledgeable, responsive, and fairly priced. 

• Insurance Brokers

• Hub International - has provided responsive and responsible service for my clients as broker across multiple types of coverages. 

• 409A Valuation

• Stout - Carta is a quick and easy option for knocking out your 409A valuation and having it nicely integrated with your cap table tool. But since they churn out thousands of valuations per year, it doesn’t always feel like they are particularly flexible or invested in your company’s story. For a more tailored approach, I’ve really enjoyed working with Stout. 

*I’ll make a point to review this list every 6-12 months and update, as needed. 

Startups: Your Financial Statements aren’t GAAP (...so why say they are?)

By the time your company is raising a Series A round, investors are probably including a requirement to provide GAAP (“Generally Accepted Accounting Standards”) financial statements as both a condition to closing the round and for financial reporting on an ongoing basis. Many founders will agree to these terms. Here’s the thing - I’ve never seen a Series A stage company with GAAP financials. 

To qualify that statement, I should say that the companies that I’m seeing generally don’t have full-time leadership in the finance function. That’s kind of my whole business. But even for the occasional series A stage company that does have a small finance team, it’s likely that they are focused on operational efficiency and supporting the management team with non-GAAP KPIs. They aren’t focused on generating audit-ready financial statements until further down the road. 

Let’s dive into (a few) of the ways your financial statements are not GAAP:

• Footnotes - The most obvious feature that you’ll be missing from your financials is the footnotes that provide additional context to the basic four financial statements (yes, four, not three. See the next bullet). If you look at any annual filing by a public company, and review the Financial Statements section, you’ll see that the financials are accompanied by dozens of pages of notes outlining accounting policies, detailing investments and liabilities, etc. For reference, here are Apple’s 2022 financials (which surprisingly contain only 16 pages of notes).

• Statement of Stockholder’s Equity - That’s right, there are four*, not three, basic financial statements when it comes to US GAAP. The income statement (or “statement of operations”), the balance sheet, the statement of cash flows AND the statement of stockholders equity. This statement is exactly what it sounds like: a rollforward of all the equity balances from one year to the next. Typically, prospective investors are receiving detailed cap tables and equity ledgers as part of due diligence, so this statement is a bit superfluous in that context and is rarely included in a startup’s financial statement package.  

• Revenue - Your customers pay you, and you record that as revenue. If your customers are paying you for an annual contract, you recognize the revenue ratably over the year. Sounds easy enough. But ASC 606 may have other ideas. ASC 606 is the section in the Financial Accounting Standards Board’s (“FASB”) codification of accounting rules that deals with revenue. It’s too complex to discuss here, but unless you have specifically done an ASC 606 study on your revenue model, it’s more than likely that an auditor would have some significant notes on how you are recognizing revenue. 

• Presentation - What does your income statement look like? Specifically your operating expenses section? You probably have some broad categories for employee compensation, legal, travel, R&D and marketing expenses, right? That’s not GAAP. A GAAP P&L has all of your operating expenses broken down into two or three categories:

• Research and development expenses

• Selling and marketing expenses

• General and administrative expenses (this line is often combined with S&M to create a single line for “Selling, general and administrative expenses”)

This means that in order to run a GAAP P&L, you need to be coding all of your expenses into these three categories, including your employee compensation. 

• Reserves & Estimates - Every GAAP set of financials requires some level of judgment from an accounting perspective to allow for reserves. Some common examples of reserves include:

• Bad debt - If your company has a history of clients skipping out on paying what they owe you, then there should be an “allowance for doubtful accounts” on your balance sheet as a contra-AR account

• Warranty - For companies selling a product that may break or has the possibility of defect, there should be a warranty reserve as a liability on the balance sheet to account for future claims. 

• Legal reserves - Companies that operate on the cutting edge of technology may find themselves in some legal battles around intellectual property. Any pending litigation should be assessed for financial impact in a GAAP balance sheet. 

• Stock-based compensation expense - A number of startups I see actually do record this. But a lot of them don’t. 

• Lease Accounting - Recent changes were made to lease accounting rules that require companies to gross up their balance sheet with a “right of use” asset and a lease liability in order to represent the value of the company’s lease commitments in a more detailed way. 

This is not a comprehensive list. But I think it illustrates just how difficult it is to maintain GAAP financial statements. Realistically, if you have not undergone a financial audit, your financial statements almost certainly aren’t GAAP. 

So how important is this? Well, I can’t say that I’ve ever seen a management team get in trouble for saying they had shared GAAP financial statements and then an investor came back yelling “these financials don’t even have ROU lease assets on the balance sheet!”. However, I’m a big believer in a) doing what you say you’re going to do and b) knowing what you’re talking about. So when I’m involved in an SPA negotiation, I make a point to clarify the language around financial statements. Here’s how that process might shake out:

• Default language: “The Company has delivered to each Purchaser its unaudited financial statements for the 12 months ended ________. The financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) applied on a consistent basis throughout the periods indicated, except that the financial statements may not contain all footnotes required by GAAP. The Financial statements fairly present in all material respects the financial condition and operating results of the Company as of the dates, and for the periods, indicated therein.” 

• Ideal language: “The Company has delivered to each Purchaser its unaudited financial statements for the 12 months ended ________. The Financial Statements fairly present in all material respects the financial condition and operating results of the Company as of the dates, and for the periods, indicated therein.” 

• Compromise language: “The Company has delivered to each Purchaser its unaudited financial statements for the 12 months ended ________. The financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) applied on a consistent basis throughout the periods indicated, except that such financial statements i) may be subject to normal year-end audit adjustments ii) may differ from GAAP in certain attributes of presentation and iii) do not contain all footnotes required by GAAP. The Financial Statements fairly present in all material respects the financial condition and operating results of the Company as of the dates, and for the periods, indicated therein.”

You can see that in the ideal language, we’ve removed the reference to GAAP altogether, but are still representing that the financials “fairly present... the financial condition and operating results of the company”, which is ultimately what the goal of startup accounting should be. In the compromise language, you still have the reference to GAAP, but have the wiggle room of “normal year-end audit adjustments” and “attributes of presentation”, which in my estimate would include all of the non-GAAP items I listed above. I have a strong preference for the ideal language, but some investors (or lawyers) may insist that there be some reference to GAAP. 

So the next time that an investor asks you for your GAAP financials, consider gently pushing back. By setting expectations and getting aligned on what everybody wants to get out of the Company’s financial reporting, you’ll be setting yourself up to a) do what you say you’ll do (i.e. delivering non-GAAP financials) and b) also demonstrate that you know what you’re talking about. 

*Really it’s four and ½. There’s a fifth statement called the statement of comprehensive income which can be represented independently, or as a tag along to the statement of operations. 

The "Pre and Post" Formula

This post is specifically geared towards the number crunchers. And I’m going to post the formula in question at the top here, so that anybody who wants to earmark this page as a reference doesn’t have to scroll all the way to the bottom of the post to get the good stuff:

There are a few situations where a transaction changes the inputs of a formula and convolutes what would otherwise be straightforward arithmetic. Here’s what I mean by that. 

Example 1: Fundraising. You’ve ironed out a pre-money valuation with your investor, but not an investment amount. The investor would like to own 10% of the post-money cap table. 

Pre-money valuation: $100M

Target ownership: 10%

It would be easy to think that you would just invest $10M (10% of a $100M valuation), but the post-money valuation is going to include the cash from the investment. So your investor would have $10M of a $110M company… 9.09%! 

How do we gross this up? 7th grade algebra, baby!

Your starting point looks like this:

To be specific, with our example, it looks like this:

Run that through some 7th grade algebra (along with some 8th grade factoring)  to solve for “inv” and you get:

Let’s check our work. 

Nailed it.

Example 2: One other example of when this formula might come in handy is when you want to pay an employee for a specific expense (relocation, option exercise, etc.) but the amount you are targeting is net of taxes. If your new star hire needs $10,000 for moving expenses, you can’t just cut a check for $10,000. That puts maybe $6,500 in their pocket after tax withholdings. Let’s run it through the formula. 

Add the gross up to your target payment and you get $15,385. Pay that to your employee, withhold 35% and they get $10,000 in their pocket. 

I’ve seen people use circular references and excel’s solver function to tackle this “gross up” issue, which I guess is fine, but it’s a pretty simple formula, and turning on circular references can be problematic. Also, using the formula allows you to show your work and retrace your steps when and if you need to review materials later on. 

Laying the Foundation for Useful Accounting

In my last post, I discussed a few tactics for identifying bad accounting. Here I’d like to take a little stroll on the sunny side of the street and talk about how to create useful accounting infrastructure once you’ve got the basics down. When starting a company, it’s easy to think about accounting as just another necessary evil like setting up payroll, maintaining a C-Corp entity and registering with all of the relevant authorities. However, putting your financial data to work can be a major source of insight for how you’re running your business. Also, doing things right early on will save a ton of headache down the road. Here are a few tips to get the most out of your accounting from a business strategy perspective:

Generate Summary Level Financials

Zoom out, then zoom back in. The Profit & Loss statement that you can download from Quickbooks is not the P&L that you should be sending to investors, bankers and other third parties. It’s also not the P&L that your management team should be reviewing on a monthly basis. This downloadable P&L (what I call the “System P&L”), is going to show all of your active accounts and is too detailed for third parties and high level management review.  Ditto on the Balance Sheet. 

Instead, set up a summary template that groups multiple accounts into summary categories to make the view more useful for somebody who might be unfamiliar with your business. I’ll likely write an entire post about this topic at some point, but you want to see a summarization like this:

Note: the summarized P&L shown above is not technically a GAAP format Income Statement (again, a topic for another blog post)

As you can see, the P&L on the right is much easier to read, even if we were to blow up the one on the left to a reasonable font size. Certainly there is more information in the detailed statement, but starting with the summary level is a better way to identify significant trends, inefficiencies and opportunities. Once issues have surfaced, then it’s time to roll up sleeves and dive into the details. 

Keep a clean Chart of Accounts

The “Chart of Accounts” is the listing of accounts that make up a company’s detailed income statement (the P&L on the left in the image above) and balance sheet. When you’re setting up your accounting system, think about how you want to run your business and organize your COA accordingly. In order to do this effectively, you need to expand a little and simplify a lot.

• Expand - What are the major cost drivers in your business? If technological innovation is a major part of your business, you may have a ton of IP related legal bills. In that case, one account for “Legal” may not do the trick. You may need “Legal - Patent”, “Legal - Corporate”, “Legal - Litigation”, etc. 

• Simplify - One example: at some point you will probably incur charges for rental cars, ridesharing apps, and employee mileage. Are these specific types of auto expenses important for running your business? If not, you can combine these types of charges into a single account called “Auto expenses”. The COA is the top-level reporting in your accounting system, so you want to be able to analyze it at a glance. It’s best to keep this pretty streamlined where possible. Which brings me to...

Make use of Departments and other Fields

If we think back to history class, in order to tell a complete story, we need to know “who, what, where, when and why?”  The chart of accounts is your first level of reporting, and generally provides an answer to the “what” question when it comes to transactions (ie. is it a sale? An expense? What type of expense?). As for the other “w” questions, I’ve seen companies attempt to use the COA to answer these and it can get out of hand very quickly. One classic example of this would be creating a separate account for each customer. So the sales section of your P&L would look like this:

4010 - Sales Customer 1

4011 - Sales Customer 2

4012 - Sales Customer 3

And on into infinity. DO NOT DO THIS. 

Instead, make proper use of your fields when entering transactions. Different accounting systems will offer different default fields, but the list below covers most of the bases:

• Date (when) - When did the transaction occur? Some accounting systems will have an additional field for “accounting period” in the event that the date of the transaction and the date of the recognition of the transaction are different. 

• Account (what) - Here you select an account from your COA.

• Name (who-external) (“Customer” if revenue, “Vendor” if expense) - See above. If you are using your fields properly, it would be redundant to maintain an account for each customer if you are recording the customer in this field as well. 

• Department (who-internal) - This field is generally used to assign expenses to one of your teams (product, engineering, legal, finance, etc.)

• Location (where) - Not all accounting systems will have this field available, but unless you are managing the business out of multiple locations, you may not need this field. 

• Description/Memo (why-free form) - You can leave notes or explanations about the transaction in this field

• Class (why-structured) - This one is a bit of a wild card. You can use it to track projects, functional teams, products, or whatever. Just be sure that you commit to a path here so that the field data doesn’t get too messy.

• Item (what) - You may not see this one in every accounting system either. For companies with inventory, this will be the specific product that you are selling or purchasing (as opposed to Class which would be the product family). Your finance and supply chain teams should be attached at the hip when it comes to the maintenance of your item list. 

Setting up some of these processes may seem like a low priority headache to many founders. But in my experience, once a company is able to organize the financial data properly, this allows for easier insights and becomes a thread that founders are eager to pull. Additionally, establishing a strategic view over your accounting operations at an early stage will make life so much easier for your future finance contributors as your team grows.

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How to Identify Sloppy Accounting

One of the more difficult aspects of writing is avoiding cliches. Cliches are cliches for a reason: because somebody wrote it once, and then it clicked for a lot of people. It’s a quick and easy way to find common ground for everybody, like playing a Beatles song. I’ve spent about 15 minutes trying to figure out how to start this post without saying “People always tell me…” and come up with something original instead, but they DO always tell me...  so here goes:

Founders often tell me: “Greg - I worry about my accounting. I feel like it’s wrong, but I don’t know how to tell”. Most startups have one of two initial setups when it comes to accounting in the early days:

• Setup 1: The accounting is performed by a founder or non-finance team member with a passing familiarity with accounting concepts

• Setup 2: The accounting is outsourced to an offsite bookkeeping firm

Regardless of which setup you have, if you don’t have a high-level review process, it’s very possible that you have some accounting issues with your books. 

Here are some things to look for that may point to accounting errors or bad process in order from most basic to most complicated:

• Assets = Liabilities + Equity. This formula is why your Balance Sheet is called a Balance Sheet. With a quick bit of algebra you can get to a much more intuitive Equity = Assets - Liabilities formula, if that’s an easier way to think about it. This is one of the most basic of accounting concepts. So if you ever find yourself looking at a balance sheet that doesn’t balance, which can’t be explained away by rounding or a simple typo, it’s probably time to find a new accounting solution. 

• Retained Earnings Rollforward. Retained earnings is a line that you will see towards the bottom of your balance sheet, in the Equity section. It represents the sum of all of the earnings (aka net income/loss) of the entity from inception up to the balance sheet date. As such, it serves as the link between your Income Statement and your Balance Sheet. To make sure that Retained Earnings is calculating properly, perform the following check:

  • Period 2 Retained Earnings - Period 1 Retained Earning = Period 2 Net Income

• Intercompany Balances eliminate in consolidation. If you have more than one business entity in your company (for example, a US corporation and an international corporation), you should be maintaining separate sets of books for each entity. When Entity A sends money to Entity B, this creates an asset and a liability on their respective books. But when considering the consolidated financials of Company X (the parent company), these particular assets and liabilities should cancel each other out. If you are seeing intercompany balances on your consolidated financials, something is amiss. 

• Rent expense consistency. You can perform this check on any expense account really, but I pick out rent because it should basically be the same amount every month. Sometimes, rent gets paid a day early, or a day late. If the timing works out just so, and your accountants aren’t paying attention, you could end up looking at an income statement that has three months of rent recorded in one month. This would indicate that your accounting team isn’t being particularly vigilant about accrual-based accounting. 

• Gross Margin consistency. This one is a little bit trickier, but is really important. Some companies may have their gross margin vary wildly from month to month, if they have a lot of fixed costs in their COGS and a lot of volatility in their revenue. However, I’d say that most companies aren’t built this way, and you should know roughly what your gross margin will look like before you even look at an income statement. If you see your gross margin bouncing around like a pinball from month to month, and you don’t think that should be the case, it might mean you have a timing issue, whereby revenue from one month is being reported over COGS from another month, and vice versa. It could also indicate a classification issue, where items which should be included in COGS are being reported in operating expenses, or vice versa. It could mean a lot of things, and you should get to the bottom of it. 

Startup accounting is tricky. There’s no history to follow, no auditors to grade the books, and usually no CFO to provide a layer of review and mentor junior staff. Not to mention the possibility that the accounting rules haven’t even been written yet for some of the most cutting edge companies. So while the above items are by no means a comprehensive list of all of the accounting landmines that a team might step on, these are the issues I see most often. If you can tick these items off your list with confidence, then there’s a good chance your books are in decent shape. 

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Does Our Plan Look Reasonable?

The question of whether a financial plan looks reasonable manifests itself in dozens of different ways. Are we hiring too fast/slow? Are we investing enough/too much in marketing? R&D? Is our demand plan too aggressive/passive?

Of course, the answer to all of these questions is that universal and most annoying non-answer: “It depends”. It depends on your Company’s goals and your strategy to achieve those goals. That’s a pretty obvious and useless observation in and of itself, so let’s drill down.

Unless your company has developed a business model that defies the laws of physics, your mission can probably be boiled down to two goals:

1. Don’t die

2. Create value

Don’t Die

Goal 1 is really more of a parameter than a goal, but I like to include it on par or ahead of everything else because it’s SO IMPORTANT. This quote from the a16z blog drives that point home:

“Should a business spend every penny wisely? Absolutely. But don’t run out of cash.  Is equity dilution something to be avoided? Sure. But don’t run out of cash. Can too much cash cause a business to solve problems with money rather than culture? Yep, but don’t run out of cash.  Can innovation be greater when a company has less capital on hand? Yes, but don’t run out of cash. Oh, and did I mention: don’t run out of cash.”

The solvency of your business should be top of mind as you put together a financial plan. Assume things will go wrong. Build in a buffer and have a plan B.

Create Value

This is the tricky part, because “create value” doesn’t always mean “create cash”. Without getting too much into business management theory, let’s define the hierarchy of a company’s road map as follows:

• -> Value hypothesis - We believe an opportunity to capture significant value exists

• --> Goals - If we can accomplish XYZ goals, we will be in the best position to capture said value. Also, don’t die.

• ---> Strategy - This is how we will accomplish the Goals

Financial planning comes into play between the Goals step and the Strategy step. To illustrate how, let’s look at three types of Goals categories that cover many, if not most, early stage companies:

1. Milestone based goals

This is for companies that may be in the developmental, experimental or market testing phase. Their milestones might have to do with product development, conversion rates, engagement, or quality assurance.

Financial planning and strategy: If your company’s primary goals for the year are outside of the realms of growth and profitability, then you are going to want to pay very close attention to the “don’t die” mantra. You should structure your hiring and R&D investment such that you can ensure that a major milestone exists between today and your cashout date, with enough buffer time to go out and raise money (or make money!) on that milestone. Any investment spent on marketing or partnerships should pay for itself in a measurable, tangible way.

2. Growth based goals

Your product is ready for the market and the customers that you do have are happy campers. Now it’s time to obtain users, sign clients, ramp up conversion or whatever your growth metric may be.

Financial planning and strategy: Growth is generally not something that you want to do on a shoestring budget. Companies targeting greater than 50% year over year growth should have a war chest at the ready to deploy for any number of roadblocks, predicted and unpredicted, on their path to capturing the market. Marketing dollars should be spent liberally, but deliberately. To this end, you should outline acquisition per marketing dollar targets at the beginning of the year to track your progress. With respect to “not dying”, map out a Plan B to see how things look if growth initiatives do not go as planned. Otherwise you may be throwing a Hail Mary without realizing it.

3. Profitability based goals

Whether your Company has already achieved its growth goals, or the idea was to be profitable from the start, you’ve landed on a revolutionary strategy: create value by earning money!  

Financial Planning & Strategy: For companies chasing net income, the value creation question becomes much more complex. At a high level, in most cases, it can be boiled down to some combination of focus on efficiency and volume. Efficiency strategies are going to focus on reducing costs and increasing per customer revenue while maintaining product quality and customer satisfaction. Volume strategies will focus on obtaining more customers. When profitability is the goal, your budgets will speak for themselves and force a conversation about what can be accomplished with limited resources. If the bottom line in your forecast changes from black to red, you know you need to take another look.

A financial plan should be strategic (why are we doing this?), achievable (can we do this?) and in some cases, flexible (what if we’re wrong?). If you start the planning process with these goals in mind, you are far less likely to end the process, staring at an income statement and wondering: “does this make sense?”

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Debt is Cheaper Than Equity

What does that even mean? This is a phrase that you’ll hear from bankers, investors and finance professors from time to time. Where you probably won’t hear it is on Silicon Valley or the Startup Podcast (though I would absolutely love to see a debt-focused Silicon Valley episode). That’s because debt isn’t sexy. You have to pay it back. "Home mortgage" is possibly the least sexy term in the lexicon of personal finance. Fun fact: the etymological source of the word “mortgage” is “death pledge”!

Venture Capital is sexy. It’s money from a really smart, really accomplished investor who is saying “I believe in you” with a seven or eight figure check. You pitched your heart out and you won their confidence, and now you are tasked with returning >10X on that investment.

As a result, here in Startupland we don’t talk about debt perhaps as often as we should. So let’s talk about that “cheaper” assertion. Equity is money invested in the company that you don’t have to pay back. Debt is money loaned to the company that you have to pay back with interest. So how is that cheaper?

Enterprise value is how.

An example:

Company X has made their way to their first product launch and they want to raise $10M. So they start pounding the pavement, hit it off with a VC and get their $10M Series A round at a $40M post-money valuation. Right off the bat, the founders have sold 25% of their company. So payouts in a potential sale of the Company look like this (assuming the founders owned 100% of the company before the investment, for simplicity):

So you can see that 25% = 25% = 25% and the more the founders increase the value of the company, the more they have given up in terms of exit dollars.

Now let’s do the same example with Company Y, who has raised debt with the following terms:

• $10M of principal

• 6% effective interest rate

• 5 year term

If we further assume that Company Y achieves an exit in exactly 5 years (how convenient), the same payout matrix looks like this:

Note: the interest calc is 6% x $10M x 5 years = $3M

No matter at what valuation the exit occurs, the cost to the company is the same. Comparing the cost of equity vs debt at each exit value looks like this:

Note: the aforementioned finance professors would also want me to discuss the additional tax benefits of debt here, but since many exits occur before companies get to profitability, let’s leave it alone for now.

Great. Debt is cheaper. Why would anybody accept equity investment? Plenty has been written about the debt vs equity question, so I won’t rehash the whole discussion. A few of the better write-ups can be found here, here and here.

I can try to distill (oversimplify?) it though: when you need to make a big bet, and the future is uncertain but really compelling, accepting the funding and expertise of an investor makes a lot of sense. But if you have a tangible need (inventory, marketing collateral, manufacturing tooling, etc.) and your business is predictable enough to map out how you will be able to pay back a loan, then debt may be the way to go.

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