Your company’s finances are the most quantified part of your business, so when it comes to due diligence as part of a potential sale, it’s almost always going to be a primary focus for the buyer. However, even without an impending sale, finance should be an aspect of your business that receives an appropriate amount of care and attention.
Starting a company with a finance system that is built to sell is less intimidating than it sounds. The first step is to make sure you have a system in place to capture all of the financial information. This includes not only expenses and revenue, but other items like contributions (cash or property) and loans. It’s much easier to establish a good system from the start, rather than going back at a later time and trying to account for information that was missed or incorrectly handled. A good accounting system ensures that you won’t waste time down the road trying to piece together historical information. Imagine the discount rate that a potential acquirer would apply to your company if the only records you had were scribbled on the back of an envelope. Even tracking expenses in Excel may not convince the buyer that your company is worth top-dollar. There are many accounting systems available for consumers, including Quickbooks (Online or Desktop), Xero, Freshbooks, and Sage.
Managing the Books
While there is a learning curve if you will be handling the bookkeeping on your own, it’s worth the time and effort that it takes early on to ensure that you have high-quality accounting records down the road. Even if you’re not the one handling the books, understanding how your accounts are kept is an important part of managing and reporting on your financial health.
If you’d prefer not to perform bookkeeping on your own, another option is to hire an external resource (see the Built to Sell: HR post for different factors to consider when staffing for this type of role). You’ll want to find a resource who will likely work for your company for the long-run, as any disruption to the bookkeeping can cause serious headaches and even cash flow issues. Ideally, you want to have a resource within your company that can understand what the external resource is doing so that they can cover any gap or transfer knowledge if the external resource leaves prior to transitioning the role.
It’s hard to justify the time and expense of an audit if there’s no requirement for it. If your company is self-funded, you may decide not to engage a CPA firm to perform audits. This is a perfectly acceptable and reasonable business decision, but it could impact you if you do decide to sell the company. Many potential buyers will request audited financials, but if you don’t have a history of these your best alternative is to be able to provide them with clear and accurate internal records (hence the importance of good bookkeeping discussed above).
If there is the possibility of a sale or capital raise in the future, it may be beneficial to begin having a CPA perform audits so that you have a history of audited financials. Again, this is often not a dealbreaker, but it’s certainly helpful in the diligence process.
Finance and Accounting Policies
We recommend developing and implementing accounting and finance policies early on in your company’s lifecycle. As the company grows, it’s easier to train new resources to follow existing policies than it is to change the systems/rules that existing personnel are used to. We discuss some policies below that are beneficial from an operational standpoint as well as a built to sell standpoint.
Expense Tracking and Reimbursement
Policies related to expense tracking and substantiation is important both internally and externally. From an internal perspective, setting standards for expense reporting and reimbursement allows a degree of control over when and how cash is spent. A policy that requires timely submission of receipts (it varies by company, but this is often a 30-60 day window between the date the expense is incurred and when it must be submitted for reimbursement) ensures that billable customer expenses can be passed through when invoices are sent. Policies that limit the type of expenses that are reimbursable and set limits are important to ensure that your company isn’t caught footing the bill for a resource’s lavish dinner or client “entertainment.”
In this same vein, external parties such as the IRS or debt holders may require companies to follow certain guidelines. The IRS has very specific recordkeeping requirements for certain types of expenses (meals and entertainment expenses are frequently scrutinized), so it’s important to ensure that company policies address these requirements.
Policies that establish accountability for expenses ensures that you won’t be subject to substantial unexpected cash outflows. There are numerous SaaS services that provide expense tracking and reimbursement systems with built-in controls that can be adjusted to meet your company’s guidelines (Expensify, Zoho Expense, Concur, Quickbooks).
Internal controls are the steps/policies/procedures that a company takes to ensure that its financial assets and records are complete and correct. It can be very difficult to implement certain controls when you’re running a company with lean staffing; separation or segregation of duties can be difficult or impossible when there are only 2 or 3 people who can appropriately perform the required duties.
Even if you can’t implement every type of internal control, you can develop policies and procedures that help bolster the accuracy and security of your finances. Whenever possible, use existing or configurable security measures for your software. In your bookkeeping software, for example, you may want to limit certain users’ access to “view only.” You may be able to tailor your banking to require approval for transfers or payments over a certain amount.
Generally Accepted Accounting Principles
Although generally accepted accounting principles (GAAP) are outlined by the Financial Accounting Standards Board (FASB) in the US, it can be beneficial to include documentation of your company’s treatment of certain financial metrics in your policies and procedures. This serves a dual purpose: first, it establishes clear criteria by which your personnel and external resources can consistently handle financial information, and second, it provides written documentation to support your financials.
One particular area in which this can be useful is revenue recognition. While GAAP dictates what steps are to be followed in determining when and how much revenue is recognized, the actual manner in which this occurs can vary widely by industry and even by company. Developing clear guidelines that allow all financial information users to arrive at the same determination will save time and provide important audit support.
We previously mentioned the importance of including recordkeeping policies for reimbursable expenses, but there are a limited number of other tax matters that you may want to address and incorporate into your financial policies and procedures. We won’t delve into the details in this post, but de minimis expensing for tangible property is one area where you will want written documentation. In this instance, you may be required to have written accounting policies regarding expensing (versus capitalization) of tangible property in order to tax the advantageous tax position.
Managing cash flows and expenses is an integral part of any successful business, and can be especially challenging for new companies that may have high start-up costs with little accompanying revenue for months or even years.
It’s even more important to understand and manage your burn rate when you are looking to sell your company/take on debt/raise capital. If your burn rate is high and you’re in desperate need of cash, this can be a leverage point for an acquirer. You should be prepared to justify your numbers, so decide early on how conservative or aggressive you want to be. Keep in mind that if you’re overly conservative (i.e., you estimate your burn rate higher than it actually is), you may end up with a worse deal. Conversely, if you’re overly aggressive (i.e., you estimate the burn rate lower than it actually is), you may upset the buyer, potentially opening yourself up to legal issues regarding misrepresentation.
Depending on how your company is structured and who has control over determining where money is spent, you may need to consult with other members of your company regarding future expenditures. You should consider whether there are any significant required or planned expenditures in the near future, as these could impact a potential sale, or at a minimum, the discussions surrounding a sale.
Be prepared to justify any anomalies in your financials. You know your business better than anyone, so it’s beneficial for you to provide a clear explanation up-front for something that appears “off” rather than leaving the buyer or a third party to guess at the reason behind the anomaly.
Just as we suggested with respect to burn rates, determining how aggressive or conservative you want to be with projections is important when you are looking to sell your business. Keep in mind that as part of a deal you are making certain representations, so if you are overly aggressive, you may open yourself up to issues with the buyer if the actual outcome is significantly less positive.
There are many actions that business owners take as part of the ordinary course of business that are necessary, but may be detrimental when it comes to valuation by a potential buyer. Keep in mind that some of these behaviors may be used against you in negotiation. For example, if you are factoring invoices, the buyer might argue that the collection time on invoices is too long, and they will discount your receivables as part of the valuation. Examine your company’s operating procedures to look for areas that may be detrimental to your valuation and try to brainstorm alternatives. In the invoice example, maybe you simply need to ensure that someone at your company follows up on overdue invoices, or perhaps a line of credit would better suit your needs.
If you’re taking funding from venture capital, keep in mind that you are often giving up freedom in exchange for cash. Even if you still own a portion of your company, you may no longer have the ability to determine where you want to focus the company’s resources and efforts. While venture capital has a great deal of benefits, including a wealth of knowledge and connections, it’s important to remain realistic about what a post-funding world will look like for you and your company.
As with the other areas that we’ve discussed in the “Built to Sell” series, planning is the number one tool in your toolkit. From developing policies early on in your company’s lifecycle to considering the impact of funding sources, being aware of the implications and importance of these matters will help ensure that you are building a company that is financially sound.
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