The Top 10 Important Finance Mistakes First Time Founders Make
In the old days, we didn’t have to worry about finance too much. Companies grew more slowly, there was nothing for a CFO to really do for years, and you could sort of outsource everything and just keep an eye on the bank statement.
Things have changed a lot. SaaS accounting and finance has gotten pretty complicated, and the impacts of getting it wrong have gone up substantially.
I’ll give you a couple of examples. Last year, I met with the founder of a start-up I really, really liked. The plan and numbers he had, both for last year and the coming year, were impressive and aggressive. But it was on the margin — the ACVs were low, and the CAC was high. And then — he sent me his financials. They didn’t make any sense. I simply couldn’t get them to even remotely tie to his presentation deck. Was it misunderstanding bookings vs. ARR vs. GAAP revenue, was that the issue? I couldn’t even figure that out. Anyhow, the gap, the delta was so large … I just had to pass. It was too big a flag for a company at the edge of where I like to invest.
I’ve also seen upside surprises, which sound good, but sometimes aren’t. I’ve worked with numerous start-ups that used outsourced accounting services with zero SaaS experience, and these firms didn’t even recognize automatic upsells, additional seats, etc. that weren’t captured in existing, crappy tracking systems. The delta was often huge — as much as 30-40%.
In the early days, I guess it doesn’t matter. Cash is king. But in SaaS, once you even get to about $2m ARR — it’s time to get your finances in order. You may blow a financing round, get your cash runway wrong, or at least, freak your investors out if you don’t.
With that, I asked my first controller at my first start-up, Anita Kutlesa, who has since gone on to be CFO at several SaaS and software companies, from Pipedrive to Coverity and more, to share her suggestions and learnings:
Anita Kutlesa is a senior financial executive with nearly two decades of expertise driving performance through cash management, process improvement and strategic planning in start-up, high growth and restructuring environments. She has worked with numerous start ups in Bay Area and Europe (Virgin Mobile USA Inc., NanoGram Devices Inc., Coverity Inc., Buongiorno USA Inc., Pipedrive Inc.) from Dotcom to SaaS era. She is currently serving as a VP of Finance at the SaaS start up Transifex, localization automation company.
You’re working on the next stellar SaaS success and your foremost focus is — and should be — the product. Quickly, though, your attention turns to initial traction, your first critical hires, and building out those early business functions. Your focus expands. With early revenue, you start thinking about churn and scalability of every aspect of the business, including product, infrastructure, customer support, sales and marketing.
However, during all this time, you’ve likely overlooked the business function that ultimately tells you — and the world — how well you are performing in all the areas where you’ve dedicated your full attention.
Accounting and Finance.
As a first-time founder, does any of the following sound familiar to you?
- Cash goes in and cash goes out. I know, roughly, how much money is in our account.
- I know I’ve got to pay all the bills and do payroll, but there are so many other pressing priorities right now.
- I’ve got my Excel sheet to help me explain to investors, advisers and friends how well revenue will increase.
- I’ve contracted accounting help. They will pay the bills, file tax returns and do the accounting.
If it were only that simple. Here are 10 mistakes made by other first-time founders that I want you to avoid. Equally important, is my advice on how to fast track your company’s proper finance and accounting support systems.
Mistake #1: Bookings are not revenue
I’ve advised many first time executives in the past 20 years. Always, my first questions is, “What’s your revenue?” More often than not, the response is, “Well, our bookings are ________”. My next question is then, “What do you define as booking?” I swear I’ve heard as many different definitions of “bookings” as there are flavors of ice cream.
Advice: Sooner or later, you will have to know both booking and revenue numbers, and the difference between them. Not doing so may cost you in a lower valuation, less investment, or even losing an interested buyer or investor. During your first or next round of financing, or during any type of financial decision involving a third party, some type of due diligence will be performed by accountants that will define revenue per Generally Accepted Accounting Practices (GAAP).
Mistake #2: Cash accounting and accrual accounting are equal
I’ve found that first-time CEOs haven’t had much experience (or time) understanding the gritty details of a full set of financial statements. With “bookings-based” executives I’ve learned there’s little value in creating a pretty financial slide deck summing up the month, when what’s more important is an education and shift from doing business in “cash-based” to “accrual-based” accounting terms.
Cash-based accounting is something we do in our everyday lives. I have $1,000 in my bank account at the end of January. I receive a paycheck for $1,500 in February and pay my only monthly bill for $500. At the end of February my cash balance is $2,000. In cash-based accounting you recognize your Net Income/Loss in a given month based on your cash in and cash out.
You are allowed to do this in business, too. But don’t.
I know a CEO who sold his company for many millions of dollars with his cash-based financial statements. During the acquisition’s due diligence, those cash-based books had to be converted to accrual-based figures. He probably lost several millions in his purchasing price because of it.
Advice: Beginning today, think of your business in terms of accrual-based accounting. Simply put, you recognize revenue or cost in the month it incurred. Let’s say you receive a contract from a customer that outlines they will pay you $100 for the monthly subscription with an invoice of terms Net 30. Accrual accounting means you send the invoice for $100 to your customer in January, but will not receive the money until February. You can still recognize $100 as January revenue because this is when you provided the service and when you earned that money. In a nut shell, you are recording your revenue/cost based on when you earned it/incurred the cost, rather than based on when the cash exchange took place.
Mistake #3: Recognizing revenue improperly
Revenue recognition has always been complicated, and is even more so these days. Additionally, specific to SaaS companies, the problem is that with increasing transaction volume, the gap between correct/conservative revenue recognition and some “improvised” approach becomes more material.
You might at some point be asked to re-state your revenue. There is nothing worse than telling your board and investors you need to adjust your revenue recognized or revenue forecast.
Advice: With an Excel sheet model, start tracking your recognized/deferred revenue balances. If this model doesn’t get set up early enough, your clean-up effort later will be much harder and more costly. Once you reach certain revenue volumes, you should invest in a tool or full time help (see Mistake # 4) that can manage correct and error-free revenue recognition with increasing sales volumes. Down the road you will need a tool that might offer some automation in revenue recognition.
Mistake #4: DIY Accounting
With initial revenue traction under your belt, you’re now diligently watching every dollar you spend and those spending priorities are ticking up quickly. You need to get to that next revenue level and KPIs that will help you with your next round of funding, which confirms my next statement: Instead of trying to pay your bills, process payroll and recognize revenue (correctly), make sure you get help from an accountant.
Find accounting firms that outsource different roles. They will help you identify how many hours of support you may need to, for example, set up your first accounting system properly, reconcile monthly bank statements, and set up a much needed revenue recognition process.
Advice: Don’t fool yourself into believing that writing a check or paying via your online banking service is all it takes to “do accounting.” The longer you wait to get that formal accounting support, the bigger the clean-up effort and larger the bill will likely be.
Mistake #5: Controller = CFO
When you finally admit you need to bring in more senior finance support to help with financial reporting to the board and investors, set up some scalable processes, planning/budgeting exercise, and prepare for future investment rounds, you will most likely stumble upon two different titles — Controller and CFO. Here’s the difference between the two: A controller will take care of everyday accounting business, close the books and report numbers, but the responsibilities end there. A CFO, on the other hand, starts working with numbers after the actual results are reported and, additionally, takes into great consideration future indicators, budget, planning and strategy variables.
This is not to say that both roles in early-stage start-ups should not be flexible and not assist with all areas to some extent. CFOs should be able to manage the month-end close and some controllers can assist with planning.
Advice: A controller can’t do it all, especially as you grow. If you hire well, you should be able to see the strategic value of your CFO within a matter of months. You should look to hire a CFO with start-up experience, someone who will help you identify business needs that you might not be even thinking about it.
Mistake #6: Putting off that CFO hire when you’re comfortable with your current “Rent-a-CFO”
While convenient, the hourly rate of your current “Rent-a-CFO” means you can’t afford that role full-time. Given that, the contractor is only asked to prepare for board/investors meetings and help with budget planning. Removed from everyday business, she can only speak to the larger picture, which is important, but that’s often not enough with the fundamental processes of billings, collections, cash flow management, revenue reporting, corporate compliance and more.
With a rental engagement, the burden falls on you. As you grow, you might miss some important steps to set scalable accounting practices that will help you along the way.
Advice: Don’t be afraid to bring in a “right-stage” CFO earlier in process than you might think warranted. It will be worth it down the road when you are facing due diligence or find that you need to stretch cash for a few more months.
Mistake #7: Not creating a detailed and complete budget
I am certain most of you first-time founders have an Excel sheet set up to track your revenue projections. And you probably have some kind of tool tracking churn, upgrades, and new revenue numbers. That’s great, but that is not a budget.
An actual budget helps you track performance and, subsequently, plan for future needs. I know of first-time founders who get money in, but they don’t know how to strategically invest in the business areas that need the most nurturing. On the flip side, I’ve certainly seen founders who need money desperately, but can’t adequately justify their ask to investors.
Advice: Make a concerted effort to define a detailed 12 to 24-month budget. It will help you answer three very critical questions: (1) “How much money do you need to get you to $X revenue?” (2) “What will you do with that money?” and (3) “What is the return on that investment?”
Mistake #8: Not reading your financials regularly
Taking my advice on numbers 6 and 7, you’ve already hired yourself appropriate accounting help and they are currently closing your books, which means they are issuing a financial package to your board, investors, the bank and, firstly, to you.
Take time to understand its details. You don’t have to do CPA-speak, but at least absorb the Income Statement and its correlation to Cash Flow Statement, your Balance Sheet, deferred revenue, and your liabilities to be paid.
Advice: You are not doing yourself a favor if you look solely at that revenue number. Have your accountant walk you through the specifics. If they get too technical, ask them to explain it again in non-accountant speak. Simply looking at you, I can tell whether I am clear enough in my explanation, or if I am losing you with terminology. Unfortunately, more often than not, once I lose you, you don’t ask questions. Rather, you opt out, saying, “That is why I have you to understand all of this.”
Mistake #9: Don’t forget about compliance
Compliance can be complicated. Here is just one simple example. You’ve likely outsourced corporate compliance using a law firm’s “start-up package” that’s helped you incorporate, create board resolutions and confirm equity documents. In most cases, you’re incorporated in the State of Delaware and qualified to do business in the state where you are located physically. You think you’re all set.
With every company I’ve worked, I proactively check whether it’s in good standing in Delaware and if the annual franchise taxes are paid to date. I’ve had more than a few crazy tax balance surprises (say a $70,000 past due bill)!
Advice: Your compliance responsibility doesn’t end after you incorporate. The same is true for taxes, US GAAP, contracts, HR….Don’t panic. Get in place the right type of resource — someone who knows which compliance is a one-time action and which have to be maintained on an ongoing basis, which, by the way, change with the size of the company and can’t be avoided without future penalties.
Mistake #10: Data Consistency Inconsistencies
I go nuts, as I’m sure you do, when found in a situation where an investor or board director says, “Why is your sales revenue different than revenue reported on your financial statements?” Or, “Why is your sales churn figure different than your marketing churn?” While not necessarily an accounting-specific mistake, it is a business management offense.
Advice: Agree on what business unit is responsible for what KPI and that the CFO defines revenue for the company. Then, make sure all departments use the same data sources for KPI reporting. This will require cross-functional collaboration and ongoing communication. A benefit is that it will reduce time each team independently spends tracking the “same” number.
By avoiding these top 10 first-time founder mistakes, you can have an easy(ier) state of mind when it comes to the accounting health of your company. Hire what’s needed sooner rather than later, but don’t remove yourself from understanding the finance responsibilities. Ask questions (again and again) until you understand, in your own way, what it all means.