Revenue Recognition Strategies for Complex Business Models

Is your startup’s SaaS business model a bit more complex than a standard SaaS subscription? If so, then you must have the appropriate strategies in place to capture revenue accurately. Proper revenue recognition is a key component of accrual accounting principles. It needs to be accurate to ensure your startup’s credibility and also put it in the best possible position with investors and fundraising success.

Yet, a complicated SaaS business model can lead to issues with revenue recognition, which can inhibit this. Many of today’s startups use hybrid models that challenge traditional accounting approaches. For some, it’s the right approach. For other startups, however, a different approach is necessary.

As a professional accounting firm specializing in supporting startups, Graphite Financial experts can help you with the right revenue recognition strategy for your startup so it can continue to grow and prosper while staying compliant.

Understanding Complex Business Models in Today’s Startup Landscape

From hybrid SaaS to multi-sided marketplaces to bundled offerings, these are all examples of more complex business models that differ from the standard SaaS approach. What’s more, they’re becoming increasingly popular, especially for startups. Some of the key benefits of these business models include flexibility, the ability to optimize revenue, better data and insights, and higher average order values. This can all lead to greater profits and enhanced competitive advantages. While these complex business models have their benefits, their complexities also mean more sophisticated SaaS accounting revenue recognition practices are typically required.

Here’s a brief overview of each of these complex SaaS business models:

• Hybrid: This model allows startups to blend the best features of different models. For instance, subscription-based pricing may be combined with usage-based pricing.
• Multi-sided marketplace: This model connects various groups of users, building value through interactions and transactions.
• Bundled offerings: A bundled business model allows consumers to combine multiple products into a single package, often at a discounted price.

While these complex business models have their benefits, their complexities also mean more sophisticated SaaS accounting practices are typically required.

Multi-Revenue Stream Architectures

Multi-revenue stream architectures come with various complexities, notably regarding revenue recognition. Various revenue streams may have different revenue recognition requirements, which can complicate accurate financial reporting. It can also be more difficult to allocate resources across revenue streams without sapping resources and increasing overhead.

When multiple revenue streams are involved, it’s important to implement a more robust accounting system to help handle them, while also being able to review financial reports and analyze the performance of each stream. Effective revenue reporting is essential to provide clear insights and support strategic decision-making.

Marketplace and Platform Models

One of the key challenges involved in marketplace and platform models is principal vs. agent determination. It’s crucial to determine whether the platform acts as the principal, thereby recognizing gross revenue, or the agent, which recognizes net revenue. The diversity of revenue streams is also a challenge, especially as platforms include the likes of commissions, listing fees, subscriptions, advertising and more. If your startup operates internationally, this may only further complicate revenue recognition based on different accounting standards and regulations, including international financial reporting standards.

ASC 606 Application for Complex Models

The ASC 606 is a five-step framework for SaaS revenue recognition based on recognizing revenue when control of a good or service is transferred to the customer. The five steps are:

1. Identify contact with the customer
2. Identify performance obligations
3. Determine the transaction price
4. Allocate the transaction price
5. Recognize the revenue when the performance obligation is satisfied

Performance obligations that extend over time may result in deferred revenue, where payment is received but revenue is recognized only as the service is delivered or the obligation fulfilled.

Performance Obligation Identification in Bundled Services

One key question in a bundled service business model is whether the bundled services are distinct. That is, can a customer benefit from the good or service on their own with readily available resources? They are separate performance obligations if they are distinct and provide value independently.

Variable Consideration and Contingent Revenue

Variable pricing components are also rising in today’s more complex business models, requiring more robust accounting to ensure accurate revenue recognition. Variable considerations refer to elements in a contract that impact the price, such as discounts, rebates, credits or usage-based fees.

For instance, the timing of revenue-sharing agreements common in SaaS startups can be complex. In SaaS, revenue is typically recognized over the subscription term, though upfront fees can be recognized immediately if they’re related to any type of separate obligation. If not, they’re recognized in time.

Success fees, bonuses, penalties and other discounts are more examples of variable considerations. While revenue for a fixed fee service is typically recognized upon completion, revenue related to a success fee is more contingent on a specific outcome. Therefore, it’s recognized when the contingency is resolved and any criteria are met.

Industry-Specific Revenue Recognition Strategies

Startups in fintech, HealthTech and eComm are more likely to have complicated revenue models based on the business’s nature. When you combine these complex models with more advanced regulatory requirements, the impact on revenue recognition can be significant.

Fintech Revenue Recognition Complexities

From transaction fees and interest income to subscription combinations, startups in the fintech industry are challenged by several factors pertaining to their revenue recognition. There’s also the ever-changing regulatory landscape, underscoring the importance of startups to stay updated on all the latest to avoid costly penalties and the potential for significant reputational damage.

Fintech startups generate revenue through various models, including transaction fees, subscriptions and lending/credit. Payment processing facilitates transactions, while financial services involve lending, investments and insurance. Both are vital in fintech startups, but differ in how revenue is recognized.

HealthTech and Regulatory Considerations

Ever-evolving healthcare regulations significantly impact revenue recognition strategies, requiring a more meticulous approach and a more careful analysis of contracts and other variable factors. To avoid problems, healthtech startups need to adhere more strictly to accounting standards and compliance requirements.

One example is differentiating between compliance and service revenue. Compliance revenue relates to adhering to HIPAA and Medicare/Medicaid rules. In contrast, service revenue recognition focuses on accounting rules defined in the ASC 606 based on the delivery of services to patients or customers.

One path forward is to use the MSO/PC model, which helps separate clinical and administrative functions; however, this also presents some key revenue recognition challenges, notably when navigating market value, managing complex fee structures and in terms of compliance.

An additional challenge is reimbursement timing and recognition. Transparent policies, utilizing advanced accounting software and staying informed about regulatory changes can help your startup overcome such challenges.

Technology Solutions for Complex Revenue Recognition

Implementing the right tools and technologies can make managing complex revenue recognition much easier. From advanced software solutions to automated technologies and more, there’s a lot available to help your startup in this realm.

Automated Revenue Recognition Systems

Automation impacts almost every industry, and revenue recognition accounting programs are no exception. Selecting the right one for your startup involves evaluating your current process, identifying any pain points and then further defining your objectives. With an investment like this, startups should consider the total cost of ownership versus the long-term benefits and return on investment. While automation can benefit your startup, there’s also a significant amount of training, testing, dashboard customization and resource allocation that must be provided to support various revenue recognition methods.

Integration with Financial Reporting Systems

Understanding how complex revenue recognition integrates with broader financial reporting is also important. Consider programs that can utilize existing data in other programs and where you can customize your dashboard and reporting for your model. Remember that accurate, compliant revenue recognition is crucial to reliable and transparent financial reporting, which is important to keeping trust with investors and other stakeholders. From the month-end close process to robust financial reporting, integration with broader financial reporting is something your startup shouldn’t overlook.

Investor Relations and Complex Revenue Models

Having the internal infrastructure to track complex revenue models is one thing. However, communicating it to investors and other stakeholders is a whole different challenge. So, how can you present complex revenue recognition to investors? Here are some tips:

• Be clear and concise
• Keep it simple so it’s easy to understand
• Structure your information in an easily digestible manner
• Be sure to emphasize the impact revenue recognition has on other key financial metrics

While doing so, connect revenue recognition to your startup’s overall strategy. Explain why you’re using a complex model and its benefits for your startup’s revenue quality and quantity. Also highlight how this strategy affects your company’s financial performance, both in terms of stability and long-term growth potential.

Due Diligence Preparation for Complex Models

Investors perform thorough due diligence before deciding to invest. Complex models can make this more challenging, underscoring the need for startups to provide well-prepared data. This is best done by proactively preparing for questions or challenges investors may raise. To best prepare:

• Address the complexities of your models and why they’re important to your startup. Be transparent and upfront about your model. Don’t hide from it, present it and discuss its advantages.
• Accurately estimate variable considerations.
• Ensure your data is accurately collected and managed to support the entire revenue recognition process.

If you can achieve this, you’ll be able to convey the appropriate information to investors and likely avoid many questions.

Common Pitfalls and Risk Mitigation

Some of the most common errors in revenue recognition for complex business models include:

• Incorrectly identifying performance obligations
• Improper characterization of contract modifications
• Poor estimates of variable consideration
• Failure to distinguish between principal and agent
• Poor data management and systems solutions
• Poor internal controls

The best way to avoid these common pitfalls is to thoroughly understand accounting standards and generally accepted accounting principles, as well as to have the right systems in place to streamline and accurately recognize revenue.

Internal Controls for Complex Revenue Streams

Establishing a robust internal controls process specific to revenue recognition may involve a thorough review process for multi-stream recognition, approval workflows for contract modifications and implementing more robust monitoring systems for revenue recognition accuracy.

Audit Readiness and Documentation

How can you ensure that your startup is prepared for an audit? It starts with how well you document your complex models and ensure that your alignment process complies with accounting and revenue recognition standards. Some tips include:

• Keeping clear and organized contract records
• Documenting processes meticulously
• Implementing the right accounting systems that can process complex scenarios
• Documenting all revenue recognition decisions

Future-Proofing Your Revenue Recognition Strategy

Ideally, your startup grows and prospers over time, and while this is great for your bottom line, it can further complicate your financial models. Every time you adopt a new revenue stream, evaluate and refine your financial model to accommodate growth and scaling. You’ll also want to look at your existing processes and workflows and make adjustments where necessary. Make sure you’re continuously reviewing and refining the model to reflect changes.

Transform Your Complex Revenue Recognition with Expert Support

If your startup has complicated revenue recognition challenges, working with an expert financial services provider can help ensure you stay on track with revenue accuracy and compliance. Graphite is here to help. As a full-service accounting firm that specializes in working with startups, we have the experience and expertise to optimize your diverse business models. Don’t underestimate the importance of getting revenue recognition right from the start. Contact us today for more information or to schedule a consultation.

FAQs

How do I determine if my business model requires complex revenue recognition strategies?

Consider the nature of the contracts and performance obligations, industry practices and various indicators (i.e., multiple deliverables, contracts, variable considerations, etc.).

What are the most common mistakes startups make with multi-stream revenue recognition?

Common mistakes include incorrectly identifying performance obligations, improper characterization of contract modifications, poor estimates of variable consideration, failure to distinguish between principal and agent, poor data management and systems solutions, and poor internal controls.

How does ASC 606 apply to marketplace and platform business models?

This revenue recognition principle helps business models focus on when a startup fulfills its obligations of transferring a good or service.

What documentation is required for complex revenue recognition during investor due diligence?

Documents include financial statements and reports, contracts and agreements, internal control documentation, compliance documents, risk assessment information and more.

How do I choose the right revenue recognition software for a complex business model?

Start by assessing your current model and your startup’s needs. From there, take the time to explore different solutions and weigh the key features that can help your startup.

What are the audit implications of complex revenue recognition structures?

Due to the increased complexity of these models, there is often a higher risk. There is also a great potential for fraud and incorrect data. It’s important for auditors to be robust in their reviews.