Series A GAAP Transition Plan

Is your startup getting ready for Series A funding? If so, then it’s time to get serious about GAAP compliance — and a big part of this is shifting from cash-basis to accrual-basis accounting. While this is a big step, it’s a process that can pay off in the long run and avoid last-minute chaos. Learn more by watching this webinar or read on for a comprehensive guide on how to plan for this shift.

Why GAAP Compliance Is Essential for Series A

GAAP, or Generally Accepted Accounting Principles, is a set of rules and procedures that help ensure any financial reporting is accurate, consistent and transparent. GAAP compliance is typically required in Series A funding. Noting this, startups should start preparing for this transition in advance of Series A. Aside from ensuring compliance, there are other important reasons for this. For instance:

• Demonstrating a deep understanding of your startup’s finances can instill more confidence in potential investors.
• Transparency builds trust and can lead to more favorable valuations.
• Any Series A term sheets are likely to undergo an audit within a few years after the funding round.

Investor Trust and Transparency

Transparency helps build trust, which thereby helps enhance your startup’s credibility in the eyes of investors. Keep in mind that investors tend to have more financial expertise and experience than startup founders, underscoring the importance of math and financial statements all needing to add up.

Additionally, GAAP compliance and high-level accounting help assure investors that they’re backing a business with robust processes. GAAP can also help signal credibility in the eyes of an investor.

Due Diligence Efficiency

Any potential investor is going to be doing their homework on your startup before they commit to it. GAAP compliance can help streamline any due diligence auditors and investors perform, allowing them to more quickly validate numbers and slash negotiation time. Having well-organized historical data also enables investors to analyze trends and assess financial stability over time. GAAP compliance also minimizes the risk of the discovery of any financial “red flags” during the process.

Understanding Cash-Basis vs. Accrual vs. GAAP

Moving from cash-basis accounting to accrual-basis is a big step when transitioning to GAAP compliance, and maintaining good accrual-basis accounting books can help make the overall process much smoother. Think of accrual-basis accounting as an ideal stepping stone toward full GAAP compliance. Understanding key accounting differences between these methods is essential for ensuring a smooth transition and avoiding financial misstatements.

Cash-Basis Defined

Cash-basis accounting is a method that records revenue only when cash is received and expenses are paid. Though simple to use and easy to understand, it does not comply with GAAP. For this reason, cash-basis accounting is typically suitable for startups in their very early stages.

Accrual Accounting Fundamentals

Accrual-basis accounting recognizes revenue when earned and when expenses are incurred — not when money formally changes hands. Key benefits of accrual accounting include providing a real-time view of your startup’s financial status and helping project financial reports for future periods, two factors that can help with investor transparency during Series A funding. Accrual accounting also follows GAAP standards.

Core GAAP Principles

GAAP has additional layers beyond basic accrual accounting. For instance, it covers standards for stock-based compensation, multi-year contracts and lease obligations. GAAP compliance also requires consistent policies and record-keeping for external audits. While GAAP is the standard for U.S.-based startups, companies looking to expand globally may also need to consider International Financial Reporting Standards (IFRS), which align with GAAP in some areas but have key differences in revenue recognition and lease accounting.

Roadmap to GAAP Compliance

If your startup is preparing for Series A funding and in the process of moving from basic accounting methods to GAAP standards, there’s a process it should follow to avoid gaps and achieve the best results.

Phase 1 – Assess Current State

The road to GAAP compliance all starts with assessing your current processes, systems and skill sets. For instance:

• Are you implementing any accrual-basis accounting practices or is your startup still using basic accounting methods?
• If your startup needs to do a full-blown transition, do you have the experience and expertise to carry that out?
• Should you consider hiring a professional to help manage any transition?

Phase 2 – Implement Accrual-Based Practices

Since accrual-basis practices follow GAAP standards, the transition from basic accounting methods to accrual accounting standards must take place before Series A funding. This is best done systematically. For example, transition to monthly close processes for more consistent updates and be sure to train your staff accordingly. Some of what you’ll want to emphasize with your staff include education on deferred revenue, prepaid expenses, insurance contracts, and appropriate cost allocations.

Phase 3 – Strengthen Internal Controls and Documentation

Your startup should expect to be audited within a few years after your Series A funding run. The best way to prepare for future audits is to strengthen your internal controls and documentation so that it’s more robust. Do this by establishing approval workflows, notably when it comes to expenses and contract sign-offs. Consider also recording policies around billing, revenue recognition, accounting policy, and inventory management.

Phase 4 – Prepare for an Audit

The fourth and final phase of your roadmap to GAAP compliance is being prepared if you’re audited. To do this, organization is key. Consider organizing your financial records in a centralized, accessible system. It can even be beneficial to host a mock audit or conduct a thorough internal review so you can proactively identify any gaps before the real thing happens. In certain cases, some startups may need to consider full retrospective adoption, which involves adjusting prior financial statements to reflect GAAP standards consistently over time. This process ensures comparability and compliance for investors and auditors.

Overcoming Common Challenges

The road to GAAP compliance isn’t without some challenges. Whether it’s budget challenges, technical issues or difficulties navigating the cultural shift in financial reporting, achieving GAAP compliance for your Series A funding run isn’t always easy. The good news is that if you’re able to identify these common challenges, you can take the necessary steps to resolve them.

For instance, working with a fractional CFO can ensure your startup has strategic oversight over its finances, while saving money on what it would cost to hire a full-time, in-house professional. Implementing cloud-based solutions can help streamline accrual processes and help with employee buy-in. Here’s a closer look at how to resolve some of these common challenges:

Budget Constraints

Most startups have limited financial resources — chances are your startup isn’t much different. Outsourcing certain financial matters can help your startup save money versus hiring someone in-house. For instance, Graphite’s fractional CFO packages start at just $1,250 per month, a fraction of the cost of hiring a full-time professional. Consider hiring a fractional CFO when your startup becomes more complex.

Another cost-saving strategy is performing gradual, or phased, rollouts to cut down on upfront expenses.

Finally, cash-strapped startups can help promote their business through strong financial storytelling.

Technical Complexities

How can you simplify things for employees who are new to more advanced accounting principles? Conducting thorough training or onboarding can help reduce manual errors. Working with a financial expert can also help, especially when it comes to complex matters like revenue recognition, deferred tax assets, or lease accounting.

Financial tools like Brex can help with expense and spend management. QuickBooks and Puzzle can help handle ERP needs, and payroll solutions like Gusto and ADP can help manage employee payments, including benefit payments, ensuring compliance with compensation regulations.

Elevate Your Startup, One GAAP Step at a Time

Early GAAP compliance can help position your startup for Series A funding success while avoiding any last-minute stress and causing investors to pause. A strong financial foundation also helps set the stage for future funding rounds.

Get Expert Backing for Your GAAP Transition

For more information on how to transition toward GAAP compliance at your startup, contact Graphite today. The Graphite team consists of experienced and expert accountants and financial professionals who can help guide your startup through the process. Contact us today to schedule a consultation to learn more about our fractional CFO and specialized accounting services.

FAQs

What specific GAAP standards are most relevant to early-stage tech startups?

Accrual accounting, stock compensation and startup costs tend to be the standards that are most relevant to early-stage tech startups.

How can I tell if my company is really ready for an audit?

Consider organizing your financial records in a centralized system where everything is easily accessible. You might even consider hosting a mock audit or conducting a thorough internal review so you can proactively identify any gaps.

Do I need a full-time CFO to manage GAAP compliance?

While a full-time CFO can certainly help, most startups aren’t in a position to hire a full-time, in-house professional. That’s where there’s value in working with a financial partner or a fractional CFO.

Which software solutions best support an accrual-based approach?

Brex can help with expense and spend management. QuickBooks and Puzzle can help handle ERP needs, and payroll solutions like Gusto and ADP can help manage employee payments.

How does GAAP compliance impact my company’s valuation?

GAAP compliance helps ensure the accuracy and transparency of financial information. This helps investors more confidently gauge the startup’s true financial health, which can help them perceive your startup at a higher overall value.

What’s the typical timeline for transitioning from cash-basis to GAAP?

While the timeline tends to largely depend on the complexity of your startup, the transition time may take several months.