In this Mucker Growth Session, Debbie Rosler from Burkland dives into the fundamental financial best practices and infrastructure early -stage startups need to put in place.
Finance 101: Why Should You Care?
It's important for early stage startups to focus on finance from the very beginning. At the very earliest stages, startups are focused on extending their runway as long as possible. They may have a little bit of funding, a limited amount of cash, and they are very focused on stretching that as far as they can. Often that means trying to do things in the least expensive way possible and that means doing finance accounting on their own. But more often than not, founders don't have that expertise or background in finance AND they are focused on starting a business, developing products, getting out and selling, etc. They are not wholly focused on the financials. They end up making a lot of mistakes and what ends up happening is that the cost of going back and cleaning up those financial mistakes is significantly more expensive than getting finance and accounting right from the very beginning.
Finance & Accounting Lifecycle and Support
It's critical to have structured financial and accounting support right from the start for startups, especially during the pre-seed and seed stages.
Early Financial Support
Startups should engage financial and accounting services as soon as they begin transactions, even before receiving funding. This includes setting up initial accounting practices and systems, HR, payroll, banking, financial controls, and tax compliance.
Evolving Needs Across Stages
As startups grow and progress towards Series A and beyond, the need for more sophisticated financial strategies becomes evident. Startups should begin to develop long-range financial models, understand their unit economics, and prepare for more complex financial planning and analysis.
Roles and Responsibilities
Startups' financial staffing needs will change as the startup grows.
- Bookkeepers handle day-to-day accounting tasks. Having a PT bookkeeper is often how startups begin.
- Controllers (often CPAs) manage more complex financial operations and ensure adherence to Generally Accepted Accounting Principles (GAAP).
- CFOs oversee the broader financial strategy, including financial modeling and support for fundraising and strategic finance.
Strategic Hiring
Startups should consider outsourcing initially to save costs and only transition to in-house when the volume of work justifies a full-time position.
Accrual vs. Cash Accounting
Setting up accrual accounting from the start, especially for venture-backed companies, is the best practice to accurately reflect financial status and meet investor expectations.
Proactive financial management and adequate preparation for each growth phase, ensuring startups are equipped with the right tools and expertise to handle evolving financial complexities efficiently, is absolutely critical.
Financial Systems
When setting up initial finance systems, it's important to think about scalability.
Initial Accounting Software
QuickBooks Online is the most popular and cost-effective option for startups, used by approximately 85-90% of Burkland's clients. It's easy to integrate with external apps and services.
However, QuickBooks Online has limitations, such as its inability to consolidate accounts for multiple subsidiaries (especially international ones), and it lacks robust tools for inventory and cost management in manufacturing.
Advanced Systems for Growth
For more complex needs, NetSuite is recommended as a next-level system, suitable for startups ready to transition from QuickBooks due to its more extensive features, though it comes at a higher cost. Puzzle is another option that is leveraging AI and automation.
Sage Intacct is mentioned as another advanced system, slightly less expensive than NetSuite, offering similar capabilities.
Integration and Automation
Debbie recommends startups leverage automation as much as possible, especially those using less robust systems like QuickBooks Online. Startups are encouraged to integrate add-on apps for enhanced functionality in accounts payable and expense management.
Airbase, Ramp, and Bill.com are highlighted for their effective integration with QuickBooks, providing good control systems and workflow approvals, essential for financial oversight.
Cap Table Management
Carta and Pulley are recommended for cap table management, helping to streamline legal costs associated with cap table management, and providing essential tools like 409A valuations as part of their service package, thereby simplifying compliance with federal tax regulations.
Overall, it's important to choose the right financial system based on the specific needs and growth stage of the startup, with a focus on scalability, integration, and compliance support.
HR and Payroll Partners
Various payroll and HR service providers are recommended, depending on the needs of startups at different stages and with varying employee profiles.
Provider Recommendations
Gusto: Noted for being the most cost-effective option, ideal for startups with straightforward needs and localized teams.
Rippling, Justworks, Sequoia, Insperity: These offer more robust services at higher costs, suitable for startups with more complex needs or those expecting rapid growth.
Considerations for Choosing a Provider
The choice of provider should be based on factors like company growth potential, the geographical distribution of employees, and the complexity of payroll management needs. Providers like Gusto and Rippling are popular, with Rippling also noted for its comprehensive services that support companies with international workforces.
International Employee Management
For companies hiring internationally, providers like Deel and Rippling offer 'Employee of Record' services across multiple countries, simplifying the compliance and payroll processes without needing to establish local entities.
These services are crucial for managing international contractors and employees, ensuring compliance with local labor laws and tax requirements.
Advanced Features and Future Developments
- Some payroll providers also offer advanced features like applicant tracking systems, which are beneficial for companies undergoing rapid expansion.
- The landscape of payroll services is evolving, with more providers expected to offer international capabilities soon.
Overall, the choice of HR and payroll services should align with a startup’s current needs and anticipated growth, ensuring compliance and efficiency in managing a diverse workforce.
Banking Partners
There has been a recent shift in banking strategies for startups, influenced significantly by the Silicon Valley Bank (SVB) crisis.
Historical Practices
Traditionally, startups were advised to bank with startup-focused banks known for providing tailored services and attention. Following the SVB crisis, however, the risks of banking solely with startup-centric banks like SVB were revealed. Many startups found their funds inaccessible, jeopardizing operations such as payroll, during the crisis.
New Recommendation
The recommendation has evolved to suggest that startups maintain banking relationships with two different banks—one startup-focused and one major bank. This approach aims to provide both specialized services from a startup-focused institution and the stability of a larger institution. Having accounts at two different banks allows startups to manage risks more effectively, ensuring that they have alternatives and can access funds if one bank faces issues.
Overall, the revised banking strategy for startups emphasizes the need for diversification and preparedness to safeguard against future banking disruptions and ensure continuous access to necessary financial resources.
Treasury Management
Cash management is a critical aspect for startups, especially in light of the SVB debacle. Startups should pay attention to balancing the following:
Capital Preservation
Ensuring that the primary focus remains on preserving the capital raised from investors, which is intended to drive business growth.
Accessibility and Liquidity
Making sure that funds are readily accessible when needed, to avoid operational disruptions like those experienced during the SVB crisis, where startups were unable to access their funds, leading to potential missed payrolls and other penalties.
Utilizing Interest Rates
While taking advantage of favorable interest rates can be beneficial, such as using earned interest to fund operational costs like salaries, the priority should still be on low-risk investment to ensure safety and accessibility of funds.
Risk Management with FDIC Insurance
Startups should consider he strategy of using insured cash sweep accounts, which distribute a company’s cash across multiple banks to benefit from FDIC insurance limits at each institution, thereby enhancing the security of the funds.
Low-Risk Investment Instruments
Startups may also consider the use of low-risk financial instruments like Treasuries, which, while not technically insured, are backed by the U.S. government, providing a relatively safe investment option.
Financial Controls
Having sound financial controls from the beginning is critical. Startups need rigorous checks within the company's financial operations to safeguard against errors and fraud. Key measures include:
Segregation of Duties
Ensuring that at least two people review every transaction (one to log the invoice or bill and another to approve payment) to mitigate the risk of fraudulent activities.
Approval Processes
Implementing system-based tools to facilitate the segregation of duties, ensuring appropriate levels of oversight and approvals are maintained.
Bank and System Integrations
Utilizing financial systems and banks that support these control processes, such as accounts payable management systems that incorporate built-in approval workflows.
Regular Review of Financial Statements
Monthly closing and review of books to monitor financial performance and identify any discrepancies or unusual trends in expenses.
These controls are essential for maintaining financial integrity and transparency, crucial for both management and compliance purposes.
Financial Reporting
Effective financial reporting for startups involves routinely closing books monthly and reviewing them to maintain control and gain insight into financial health. This practice is crucial from the beginning, not only for internal management but also to meet investor expectations. Establishing a standard chart of accounts is recommended to properly classify expenses and understand spending on different business areas like sales, marketing, and research and development.
Regular financial reporting packages, including income statements and balance sheets, should be shared with the board and investors, ideally reflecting the startup's financial strategy and performance against projections. This approach facilitates seamless communication of financial health and key performance indicators (KPIs) such as annual recurring revenue (ARR) and churn, making it easier to respond to investor inquiries efficiently.
Corporate Tax
Non-compliance with corporate taxes can come with a very high penalty. It's particularly important to have timely and accurate tax filings, even if a startup is not yet profitable. Startups need to handle payroll taxes correctly, take advantage of potential R&D payroll tax credits which can offer refunds, and make sure sales tax is compliant to avoid severe penalties. Given the intricacy of these components, Debbie recommends having a tax professional to navigate these complexities, especially for startups with foreign activities or investments, where reporting requirements are stringent and penalties for non-compliance can be significant.
Due Diligence Prep
- Hire experienced financial personnel from the start
- Utilize cost-effective and easy-to-use financial systems and payroll
- Automate processes
- Maintain dual bank accounts
- Implement rigorous financial controls
- Ensure tax compliance to prevent future complications.
Thanks to Debbie Rosler for sharing this information.
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