Over the years at Laurentian, we’ve seen many emerging tech firms manage their finance function well, although we’ve also seen firms treat it as a lower-priority, compliance-type task. This second “strategy” can lead to serious problems down the road for a tech startup. Not taking enough time and effort to set up and manage a proper finance function can lead to many issues that you won’t want to deal with when you are busy growing the firm.
Six of the major issues we see repeatedly are the following:
- Not knowing where you stand financially: As you may have heard, you can’t manage what you can’t measure, so having solid accounting and operational data is necessary to knowing where you stand. You always want to be able to act proactively rather than have to react to business challenges. Without reliable books, It’s difficult to maintain a reliable dashboard of Key metrics to measure your performance. it’s also easy to lose track of spending in areas such as over-hiring, excessive spending on software development, and on marketing activities such as trade shows. All of these can lead to serious cash burn issues and investments that don’t pay off. This can lead to a cash crunch, which is our next problem.
- Cash crunches: In our experience, it is very easy for firms to overestimate sales and underestimate expenses. In fact, we’ve seen these many times. Overestimating cash inflows and underestimating outflows can quickly lead to cashflow problems much sooner than expected. Over the years, we’ve worked with companies that lacked sufficient cash to meet payroll at the end of the month, and it was a real challenge to address. One company had to call in favors from customers, delay payments to vendors, and even skip paying the management team for a short period of time order to have enough to pay employees. Making sure you have enough lead time to address cash flow issues is crucial. That’s why having a forecast and reporting system that compares actuals to plan is a standard management practice. This can help avoid a situation that no one wants to be in, but which does happen with a surprising amount of frequency.
- Eroding investor confidence: Sloppy accounting practices are a red flag to investors. These can raise questions about your ability to manage a growing business and can cause investors to question your numbers – and either of these concerns can lead to an inability to raise funds or result in a lower valuation of your firm. Moreover, it’s very humbling to have to ask your investors for unplanned short-term funding to keep the firm going for an additional few weeks or months.
- Increased Fraud Risk: Having a strong structure of internal controls will reduce the risk of financial improprieties. Unintended mishaps such as simple but expensive errors can occur with poor internal controls. But fraud also can be much more serious, such as if a sales rep was siphoning money from sales revenue or an employee or hacker was stealing from the company. Not only can these types of incidents cause serious harm to young firms, but they also suck up a tremendous amount of time to address. Unfortunately, many accounting firms have seen incidents like these.
- Missed Compliance/Tax Obligations: Missing filings deadlines for income tax returns, payroll tax filings, state sales and property tax returns, and event franchise tax filings will lead to significant financial penalties not to mention wasted management time and directors’ liability issues. Moreover, losing eligibility for credits such as R&D tax credits can result in missed free money. Yes, managing tax obligations is a standard compliance task, but we have seen many emerging tech firms struggle to stay on top of it.
- Exit Challenges: If you eventually want to sell, buyers, investment bankers and auditors will have visibility to all of these financial management shortcomings during due diligence. This will make an exit much more difficult. Deals can be delayed or forced discounts will take place because of this increased financial risk.
Ultimately, weak or sloppy accounting can lead to loss of trust, legal exposure, and even company failure. Additionally, being unprepared for opportunities such as funding or M&A events can be costly. You must be ready when the market is ready, and not when you are ready.