Do you want long term success for your technology startup? There’s a lot to consider. Working through your accounting responsibilities can be a daunting addition to an already stressful time. Today, Shareholders Trina Painter and Taylor Neese are sharing important concepts you should pay attention to from their work with technology companies.
Below are the four things every technology company, including yours, needs to know, especially during the start-up and growth phases:
Revenue recognition, or the accounting principle that designates the exact conditions under which revenue is recognized or accounted for within a business, may not be as straightforward as you think. More so, revenue does not approximate a cash basis, which is how many start-ups end up recognizing it. It’s important to realize that guidance exists for understanding when to recognize revenue, to what extent and to ensure it’s being recognized appropriately.
Understanding revenue recognition is vital because when it is time for your company to grow and raise equity, it shows you’ve taken part in the proper due diligence. Adjusting historical revenues later could affect the valuation of your business and, in turn, the amount of capital that can be raised.
Likewise, the structure of sales contracts may impact the accounting treatment. It’s important to understand the revenue recognition rules, so you can structure your contracts accordingly to achieve the desired accounting results. While the accounting should not ultimately drive the way your technology company structures its transactions, it’s important to recognize that the structure of these deals does drive the accounting results. By understanding the accounting and how it’s going to impact the amount of revenue, you’ll ultimately be in a position to consider both the business (what results in sales for you) and how it will be reflected in your accounting records.
It’s important to understand when to recognize the revenue for various deliverables. A typical sale may include a number of products and services. For example, as a software company, you may sell a license to the software, along with installation, deployment, maintenance, training and hosting. You’ll need to be able to allocate and recognize revenue across services and products.
With many technology companies engaging other companies, such as resellers, or embedding their products in another product, it’s important to understand which business revenue should ultimately be attributed to. Perhaps this is recorded as the total amount or it’s recorded as the net cost to resell. As with revenue recognition, accounting rules apply to determine where the revenue truly belongs.
As a new company, one of the first decisions you’ll make is how to compensate employees as you grow. Because of the lack of cash, many start-up technology companies compensate their employees with non-cash or equity-based compensation. Some examples of these compensation options include equity-based compensation like stock options, restricted stock plans and stock appreciation rights, bonuses and/or commissions. Regardless of your compensation structure, determining compensation structures is a complex process and the rules for how to record compensation can be complicated. Because of this, it’s important to engage legal counsel and a top accounting firm and to get legal and accounting documentation in place early to ensure things are done correctly.
Furthermore, many plans include features that require getting annual valuations done or recording a liability. Since it can be costly to prepare valuations, you need to make sure that your plan is structured so that you realize what the administrative costs of it are from the beginning.
To maintain confidence with investors, it’s imperative to ensure that the data they are receiving is accurate, timely and informative. One way to do this is to take time to make sure you understand all of the accounting issues, so there are no adjustments later.
Taylor notes that it’s critical to understand the different types of investments that a company can use to raise capital. For instance, “if you are putting a redemption feature into the stock that you’re issuing, you need to know what the accounting implications of doing so may be; this is also true for warrants or conversion rights.”
Until your business reaches critical mass and becomes profitable, understanding your cash burn rate is critical. Trina explains, “besides estimating and tracking the cash burn rate, it’s important to communicate with investors and manage cash flow by consistently producing results rather than spending money without a strategic plan in place for when and how you spend.”
Along these lines, your projections need to show what cash burn rates are likely to be so you can understand how much equity you’ll need to raise and how long it will last until the next round of funding needs to take place.
With recent changes to US GAAP revenue recognition and accounting principles shifting along with legislative changes on an ongoing basis, it’s critical to align your technology company with qualified advisors who can help each step of the way. Even more importantly, as a young technology company, you need to understand each of the principles outlined above.