You’re a startup CEO. You’re running your business fast and lean. Getting your company’s financials cleaned up and organized is on your to-do list, but so are a thousand other things. You’ll get around to it—just as soon as you secure the loan that will help you scale up.
I hate to break it to you, but as long as your financials are a mess, that funding is going to stay forever out of your reach. At Lighter Capital, we field a lot of loan applications, and the number one reason we reject potential borrowers is that the entrepreneur is unable to produce financials. And we’re not the only ones who feel this way.
In order to fundraise effectively—from equity investors, traditional banks, or alternative debt providers—you’ll need accurate, organized financials. These help investors determine terms and pricing and show them that you know what you’re doing as a business owner. An entrepreneur with clean financials is an entrepreneur who understands how to operate his or her business.
Here are the five most common financial red flags that could torpedo your funding
1. You don’t use accounting software to track your financials.
An Excel spreadsheet or Google Sheet is not accounting software.
We see early-stage companies using Excel to track their financials all the time. This is fine when you’re just starting out, and you’re not sharing detailed financials with third parties, but when you reach the point where VCs, investors, or lenders might want to look at your data, you need a more robust system.
At Lighter Capital, we need to verify and reconcile transactions from your bank statements. Using an industry-accepted accounting software package makes verification and reconciliation much more straightforward. Not only does using an Excel spreadsheet force investors to reconcile and verify your transactions manually, but it also shows that you don’t take your accounting seriously, which raises a big red flag. Accounting software also checks your work to help make sure you do not make basic accounting errors like not balancing your balance sheet.
2. You have projections, but you don’t have actual financial data.
Revenue modeling can absolutely be useful—especially for you, the business owner as you start making plans one, two, or three years out. But projecting your business’s monthly expenses and operating costs as you start thinking about your first hires, travel plans, and fundraising targets is where the utility ends.
When investors ask for financials, they want to see actual financial statements—not projections. Why? Because as many VCs and startup advisers will tell you, your early projections will almost certainly be off target.
At Lighter Capital, our underwriters look at your recurring revenue to assess risk and determine pricing. If you don’t have a historical record of your company generating revenue, we won’t be able to fund you. Investors need hard historical numbers, not guesses at what you think you’ll do. They’ll use the data you provide to make their own projections about your future success.
3. Your financials are incorrect.
Sometimes we review financials, and they’re simply wrong. Often this is due to misleading line items on an organization’s account or financial statement—a symptom of using the wrong accounting method.
Because Lighter Capital’s funding mechanism requires borrowers to have sticky revenue streams, we see a lot of SaaS and subscription-based revenue models. These businesses are likely to receive many prepayments and recurring contracts. If your business plan revolves around revenue from subscriptions and you’re not using accrual accounting, you may be underselling your company’s performance by underreporting deferred revenue.
Psst! Read more about deferring revenue with accrual accounting while still following Generally Accepted Accounting Principles (GAAP) here.
4. You aren’t producing monthly financials.
When your company is very young and doesn’t have much variability month-over-month, you may only need to produce financials on a quarterly or annual basis. However, when you start scaling and looking for outside capital, monthly financials are a must.
Monthly financials show investors that you’re monitoring your business closely and adopting best practices for accounting. They can also illustrate revenue trends and seasonality. For lenders providing revenue-based financing, monthly financials are key—your repayment of your loan is typically a percentage of your company’s monthly revenue, so if you can’t produce monthly financials, a lender won’t be able to offer financing.
5. Your personal and business financial accounts are all mixed up.
The first rule of being a business owner? Don’t commingle your personal and business spending. Just don’t do it. Even if you’re just starting out, it’s much easier to prevent in the moment than having to go back and fix later on. (Worried you’ve already broken this rule? Here’s what you should do immediately.)
Mixing personal and business expenses is one of the most common reasons small business get audited, and it also makes it harder to track and report the financials investors want to see. Investors and lenders aren’t going to want to get involved with a company that is unwilling or unable to follow basic accounting practices let alone one exposed to that much legal risk.
Getting your financials in order at an early stage shows investors that you understand your company’s expenses, growth, and path to profitability. It’s never too early to start thinking about how to organize your accounting practices.
Image, “Red Flag” by Tim Green, “Price” by Kevin Dooley, and “Map” by Normam Vleventhal Map Center. (All CC BY-SA 2.0.)
