This week TechHub Harare got in touch with Culverwell to discuss on one key element of the information sent to investors when seeking finances for your start-up. This is what he had to say about compiling financial statements in preparation for investor runs.
Critical to the quest for raising funds is being prepared. Such preparation will require the scouting for potential investors or funders, developing an information memorandum which you will give to investors when courting them and engaging in initial negotiations. Financial statements are part of the information memorandum which you give to investors during the pre-investment phase. In addition to the financial statements, it is often accompanied with the strategy and business model information. This all means an information memorandum is simply a pack containing the initial answers to questions investors may have concerning your start-up. It, therefore, provides the first touch-point of your start-up to these would-be investors. In this article, we shall focus on the financial statements that you prepare as part of the information pack.
What are they?
Financial Statements are a picture of the current financial capacity and capabilities of your start-up. They communicate about the economic resources and claims you control and utilize. Often this picture is captured in three main statements namely the statement of financial position, statement of comprehensive income and the cash flow statement together with a management commentary which explains the numbers. A statement of financial position, commonly known as the balance sheet, will show the investor the assets that you control in your start-up, how the assets where financed and by whom. All this is shown at a specific date, normally the last date of your financial year. The statement of comprehensive income which you are familiar with as the profit and loss statement will communicate the financial performance of your start-up during a particular financial period. This speaks to the profitability of the venture. The last key statement talks of the actual cash that was generated and expensed by your start-up giving the investor insights as to the cash cycles your start-up goes through. To bring context to the numbers, a management commentary is added. This will seek to explain to the investor what these numbers mean and how they came about within the context of the business model.
Getting it right!
Investors require that these statements be prepared according to best practice i.e. generally accepted accounting practices. In Zimbabwe, your set of financial statements must be prepared following the standards issued by the International Accounting Standards Board. As a start-up, I suggest you use the standard that is meant for non-public entities called the IFRS for SMEs. Following this standard will give your would-be investors the confidence necessary for them to use your financial statements in evaluating your start-up. In addition to this, you will also give investors statements that are comparable to other start-ups competing for the same funds and this will make the process of obtaining funding efficient. An efficient funding process will save you time.
How to use them for sourcing funds
Types of investment largely fall into the equity and debt categories. Through analyzing your financial statements you can identify the type of investment which best suits your start-up. For example, if your cash flow statement shows that you have a strong cash position (i.e. net cash positive) considering approaching debt financiers may be more appropriate. Apart from the fact that your start-up will stand a better chance of accessing this type of funding (because of the positive cash position), the business would be able to make the principal and interest payments much easier than if it had a negative cash position. Alternatively, if your strategy does not permit getting into long term debt arrangements or when you are seeking out a seasoned investor who takes up equity and who you need to commit more to the growth and development of the start-up, either through mentoring or taking up an executive role in the start-up, the same positive cash position can be used to bargain such additional commitments from the investor.
While there are valuation issues to do with the value proportion and the business model, which all must be seamless with the financial valuation attached to the start-up, part of the ingredients for financial valuation is general purpose financial statements of the start-up. Employing valuation techniques that consider the financial statements is critical to the understanding of the minimum and maximum valuations of the start-up. Performing such valuations ahead of courting investors will give you a basis for negotiating financing deals that add value to your start-up by offering you a range with which to price your business. This is particularly important when you are seeking out equity investors whom you want to sell the residual value of the business. So to effectively win them over, there must be a demonstrable value of the start-up that you are confident of and can prove from the financial statement. This, however, may be difficult if you are a tech start-up since you generate most of your value off-balance sheet. In such start-ups, the management commentary section of the financial statements can become handy as key metrics (such as revenue per subscriber numbers, acquisition of new customers and new subscriber counts-just to mention a few) can be drilled down to enhance their support in the valuation.
How to prepare financials
Now that you know what they are, how to get it right and how you can use them, you must be ready to prepare them. Compiling financial information which is compliant to the required standards may mean contracting a professional accountant. This is a critical piece of the investor information memorandum which you cannot afford to get wrong- your funding prospects rely on it.
Culverwell Venge is a professional accountant who is a member of the Association of Certified Chartered Accountants. He writes in his personal capacity. For comments and discussion contact him on +263 714 166190 or firstname.lastname@example.org