Adding Value Through Due Diligence
How Cortado partner HoganTaylor prepares companies to succeed from launch to unicorn status
Thank you to Aaron Ackerman and HoganTaylor for contributing to this article and sharing their insights.
It may not sound like a super power, but we see it differently: due diligence can add significant value. Not only in our investment round, but for the long-term success of our portfolio companies.
Cortado is often the first institutional investor many of our portfolio companies have, but hopefully not the last. We know from experience, when you’re starting a company, the last thing you think of is the “back office,” the accounting and legal structure and practices that keep a company operational. Cortado helps our companies in many ways. One of them is to get these companies ready for large institutional Series A investment rounds. As part of our diligence, we investigate the accounting and legal structure and practices. This is important to validate the opportunity, but it’s also critical to bring the company’s back office up to institutional standards. We can quickly navigate this process and save a lot of headaches before a more significant funding round.
Cortado works with best-in-class partners to conduct this diligence and make recommendations to improve a company’s processes and brings fractional services which can cost-effectively help on an enduring basis. One such partner is HoganTaylor, an accounting firm with tremendous resources for companies from the earliest stage and through the corporate life cycle.
We welcome Aaron Ackerman from HoganTaylor who has contributed their insights into this process.
A very successful early-stage investor once told me “We rarely see portfolio companies fail because they don’t have a good idea or product. Failures almost always are the result of a lack of attention on back office.” The great news is that is easy to correct. Whether advising a start-up or a well-established business, I often talk to clients about “PSP” which is people, systems, and processes.
Bringing reputable and experienced advisors on to your team early is critical for any early-stage business. Good advisors can be expensive when you are on a shoestring budget but remember that a good advisor can help in keeping the pace of success quick and help you steer clear of critical missteps with compliance issues. Failing to give adequate attention to these areas could ultimately cost time, additional precious cash and in extreme cases, lead to ultimate failure. One of the most important skill sets to have on the team is that of a CFO. CFO’s can bring a level of experience and professionalism to numerous important tasks including:
- Create business models and forecasts
- Negotiate debt and equity covenants and terms
- Establish sound policies and procedures
- Help with strategy on resource allocation
- Investor due diligence
- Provide accounting guidance and financial statement preparation and analysis
Another key advisor is a tax consultant. There are seemingly countless thorny tax issues that vary by country, state, county, and city. Some of the common tax compliance areas that can trip up a new company include:
- Income taxes
- Sales and use taxes (google “Wayfair decision” if you want to scare yourself silly)
- Property taxes
- Franchise/ad valorem tax
- Business personal property tax
We usually recommend a cloud-based accounting system. Cloud-based systems provide easy access for mobile or distributed team members and remove the stress of having to manage hardware, software updates, server hosting and maintenance, to name a few. QuickBooks Online (QBO) or QBO Plus are very solid accounting systems for most start-ups (or any SME for that matter). Intuit is putting a lot of resources behind the cloud-based offering, and it is quite good compared to where it started a few years ago. And of some importance to start-up founders, it is very affordable. Other popular cloud systems include Intacct and NetSuite. It is also important to ensure that any other systems utilized by the company (POS, dispatch, inventory, etc.) will communicate seamlessly with the primary accounting system. Founders should also consider other necessary software platforms such as payroll and sales tax, if applicable.
Assuming you plan to seek outside investment from angels, venture capital, private equity and/or the public markets, you will need a robust and well-organized virtual data room (VDR) for investor/buyer diligence. A VDR should include corporate documents, contracts, employment agreements, models and forecasts, patents and other IP, cap tables, tax returns, customer lists, vendor lists, financials and much more. It probably doesn’t make sense to keep the VDR updated with monthly/quarterly financials unless active due diligence is being carried out but getting the permanent files uploaded and organized will save time and stress later.
It is important, even early in the life of a start-up, to have sound policies and processes set up and documented. Even though it may seem unnecessary when transactional volume is low, it serves to establish credibility and communicates to investors, potential employees, and customers that you are running a well-organized operation and planning for scalability. It is also a good idea to develop sound internal controls. A well-designed internal control system often includes several individuals to provide adequate separation of duties. When the company is just getting started and has few employees it may not be possible to fill out your internal control structure in practice. However, having the system in place paves the way for future growth and provides clarity for all team members as the complexity increases.
The best time to get your financial house in order is now. And it’s never too early to start thinking about improving your chances of success through people, systems, and processes. (Not coincidentally I prioritize people first because if you do a good job there you can largely delegate systems and processes) In fact, it’s much easier to stand these areas up before you are swamped with sales demos, customer orders to fulfill, employees to manage, a high volume of transactions to process and record and investors to pitch.