Questions on Startup Finances? Watch Jessica McKellar’s AMA
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There’s a lot to keep track of with a new company, and it’s normal for first-time founders to have a lot of questions about the business side of their startup. It can be a big help to ask someone who’s done it before – or, in the case of Pilot CTO and co-founder Jessica McKellar, someone who’s done it before three times.
Jessica recently sat down with our partners at Stripe Atlas for an educational session and AMA about finance basics for new startups. We’ve excerpted some highlights from the Q&A below (and you can watch the entire recorded session here).
When to hire for finance
Q: How do you know when to make your first full time dedicated finance hire?
Jessica: I think that it depends on the nature of the business and the nature of the expertise on the leadership team, but as a general principle, I would actually advocate for deferring it as much as you can. It’s really expensive to have a full time dedicated finance hire.
To the extent possible, see if you can benefit from the expertise of a team or a firm that has seen many examples of a business like yours, including where you are today and where you will be in the future. You can benefit from that expertise, and it’s hard to package it all into a single finance hire. So usually you want to defer this as much as you can, both from just the economics of it for you, and how you manage your burn.
When you do actually make the hire is usually when you need a level of process control that requires someone internally, who has the internal context and the ability to enforce process internally. And to drive the sort of monthly finance cadence for the business.
So once you’re at a point where you have a monthly close process that needs to happen on a certain timeline, that’s going to feed into various types of modeling and projection activities on a particular timeline. To do all of these things, you have all these stakeholders that need to be wrangled, and that type of activity usually requires somebody in-house to do it, who has enough financial context to help set up the process and enforce it.
Sometimes if you have a really complex business that has complex finances, it’s an early hire. You might have a full time dedicated finance hire within your first 10 hires. But there are also businesses that have 40-50 people who have a head of operations, but actually still fully outsource their finance team.
So that’s some context, it really depends on the specific nature of your business, though.
How to set up finances in a bootstrapped startup
Q: How do bootstrapped company finances differ [from VC-backed companies]? What’s the right way for a founder to put personal money into the business?
Jessica: So other ways [besides VC funding] you can initially capitalize the business – you can put money in yourself, you can get a loan, or you can fundraise using various funding instruments in the Valley for startups. The most common thing these days is to raise on a SAFE note, maybe slightly less commonly on a convertible note. I guess there’s also some level of crowdfunding these days, which is exciting. You should do what’s right for you.
There’s no wrong way to do this, as long as you’re tracking it correctly. So if you put $50,000 of your own money into the business, you need to have great clarity about if that was a loan to the business, or if you’re not expecting repayment, or if it was an exchange for equity (that you need to have appropriate documentation on).
You need to have this stuff really clearly documented to avoid trouble once your business is wildly successful. The last thing you want to be doing is litigating who actually had what percentage ownership. The way that you avoid issues with this is to have experts helping you, an expert bookkeeper and a professional tax preparer who specializes in startup taxes (even better, under one roof). Your team will ensure that you’re handling it appropriately.
Something we also see a lot is conversions on entity type, like ‘oh i started as an LLC and am converting to a C-corp.” It’s really important to get that conversion right, and there’s no way to get it right aside from having an expert do it.
On accrual accounting
Q: We’re starting an LLC with a subscription software business model. Do we have to do accrual accounting?
Jessica: So, what actually matters for this at the end of the day: number one, you need to have the visibility into the business that you need to run it successfully. If you have investors, you need to make them happy. You need to be able to pass audits. They’re very rare for early stage companies, but they do eventually come up. And then, if you get far down the line, public companies have a rigorous set of accounting principles that they need to comply with.
So do you have to do accrual basis accounting? There’s nothing that legally says you must do accrual basis accounting. However, your investors are all going to expect accrual basis books. Especially if you have a subscription software model, you’re going to find that the metrics that you’re expected to track, and that you’ll definitely be expected to report on for fundraising, and that I imagine you would need accurate data on to run your business, are going to require accrual-basis accounting. You’re going to want data like your monthly recurring revenue or your ARR or your MRR, and you’re not going to get a clear picture of that unless you’re doing true accrual basis accounting.
So do you have to? You’re not legally required to, but everybody’s going to expect it. You’re going to want to do it anyway for your own purposes.