Top 4 accounting challenges businesses face as they scale up

April 27, 2022 BDO CANADA

Businesses in the scale-up stage often overlook the financial and accounting functions within their organization. Scaleups are typically more focused on building their business and raising capital and tend to view financial reporting as compliance. But this thinking can damage the business further down the line, especially when it comes to financing. Proper financial reporting will help your investors have confidence in your business, which will help you raise money and keep investors on board should you need to raise funds again.

In this article, we look at key accounting challenges businesses face while scaling up. We also outline solutions and best practices so your business can avoid making the same mistakes.

Firstly, let’s look at the differences between a company in the scale-up stage versus companies in the start-up stage.

What’s the difference between a startup and a scaleup?

  • Startups - Are at the very beginning of their life. Startups typically have very little formal structure or processes in place, but they’re meant to be that way to allow for a deeper focus on innovation.
  • Scaleups - Are, simply put, just a successful startup. The company has likely hired a number of permanent employees, has generated sales (or at least has been able to prove that its product or technology works on the market), and has probably started to raise money from outsiders.

BDO’s Accounting Advisory Team works closely with many clients in the scale-up phase and have identified four common accounting and finance challenges these companies frequently face—often costing them time and money.

1. Neglecting to scale up accounting and finance functions

As companies are scaling up, they often do not also scale up their accounting and finance functions, since their focus is on the business. Many of the first employees hired are in product development and sales. As a result, the accounting and finance function doesn’t change from the start-up phase.

Scaling companies need more financing to support growth and develop their products. There is a real risk for financing deals being delayed and even falling apart because the company couldn’t produce financial statements in a timely fashion, or they were unable to produce reasonable forecasts.

“As accountants, we obviously think accounting and financial reporting is critical, however, non-accountants don’t always see it as critical and typically just look at accounting as compliance,” says Armand Capisciolto, National Accounting Standards Partner at BDO. “But there’s a happy medium.”

Companies that successfully scale up see the accounting and finance functions as more than compliance and invest in this area of the business. They understand proper financial reporting is needed to move their business plans forward.

2. Entering into complex financial agreements

As mentioned, financing is a crucial area of focus and scaleups are increasingly interested in capital sources with more flexibility. To find this, they are looking to venture capitalists, alternative lenders, or other private investors to raise money instead of seeking traditional bank loans. As a result, the financing agreements end up resulting in more complex accounting than for a typical loan.

Simple Arrangements for Future Equity (SAFEs) are becoming a common type of financing arrangement for companies scaling up. SAFEs may seem simple from a legal standpoint, but they are anything but simple from an accounting perspective. SAFEs are a type of equity financing often used by startup or scaleup companies in the early stages as a form of bridge financing. Investors make up-front payments in exchange for the right to future shares issued by the company in the next equity financing, typically at a discount.

“Often, these complex financial instruments have aspects of both equity and liability and therefore determining if it is a liability, equity, or both is the big issue,” says Anne-Marie Henson, Assurance and Accounting Partner at BDO. “For example, if you think you are issuing equity, but in fact the instrument is a liability that needs to be measured at fair value, this will make financial statements look a lot different than you thought they would look,” she adds.

To build confidence with investors, scaling companies must strengthen their finance and accounting functions, ensuring that accurate information is reflected in their reporting. It’s important to note that having a strong finance function does not always mean having a finance team. Fast-growth, agile companies are outsourcing everything from cloud accounting and bookkeeping to payroll to CFO services in order to grow—unhindered by the slow pace of hiring.

3. Creating bespoke revenue arrangements with customers

Revenue recognition is another accounting complexity that can arise. It’s imperative to get ahead of this issue, since revenue is hugely important from a valuation perspective, and could have an impact on your valuation at your next round of financing.

As companies scale up, especially in the technology space, they often engage in nontraditional arrangements with customers to start generating more revenue. For example, they might create one agreement with one customer and slightly change the agreement with another customer. Businesses are often surprised by the complexity in determining the proper accounting for revenue and the timing of recognizing revenue ends up being different than they originally thought.

As with complex financial agreements, companies seeking to use bespoke revenue arrangements with customers should fully understand the nuances of the arrangement, including the accounting treatment.

4. Using the wrong accounting standard

Another accounting challenge facing scaleups is deciding what accounting standard to use. If the company is not listed, there are options: ASPE, IFRS, and in some cases U.S. GAAP. Many startups neglect to match their accounting framework to their unique business needs now and in the future.

Ultimately, the decision depends primarily on the company’s core business strategy and what they plan to scale up to. Are they going to sell to a larger company? Are they going to go public or remain private? These are all the factors that should be considered when choosing a standard. Learn more about choosing accounting standards here.

Next steps

As a scaleup business owner, you don't have to prioritize accounting decisions over business decisions, but it helps to learn about their impact on each other. This can help you negotiate more effectively. “At the end of the day we want our clients to be successful and, in my opinion, they will be much more successful if they have proper accounting and finance functions in place,” says Anne-Marie Henson.

You need to grow and evolve your business, we’re here.

BDO’s Accounting Advisory team can help companies handle the financial complexities that come with scaling up, and ensure hard-won growth translates into real value.

Armand Capisciolto, National Accounting Standards Partner, BDO Canada

Anne-Marie Henson, Partner, Assurance & Accounting, BDO Canada

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