What is GAAP Accounting and Do I Need it?

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GAAP stands for Generally Accepted Accounting Principles.

It is a type of accounting standard that is generally considered more stringent than Pro Forma Accounting and is looked upon favorably by investors and banks. The goal of adhering to GAAP standards is to establish consistent and transparent financial metrics by which companies can be measured.

If your company is preparing for an IPO, GAAP standards are essential as the SEC requires GAAP accounting for any Initial Public Offering. But what about companies who are simply raising capital, looking at an exit, or looking to raise funds to acquire other smaller companies?

For those companies choosing to adhere to the GAAP principles (of which there are 10) may make investors look more favorably on your company.

First let’s review what the GAAP standards are:

10 Principles of GAAP

  1. Principle of Regularity
    The accountant has adhered to GAAP rules and regulations as a standard over time and regularly.
  2. Principle of Consistency
    Accountants commit to applying the same standards throughout the reporting process, from one period to the next, to ensure financial comparability between periods.
  3. Principle of Sincerity
    The accountant strives to provide an accurate and impartial depiction of a company’s financial situation.
  4. Principle of Permanence of Methods
    The procedures used in financial reporting should be consistent, allowing a comparison of the company’s financial information.
  5. Principle of Non-Compensation
    Both negatives and positives should be reported with full transparency and without the expectation of debt compensation.
  6. Principle of Prudence
    This refers to emphasizing fact-based financial data representation that is not clouded by speculation.
  7. Principle of Continuity
    While valuing assets, it should be assumed the business will continue to operate.
  8. Principle of Periodicity
    Entries should be distributed across the appropriate periods of time. For example, revenue should be reported in its relevant accounting period.
  9. Principle of Materiality
    Accountants must strive to fully disclose all financial data and accounting information in financial reports.
  10. Principle of Utmost Good Faith
    Derived from the Latin phrase uberrimae fidei used within the insurance industry. It presupposes that parties remain honest in all transactions.

GAAP Compliance

All of these principles make sense from a transparency and honesty perspective. Ensuring that the spirit of the rules being adhered to, however, can be easier than actually being marked as being GAAP compliant. Larger corporations often adhere to GAAP requirements even when they are not required to by the SEC because their lending institutions request it and or simply look favorably upon it.

For investors looking at opportunities to grant funding to middle-market companies, GAAP accounting can make the difference in their interest level, their risk tolerance and their terms. Compliance With GAAP
To ensure GAAP compliance an external audit is conducted by the CPA of the investors. And many Banks require annual GAAP-compliant financial statements when issuing business loans.

How to Hire an Investment Banker

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When you’re looking for funding, whether you’re taking chips off the table and bringing in P.E. money or funding your next growth phase, the process is going to be a little like that home renovation project you underwent last year. It’s going to take 3 times as long and cost twice as much.

In part, that’s a joke, and in part, managing your expectations of the complexity of the process of raising capital is essential to creating the most profitable partnership you can have.

During the process, you’re going to need a team. You need an Investment Banker, you also need a business transaction lawyer, a good CPA, you’ll need your Bookkeeper to be involved and, if you have one, your CFO’s time will be spent working with the team to determine valuation.

An investment banker’s job is to help you create the forward-facing package of your company and then share the information about it with the right investors. So, having the right investment banker on your side can make all the difference.

The right investment banker for one company, say, a startup with 2 dedicated founders might be quite different from the right partner for a large company that sells widgets in multiple markets and has a vast hierarchy.

Here are a few questions to ask as you align with the right partner to help you get funding:

Size Matters

Bigger isn’t always better. If you’re not raising hundreds of millions of dollars, you’re better off with a smaller firm where you have access to the attention of the A-Team than a Goldman Sachs where you’ll have someone from the mail-room working your cap-raise.

Experience Matters

Working with someone who understands how to pitch a service-based business might be quite different from working with someone who works predominantly in the manufacturing or distribution space. Finding someone who understands how your business runs and what makes it valuable is essential to a successful cap-raise.

Money Matters

Fee-based, success-based, retainer-based… the fee structures vary widely. Draw up an agreement and be comfortable with it before you start working with your investment partner. They are an essential part of your team and can help you shorten the process, bring in the right partner and acquire the right amount of funding for your business. Don’t overlook the details of the engagement.

In the end, like with every hire, culture counts so interview, talk to the person who is going on this journey with you. The stakes are high and this decision counts. We should talk.

Private Equity vs Angel Investors vs Venture Capital

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Private Equity vs Angel Investors vs Venture Capital

Which is right for my business? 

So you’re ready to raise capital. Periods of growth and acquisition are exciting times for entrepreneurs, filled with opportunities to create a brighter tomorrow for your company, your employees, and yourself. Finding the right sources for the capital you need to make it to the next stage of your company’s lifecycle is a crucial piece to attaining your goals. 

The amount of funding you are seeking will determine the right group of investors to approach, as will the lifecycle stage of your company, your desire to retain a controlling stake, and your risk tolerance. 

First, let’s define the 3 investor groups: 

Angel Investors

Angel Investors come in pre-revenue and invest smaller amounts into very early-stage companies: Often Angel capital is as little as $10,000 – $2 million.  Angel groups are often made up of entrepreneurs who have successfully exited and want to get back into the game without having to start their own company again. Angel investors know that they are likely not to see a return but a small chance they’ll be in on the ground floor of the next great thing. 

Venture Capital Groups

VC groups are often made up of a group of investors who have a higher tolerance for risk and bet on many smaller companies knowing that their investment is likely to pay off only a small portion of the time (but when it pays off, it pays off big). VC traditionally focuses on tech, biotech, and clean-tech companies. Venture Capital investors invest smaller amounts, usually under $10 million into earlier stage companies (pre-seed and Series A rounds of funding).  

This is the traditional VC description though in the past 5 years the lines between VC and PE are getting more and more blurred. 

Private Equity Funds

PE funds traditionally invests in companies that are more mature, they invest more and use debt and equity instruments in their investment portfolios. PE groups use the leveraged buyout model (100%) or take a controlling interest (51%+) in the companies in which they invest. This used to be true all the time but in recent years PE has taken a greater interest in promising early-stage companies. PE will often be actively involved in optimizing the operations of a company in whom they invest. 

Which kind of investor is right for you?

When you are deciding to raise capital it is important to be realistic about how much money you need, to be clear about what that money will do, and then to target the right investors. In addition to what you want, be clear on what you are willing to give up. There’s no such thing as free money, know that your investors will have their own expectations for their level of involvement and also what their exit strategy is. Aligning with the end in mind is important to forging a healthy path forward with the right investors. 

Here’s a list of what questions you should ask before pitching to investors: 

1: How much money do we need? 

Sometimes it’s wise to bring in a seasoned pro here to help evaluate your estimated needs vs your idea of what you can do with $10K. If, for example, you are raising money to get the word out, raising $10K isn’t going to get you very far.   

2: What are we willing to give up? 

Nothing is free in this life: What is acceptable to you? A Leveraged Buyout (LBO) is exciting when you are ready to make that move, whereas giving up 10% of control might be too much for an enthusiastic founder at the beginning of their growth. 

3: Why would someone give us money? 

If the answer is, because we need it, go back to the drawing board. See the future, envision the end-game, and then believe in it with everything you have and everything you are.  Your business plan should read like a prediction grounded in evidence. 

4: Would Aunt Martha understand our value proposition? 

Look at your pitch deck objectively. If you couldn’t give it to an outsider without industry knowledge then you’re too far in the weeds.  Revise, restructure, clarify.  It doesn’t have to be the most beautiful deck ever, it does have to be clear and compelling. 

Need help getting started? This is our specialty, drop us a line and we’ll review where you are, where you’re going, and what steps you’ll need to take to get you there. 

SEC changes to the advertising rule

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An overview of the SEC’s advertising rules

In 1940 the SEC set forth Advertising rules for investment advisors. Now, 80 years later, they have provided an updated ruling to govern advertising for SEC-registered investment advisors. The purpose of the 1940’s advertising rule was to ensure that the public did not fall prey to unscrupulous marketing and advertising tactics by registered investment advisers. In 1979, the most recent amendment (the cash amendment) was added to the advertising rules… and there had been no further updates since the late 1970s until this new set of rules.

The new rules went into effect in May 2021 and will be enforced for all advisors after Nov. 2022.  In the interim, advisors and advisory firms have the option of adhering to the old rules fully, or the new rules fully.  What advisors cannot do is cherry-pick regulations. All firms must keep written records of all marketing and advertising efforts and which regulations those efforts were constrained by. 

What is changing with the updated SEC advertising rules?

In question is the use of testimonials, third-party ratings, and performance statistics as part of unsolicited communication for SEC-registered advisors. 

So much has changed in the world of investments, advertising, and marketing, and communications that the SEC has at long last amended the rules for investment advisor communications. The challenge is in reading legalese for advisors, marketers, advertising firms, and investment bankers who are registered with the SEC but do not have advanced law degrees.  

Here, we’ll attempt to translate the legalese into plain English. Please refer to the SEC ruling here https://www.sec.gov/investment/investment-adviser-marketing for the actual rules and regulations: 

A list of the activities that are prohibited under the new SEC advertising rules

The changes to the advertising rule still prohibit certain activities the following are our interpretations in order of the list of prohibited activities: 

PROHIBITED

  1. Deliberately misleading statements
  1. Wild statements of fantasy
  1. Leading statements or suggestions that lead to a false conclusion 
  1. Unsupported performance statistics
  1. Opinions stated as facts
  1. Old or misleading performance stats

A list of the activities that are now allowed under the SEC advertising rules (with stipulations)

The new rules from the SEC allow the following (again, these are restated in plain English to help clarify the SEC ruling): 

ALLOWED

1: The use of testimonials and endorsements in an advertisement, if:

There are clearly and prominently disclosures around the person making the statement: are they a client? Were they paid to say this? Do they have any conflicts of interest? Are they staff or referral partners?

Advisers must have a written agreement with promoters, except where the promoter is an affiliate of the adviser or the promoter receives de minimis compensation (i.e., $1,000 or less, or the equivalent value in non-cash compensation, during the preceding twelve months).

You cannot use people who are already designated as bad actors in advertising* 

2: The use of third-party ratings can be used if: 

These can be used as long as they are put in context as to how they were compiled and who performs the ratings. 

3: Performance information may be used if: 

The data is recent and supported with documentation to ensure it is accurate.  The data should be from the previous 12 months or the closest 3 quarters available in cases of delayed reporting.

The Commission must approve or review any calculation or presentation of performance results.

You can’t use performance results for one type of investment to advertise another different type of portfolio or investment.

You can’t pull out only the good stuff and say it is a performance result of a whole portfolio.

You can’t tell a story that isn’t real about how well someone did.

You can’t rely on Bob’s performance after Bob leaves the firm.

You have to have a lot of small print disclaimers.

(*this does not include poorly rendered performances in badly directed rom-coms)

Our take on the new rules

As investment bankers, we at Solis Advisory are subject to SEC rulings. We pride ourselves on telling the truth and not over-promising. Reach out to us to find out how we can help you raise capital for acquisitions or growth initiatives in 2022 (and beyond!). 

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