When you’re building a tech startup, accounting probably doesn’t feel very exciting. Who wants to think about spreadsheets when you’re busy building or scaling?
But, as a Y Combinator funded company and referral partner, we’ve noticed a pattern: promising startups regularly fail because of poor financial management.
In this article, we’ll explore the essentials of tech startup accounting, including best practices, common mistakes, and the accounting software we think will make your life easier.
The Importance of Accounting for Tech Startups
Accounting is about more than compliance. Startups that hope to attract venture capital need to be able to provide high-level financial statements to investors. Not only does it speed up their due diligence, but founders who practice good financial hygiene are better equipped to make informed decisions, manage cash flow, and demonstrate the discipline that builds confidence among investors.
Good accounting also helps avoid costly mistakes: misfiled taxes, underreported equity, or mismanaged cash flow can snowball into major problems.
Important: Startup funding deals fall apart all the time because of this oversight. Don’t make this mistake.
When distributing equity, file an 83(b) election. Doing so informs the IRS you’d like to be taxed on the date the equity is granted rather than when it vests.
| Presumably, the value of shares will increase over time. Without an 83(b) election, the IRS will treat that increase as taxable income. As a result, founders who don’t make 83(b) elections are less attractive to investors or collaborators. |
What’s Unique About Tech Startup Accounting?
Conventional companies and startups are different enough, but tech startups come with an added layer of complexity that’s important to consider. Let’s explore what makes tech startup accounting unique.
Revenue Recognition Timing: Cash vs. Accrual
This is one of the more common reasons startups come to us for help. If you run a SaaS business model, revenue recognition is trickier than just recording money when it lands in your account. Since customers often pay upfront for long-term subscriptions, you need to defer revenue across the length of the service.
The key is the difference between cash and accrual accounting.
You’re already familiar with cash accounting; it’s how people manage household budgets, where transactions count when money physically changes hands. Accrual accounting is a bit trickier. This method recognizes revenue and expenses at the time the service is provided, irrespective of when money changes hands.
Accrual accounting is better suited for tech startups. It requires more sophisticated accounting but is more accurate and, if applied strategically, can even save a company money on taxes.
How to Value Intellectual Property?
Intellectual property is often the crown jewel of a tech startup. Whether it’s software, a proprietary algorithm, or a patent, your IP might be a key driver of investor valuation. But accounting for IP isn’t as simple as listing it as an asset.
There are multiple valuation methods to consider, and you’ll need to decide whether the costs associated with development should be capitalized (spread over time) or expensed immediately. Each approach has tradeoffs, but regardless, there are also regulatory requirements to be wary of when listing IP as an asset.