The ultimate situation of being between a rock and hard place. Alas, as we approach the third audit season since FAS 157 was put in place, it is time once again to put on the Kevlar and go forth and wrest information from our managing directors for the sake of laying at the audit altar table, proposed Level 3 portfolio company valuations in order to create GAAP statements.
We submit reams of data in support of management’s opinion in the hopes of a clean opinion. Unlike most food chains, the most junior members of the audit team feast on the data first, then the audit supervisor takes a turn at the materials and so up the seniority chain of command until they submit the “final” numbers to the lead partner. But wait! The concurring partner needs to additionally opine and we start all over again. While feeding the audit food chain, we are constantly flogged by the managing directors for not getting the audit done all the while they balk at making available any additional information requested by the audit teams. Does this scenario seem familiar?
What is a venture CFO to do?
- Early Preparation Do not wait until after year end to begin compiling the valuation documentation. We recommend performing the valuation process quarterly in order to demonstrate an establish procedure. We also recommend hosting a meeting with the audit team and your key managing directors prior to year end so you have clear communication regarding timing and expectations.
- Supportable Evidence This is the most important part of FAS 157 preparation. Do not let the managing directors provide only hearsay evidence of market conditions, milestone achievements, etc. Observations need to be verifiable. Verifiable data can come from the portfolio company’s 409a reports, board of director packages and financial statements. For example, revenue and expenses that are in line with the projections submitted at the time of investment are reasonable arguments for an unchanged valuation.
- Consistency Create a checklist of data required for each portfolio company and use a standardized template for summarizing the data and the valuation methodologies. Make changes to methodologies only when it is warranted.
- Correct Amount of Backup Materials The more information that you submit, the more you will be expected to produce. The secret to a painless audit of valuations is to provide concise, credible information on each investment with appropriate documentation. Multi-tab spreadsheets and voluminous paper reports on every portfolio company will require the audit staff to read and examine everything. Providing too little information will cause frustrations for everyone, while overwhelming auditors will slow down the process.
If you would like more information on how to avoid being between the rock and a hard place during your next audit, please contact us at info@greenoughgroup.com