Should I Agree to Be Audited?

VCs’ default documents often require annual audited financials.  That makes sense from the VC’s perspective:  They are, after all, investing other people’s money and they feel a need not only to conduct diligence on you before they invest, but also to keep an eye on you financials afterwards.  Audits are also part of their exit plan and, as such, it’s part of your exit plan, too.  The two principal exit mechanisms – a sale or an IPO – both require credible audited financials.

All of that said, audits can be expensive.  They feel like a waste of both time and money to many entrepreneurs.  Bear in mind that the VCs are putting up the money for the audit and they want you to be economical as much as you do.  So the best place to focus is on characteristics of the audit that might make it cheaper.

The biggest potential source of added expense is a requirement to use a “nationally recognized” firm to do the audit.  This is often the VCs’ opening position.  Again, you should understand and be sympathetic to the reason for that:  Both you and the VC will want a credible audit for the next round of financing and for any possible acquisition or IPO.  The “Final Four” accounting firms (Deloitte, E&Y, KPMG and PWC) have very strong brands so, despite some notable failures, their audits tend to be automatically credible.  Still, you can get a credible audit from a regional firm that is very reputable (it’s much better if they audit some public companies) but less expensive.  So try to get the VCs to agree on a regional firm.  Ask the VCs which firms they would find acceptable.  If you’ve already been audited, of course, the VCs can inspect the quality of your auditors’ work.  That’s a good idea if you already have a history of operations and revenues, but overkill otherwise.

Always remember that you share a lot of interests with the VCs on this because both of you want to be ready for any potential exit.  So even if you somehow succeed in convincing a VC to skip audits or to let you use a non-credible firm to save money, it’s likely to be false economy.  You’ll spend much more than you save when you decide to sell or go public and realize that you have to hire a serious firm to clean up several years of financials in a hurry.