Preparing for an audit from a venture capital firm

Startup businesses face many challenges, including a major one — funding. Finding a reliable source of capital can be daunting, but doing so can mean the difference between success and failure. While some businesses can rely on founding capital and their current revenue stream, it rarely leads to explosive growth. 

One of the more popular methods of acquiring financial support is to seek out venture capital (VC) funding. Although competition for funding is fierce, a venture capital firm can provide a startup with a significant amount of cash without much personal risk to the business owner.

Acquiring venture capital funding is easier said than done, however. A core part of the funding system is the completion of due diligence. During the venture capital due diligence process, the company seeking funding (called a target company) will be thoroughly investigated by the VC firm. The VC firm will pay particular attention to the financial workings of the target company, completing a full financial audit. 

To help your business improve its chances of winning venture capital funding, this article will provide you with a range of helpful advice on preparing for an audit, specifically those that form part of the venture capital due diligence process. Read on for more.

The point of due diligence is to ensure both parties in the funding agreement are aware of the risks and benefits involved. As part of this information-sharing process, the VC firm will complete an audit of the startup to make sure its finances are in order. 

A startup should prepare for a due diligence audit the same way they would for a typical audit from a tax authority, making sure all business paperwork is in order, from financial statements to past tax returns. For software startups based around a subscription model, this may mean sorting through a lot of information, particularly if customers have been subscribed for an extended period of time.

It’s important to note that due diligence is not a test that can be passed or failed. Any minor compliance issues will likely be filed away by the VC firm and added to the term sheet. A term sheet includes a list of additional conditions for the venture capital funding agreement. For instance, if tax compliance issues are found during the venture capital due diligence process, funding will only be given if the target company fixes those issues. 

While VC firms will overlook minor issues, significant compliance failings can jeopardise the startup’s chances of receiving an investment, as the VC firm will likely not want to risk working with a non-compliant company. 

Preparing for due diligence is a good idea because it’s a chance to impress potential investors. Although they’re unlikely to pass over a company for investment because of a few compliance errors, a VC firm will prefer to fund companies that demonstrate exceptional financial management skills and an understanding of tax regulations. If you have any competitors for VC funding, excelling at tax compliance can be a great way of getting ahead.

Tax compliance is vital to venture capital firms. Although it doesn’t directly generate revenue, a VC firm will not want to enter a partnership with a non-compliant company. As such, preparing for an audit should include an investigation of your compliance processes.

Below, we’ve listed a few common compliance issues that a venture capital firm is likely to notice during an audit, and how you can solve them:

• Registrations: All businesses need to register with the relevant tax authorities if they’re going to continue operating. It’s a basic business requirement and will likely be one of the first things a VC firm might check during an audit. If you don’t have a firm grasp of tax registration rules, don’t worry. Avalara can help, whether you’re completing VAT registrations or registering for U.S. sales tax.
  
• Calculations: Charging the right amount of tax is crucial for both impressing your investors and for keeping your customers happy. To calculate tax rates, you’ll need a comprehensive digital solution that can integrate with your existing ecommerce platform. Avalara AvaTax can help. Click here to learn more.
  
• Liability: Tax liability is a confusing subject at the best of times. During a VC firm audit, your past and present liabilities will be checked, so the more information you can get, the better. Avalara can support your research — use our sales tax risk assessment if you're selling in the U.S. or our VAT risk assessment for businesses selling throughout the EU.
  

Winning venture capital funding can provide all sorts of opportunities for your business. For example, you could invest in marketing, hiring, or product development to grow your company and increase revenue. Whatever your reasons for seeking investment, it’s essential that you put your business in the best position to win funding, and that means being tax compliant. 

At Avalara, we’re dedicated to helping our clients overcome their personal tax challenges. Our staff of experts can advise you on the best way to stay tax compliant as a startup seeking VC funding, and we offer a range of digital solutions to help support your company’s compliance processes. 

If you’re ready to speak to a venture capital firm but have concerns about compliance, don’t hesitate. Click here to get in touch with Avalara today.

If you’d like more information on improving your chances of winning VC funding through tax compliance, click here to download our free VC funding guide.