This post was written with guidance from Carrie Small, Insurance partner, Baker Tilly, and Kaelan Ward, Director, Baker Tilly
You have now raised capital initially using a Convertible Promissory Note and soon, your Series A Preferred Stock; you now have a Board of Directors with three members – and there may be five including one or more Independent Directors; you are further expanding your management team – and have established an Option Plan under which you can issue both ISOs and NQSO.
So when do you formally retain an Accounting firm?
Here are some suggestions and insights for the appropriate benchmarks!
When InsureTechs begin to scale, business operations are increasingly complex and the Board of Directors, especially if there are Independent Directors, often request more detailed information and economic analysis. The following are some suggestions that may help you decide between a solo accountant; a small accounting firm; a mid-market accounting firm with limited business advisory services; and a large full-service accounting firm that can provide multiple services and for a variety of situations:
Considering a technology change
QuickBooks is great for the InsurTech start-up. Simple to use and accurate, so long as the inputs are accurate, it is an important tool for the InsurTech start-up, initially. However, once the InsurTech start-up looks to raise capital from third party investors, most especially when the Series A Preferred Stock Offering is on the horizon, it may well be that the InsureTech will soon not only outgrow QuickBooks or other early stage accounting systems, but it will need to begin to incorporate resources designed to minimize tax exposure, take advantage of relevant governmental incentives, and quickly and accurately provide more detailed reports to both the Board of Directors and senior management with regard to the business operations.
Raising institutional capital
Specifically, most start-ups will do one or more “friends and family” or Convertible Note funding rounds that require accurate financial information, but minimum financial analysis. When approaching capital venture firms, private equity funds, incubators, high net worth individuals or other accredited investors, many InsureTech start-ups will be asked to commit to when more sophisticated reporting procedures will be implemented, such as becoming GAAP compliant or providing a full GAAP audit of the financial statements.
GAAP compliance and fully audited financial statements take time – and are certainly more expensive than QuickBooks. However, with some advance planning – and negotiations with investors – the cost associated with such a transition and the time-consumption and disruption to the business operations can be controlled.
Generally, hiring an accounting firm to complete the audit three to six months before required by investors will allow InsureTech start-ups to work through any initial questions or comments without slowing the investment process. But this means that the InsureTech start-up will need to reach out to possible firms well before the fundraise begins, begin to build relationships, determine who not only has the requisite accounting experience, but what firm understands the intricacies, most particularly, the regulatory framework of the Insurance industry. Having an Accounting firm that also provides business advice and insight into the Insurance Industry often demonstrates sophistication and foundational infrastructure, making the InsurTech start-up more attractive to the investor, institutional or otherwise.
At times, investors may be more patient with the implementation of GAAP and will allow a period of two years to complete the conversion, when it is clear that (i) there is a process that has begun to identify and vet the appropriate Accounting firms, and (ii) that accurate financial information is available; and (iii) the resources to provide more sophisticated financial information is available to the Board of Directors and management. This implementation period, however, should not be wasted and can be used by experienced resources to further reduce the cost of becoming GAAP-compliant.
Reaching more complicated operations
In addition to the standard challenges of establishing and growing a start-up, InsureTechs face additional complexities, including state entry, sensitive data management and cybersecurity, customer-requested System and Organization Control (SOC) reports, evolving accounting regulations and increasing state tax footprint. The InsureTech start-up, as it matures, may be able to take advantage of specific tax incentives (e.g., the research and development tax credit). An Accounting firm with industry specialization can bring these opportunities to the entrepreneur and help determine what should be accomplished today, and assist in planning for future services and benchmarks that the organization should consider for the future.
Expanding industry network
One of the many benefits of working with industry-specialized Accounting firm is its access to additional resources including when an InsureTech expands into a state where it does not have a full view of the business landscape. An experienced Accounting firm that can help avoid “local” pitfalls can be invaluable. Although InsurTechs don’t always fully know when and where business will be sourced, it can be helpful and will create numerous efficiencies if the InsureTech takes a look at different state regulatory environments before fully committing expansion resources. An Accounting firm that can assist with such is valuable.
As with building your Management Team, bringing on a financial resources that will work closely with the Entity, it is furthermore critical that understanding common cultural values and approaches to decision-making is a given. When meeting with possible providers, InsureTech start-ups are well advised to be candid about the current state of the InsureTech start-up and its projected growth, including state entry and product diversification, anticipatory operational needs and changing market conditions. Demonstrated excitement and understanding of the business is a key requirement for any Accounting firm that works with an InsureTech start-up. Which means that once identified, InsurTech start-ups should fully vet possible Accounting firms with their current counsel as well as other clients’ of the Accounting firm – collaboration and common culture being critical to a successful and long lasting partnership.