Five Simple Steps Key Venture Capital Staff Can Take to Support a Successful Audit

I often work with general partners or operations team members of venture capital funds who are unsure about their role in the financial statement audit process. They typically do not have an accounting background and may never have been involved with an audit process. They often assume the third party administrator (TPA) will handle the entire process with the auditor.

A hands-off approach by the General Partner is not recommended. Without some involvement from the General Partner or operations staff, deadlines for audit milestones may pass or key information may not be communicated. This can lead to a fire drill before the audit deadline or, even worse, a missed reporting deadline. The consequences can be serious. Missing reporting deadlines or otherwise not meeting investor expectations can result in reputational damage.

This can easily be avoided. With a few simple steps, general partners or operations team members can help ensure that the audit progresses towards a timely completion. Here are some key steps to ensuring a successful audit:

Create and agree on a time line. Good preparation begins with a realistic plan so that everyone knows what to expect and when as well as who the responsible party is. The timeline should include dates for the following key audit milestones:

• Performance of planning and interim procedures
• Confirmation preparation
• Valuation updates provided to the TPA (third party administrator)
• TPA package and other auditor requests provided to auditor
• Performance of year end audit procedures
• Audit issuance date

Establish a Valuation Policy. Generally, venture capital investments are held at the last round of financing, but there are some nuances. It’s important to think through the investment portfolio and consider whether there are outliers that need special consideration.

The valuation policy should address:

• The policy and process for considering potential impairment of stale investments: Are you getting regular updates from the portfolio companies? Do you have adequate information to conclude that the investment is not impaired (can the company survive until the next round of financing)? Keep in mind that the more investments you have, the more important it will be to have a process around tracking updates.
• Consideration of subsequent events: For example, if a round of financing closes in January of the subsequent year, it is most likely that market participants had information regarding this financing round as of the valuation date. In such an instance, this round of financing should be considered as an additional data point when determining the valuation of the investment as of the valuation date.
• Closing of subsequent SAFE rounds at a valuation cap that differs from the valuation cap at the time of investment: Consider whether the portfolio company has achieved any key milestones that might indicate an increase in its value. Examples of key milestones might include increased revenues or positive operating results.

Discuss deviations from your policy with the auditor. If you run into something outside the box, reach out to your auditor to discuss. Your auditor is likely to have run into a similar situation and can guide you through how to consider the impact on the valuation.

Perform an effective review of the TPA package and financial statements. The key elements of the review include:

TPA Package

• Ensure valuation marks match what you communicated to the TPA. Consider whether the price per share is reflected as expected. Consider whether any note or SAFE conversions have been properly reflected.
• Ensure carried interest is calculated correctly.
• Ensure management fee is correct.

Financial Statements

• Are all related party transactions disclosed (LP commitments by investors affiliated with the General Partner, fees received from portfolio companies, warehoused investments contributed to the fund, receivables/payables between the General Partner and fund)?

Ensure your Request List responsibilities are aligned.

• What will the TPA provide?
• What are you responsible for?
• Is there a plan in place for how information will be shared?
• See the Request List Checklist on Page 6 of Preparing for Your Annual Employee Benefit Plan Audit as a guide for discussion with your TPA.

Don’t assume no news is good news. Check in on adherence to timeline. Check in with TPA/Auditor if you are unsure whether any milestones on the timeline have been met.

It’s important to respond timely to any auditor requests. Audit teams have tight schedules for completion of audits. Teams may need to move to another audit if there are delays in responses or lack of adherence to the timeline, which could ultimately delay the timely issuance of your audit.

By taking these steps, you can protect yourself and your organization from reputational damage or other negative consequences of missing the deadline for completion of your audit. For assistance with any of these processes, contact us. We are here to help.

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