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Apr 23 2019 - San Francisco, CA

Early Audits: Michael Tannenbaum

Chris R:
Welcome to brex in the black where we discuss financial operations. We've got our CFO here, Michael, Michael.
Michael T:
Hey, how are you?
Chris R:
So for audits - audits are not really something that exist for a lot of startup companies. So why are they important? And maybe what were some big cases of the importance or necessity of audits?
Michael T:
Sure. So I think audits, I mean, just to be clear, an audit is going to be where you hire some third party firm to validate that the books and records that you maintain reflect the actual business operations of your company. So it's a third party coming in and saying: Company A said they have this much in revenue and this much in expenses. And that's actually true. And they're also in a sense, auditing the processes and internal procedures of how the books and records are recorded and implemented. And so I think, in my experience, an audit provides a lot of third party validation. I've always been in the FinTech world where you're dealing with bank partners, funding partners, loans, lending regulators. And so having a third party stamp of approval has been particularly valuable. But I think at the same time, from an investor perspective, even an employee perspective, and even just a internal fidelity of process and record perspective, it's really valuable to have a third party come in and validate what you're doing. And so I think if you're trying to build, which most people aren't doing, and working at a company to build it for the long term and build it to be big and successful — if you're doing that, I think it's reasonable to invest in an audit.
Chris R:
So most startups are not focused on this. So is this just particularly important for financial services?
Michael T:
So I think it is more important for FinTech or financial services startups. And I also think that, look, an audit is not going to make or break you as a company, right. You're going to build a product that will work or not. And whether you were audited or not, is really probably, in the near term, not going to make a difference. But I mean, one example is in my old employer, SoFi, we kind of ignored audits for a bit, we used a not so diligent provider for a while. And then it came time that we were more interested in going public — I actually sort of received a battlefield promotion to VP of finance, because I was able to clean up the sort of mess that was our books and records and get us through our first audit, our first big for audit, which was with PwC. And I think that this is an example of not having invested early sort of hurts you later. So in the chance that your company does hit escape velocity, and is really successful, you want to have those processes and procedures in place, including audits, because each year that you go un-audited makes the next year that much harder, because you haven't gotten the third party to say yes, and your processes and people need to agree on where you're starting from — and where you're starting from has to be signed off by an auditor.
Chris R:
In terms of actually going through the audit, what's the calculus for the big four versus somebody else, and then whether or not there's any difference, between any of the big four members?
Michael T:
Sure, I'm kind of a big four guy. I didn't work in big four myself, but my parents both did. But I think that if you're going to go through this, and you have the capacity, if your systems and your infrastructure is relatively under control, and you have visibility into being a big company, I think it makes sense to just to get too big four as fast as possible.

A big four is not going to take every customer, they have to have a reason to believe in you — you can't just pay them. In the grand scheme of things it's not that expensive. A kind of a regional firm audit could cost you 10 to 20 [thousand], for your first year of big four could cost you somewhere between 20 and 30 [thousand], maybe as high as 50 [thousand], depending on when you're doing this. Brex for our first year of operations, we probably paid around 25. They're probably mad that I'm revealing pricing on the call.

So I think that if you can get big four — and just to be clear, Big Four means ey, kpmg, pwc, and deloitte. If you can get one of those, you're already set up in the event that you want to be a public company and everybody recognizes those brands. But if not, if you're too small, if you don't think you're ready — you don't have the processes in place internally — then I think a regional firm can also make sense.
Chris R:
Do they just not accept you because they don't think you're going to be around in a few years?
Michael T:
Yeah, they would probably say it differently. They might say, oh our staffing plans don't work or somethting but it's basically that, yeah. They don't want to invest, because in the beginning, a big four auditor, they're not really making much money on that 25,000. They have expensive people, they have to go learn your processes, understand your company, do all this work, and they're probably not making money - they're playing for the long term. And so they want to believe that you're going to, that there's a chance your company is going to work.

Having an experienced CFO or finance person would help. So because I had done a big four audit before, when I came to brex, we were able to get PwC in our first year. I had done audits before. And so I seemed like someone who knew what the expectations were coming in. Sometimes audits can go really bad. Because the team comes in, and the person managing the audit has no idea what is expected. An example of that would be process narratives and walkthroughs. An auditor, for example, is going to come in and wants to see what is the process you have for paying bills, they want to see that written up that there's actually a process. It's not just, Sally says to Johnny, hey, we got a bill to pay. Okay, great. Go pay. It needs to have approvals. What account does it come out of? What are the thresholds? Who knows about it? How quickly do we pay it? How do we then make sure it gets booked into our accounting system? Payroll would be another process: how do you how does payroll work? And so people usually want to see that written up.

The other big thing that trips people up are critical accounting policies, usually around revenue recognition, anything where there's some sort of estimate they're going to expect a certain level of writeup - internal writing and documentation and memorandum describing how you recognize revenue or estimate expenses. So those are a few like internal things you'd have to do to prepare for an audit. I think that an auditor is going to want to have confidence that you know, what's expected.
Chris R:
What else do you need in order to have a successful audit? In terms of like financial infrastructure tools?
Michael T:
So typically, look, brex went through a big four audit on QuickBooks. That's not common. Typically, auditors are used to seeing a more robust financial software. I think we're covering financial software in a different podcast. So we won't cover exactly the nuances of what you use. But I think from an audit perspective, what they're looking for is basically a controlled environment. So they want to know, is there's at least one person reviewing the books and records that are being entered by another person. That sort of control some financial software makes easier, because it's sort of in product. It's outside of QuickBooks, which made being audited on QuickBooks a challenge. NetSuite would be an example of a software that has a review and approve function within the software in terms of preparation for an audit.

The core thing that they're auditing is the financial statements. So the expectation from a quality auditor is one that you've closed your books and prepared a p&l, profit and loss, or income statement, balance sheet, a statement of cash flows, and a statement of equity. So those four statements are the expectation. And those should have been prepared and finalized for the fiscal year. Typically, auditors are auditing a fiscal year, and then they're coming in and analyzing the veracity of those statements. And then separately, those statements are included in a packet. That includes notes that explain the statements. And the expectation, that is when the auditors come in, is you have those notes prepared as well in a certain form.

It's a little bit like the law, and the sense that you're referencing other accounting standards promulgated by the FASP, PCA, EOB, IRS, etc. So I think that there's an expectation that you've done that work, and you've consulted the guidelines that those people put out. That some would call technical accounting. I think if you don't have any of these proficiency in house, you can hire a consultant. But the point is that by the time the auditors come on site to do their work, their expectation is this all exists.
Chris R:
All right, Michael, thanks so much for coming on talking about audits.
Michael T:
Thank you.
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