Dear FAF: One Size Does Not Fit All

Clothing stores and automobile dealerships have known for years that one size does not fit all, nor does one style.

Currently in the United States, the Financial Accounting Standards Board (FASB) is responsible for developing accounting standards for both private and public companies. Yet, they have only been serving up standards based on public company practices. And it has not been working well for private companies.

The needs of private and public companies are very different. Take just one area—transparency to investors. Investment decisions for public companies are largely based on published financial statements. Those documents need to be self-contained and expansive. In fact, additional disclosures are tightly controlled by SEC Regulation FD.

Yet, the needs of private company investors and lenders are very different. When was the last time you heard of a venture capitalist investing in a private company solely based on the formal financial statements? Close to never, right?

In various testimonies and roundtables over the years, NVCA reps have been joined in this chorus by lenders and appraisers. For startups and pre-revenue companies, financial statements have little use in the investment process. No conceivable set of financial statements could tell the whole story. This is why in establishing and maintaining long-term relationships, equity investors and company managers conduct due diligence and establish an information flow far beyond what could ever be put in a financial statement, and which would not be appropriate for public companies.

In 2010, the Financial Accounting Foundation (FAF) formed a Blue Ribbon Panel (BRP) on Private Company Financial Reporting for the express purpose of making recommendations on changes to standard-setting for private company financial statements. The VC industry was represented on this panel by NVCA board member and Foundry Group General Partner Jason Mendelson.

Over the course of the past year, the BRP came to several critical conclusions:

1. There is a fundamental difference between public and private company accounting issues.

2. Applying public company accounting standards to private company financial statements has caused the cost of preparing private company financial statements to skyrocket while the relevance of the information has plummeted, making these statements expensive to their preparers and meaningless to their users. Not only is the financial cost a burden but so is the excessive time it takes to retrofit public company standards to private company operations.

3. Historically, FAF and FASB together have been unsuccessful in attempts to set accounting standards for private companies within a single board structure.

The panel called for a separate private company board with standard-setting authority under the Financial Accounting Foundation’s oversight. The new board would consist of five to seven members with private company constituent experience and work closely with the FASB, which would continue to set accounting standards for public companies and not-for-profit organizations and report into FAF. This independent board would drive appropriate modifications to existing U.S. GAAP for private companies to better reflect their financial statement users’ unique needs.

We are surprised that, to date, the FAF has shown only tepid support for its BRP recommendations. This summer, dozens of NVCA members signed a letter to FAF urging acceptance of the recommendations.

A change to standards-setting practices would provide an opportunity to bring sanity to both GP-LP reporting as well as portfolio company reporting. Thus, it is the NVCA’s position that FAF should accept and implement the BRP’s recommendation.

Nothing in our support of a carefully selected and empowered group to address private company needs suggests that private and public accounting rules should conflict. On the contrary, well-crafted rules for private companies would provide a clear path for private companies with an IPO or acquisition by a public company in their sights.

The venture capital industry’s ability to fund innovation and empower entrepreneurs is contingent upon financial information that is meaningful and effective. The time has come to give private company accounting the unique attention it deserves.

John Taylor is the head of research and the CFO Taskforce for the National Venture Capital Association. He can be reached at jstaylor@nvca.org.