Revenue recognition rule ASC 606 has been described as the most significant change to corporate finance and accounting in the 15 years since Sarbanes-Oxley Act.
Trouble is it’s hardly front-and-center for many venture investors, or the portfolio companies they fund.
The regulations, from the Financial Accounting Standards Board, will standardize how companies recognize revenue from customer contracts, aligning practices across both industries and the public and private markets. Public companies will begin implementing the new standard first, private companies a year later.
For Heather Gates, recently named national managing director of the emerging growth company group at Deloitte’s Audit & Assurance practice, the new criteria is a challenge that needs to be addressed.
“There are changes to accounting standards all the time,” she said. “But rarely does it impact revenue in the way this does. I think the last time revenue was impacted this significantly was back in the ‘90s when Statement Of Position 97-2 came out. That was a drastic change.”
For many financial departments at young companies, resources will be stretched and experts required. Later-stage startups will likely be those most affected, as they re-examine how to book revenue and then implement process change.
“As you’re becoming more of a mature company, you start preparing your financials and your controls of systems as if you were a public company,” Gates said.
However, private companies in general have an important advantage.
“For the privates, it’s going to be a little bit of wait and see what happens to the public companies, and then we’ll copy what they do, which is nice place to be,” she said.
VCJ recently spoke with Gates about ASC 606. An edited transcript of the conversation follows:
Q: Are VCs adequately aware of ASC 606 and its impact?
A: I would say a significant majority of them are aware of it. When you have conversations, they are like, ‘Oh, yeah. I’ve heard this is coming.’ Especially if they are later-stage investors, they’re going to have a bunch of their companies being audited. I would say the majority is aware of it.
Would I say the majority knows what the impact is going to be? Probably not. There’s probably a few that are more financial-statement savvy, especially if they have a company that is trying to go public.
This is where it gets tricky. If they have a few companies in their portfolio that are trying to go public in the next 12 to 18 months, they have to understand what the effects of the adoption are way earlier than the other privately-helds, that can just wait and see.
Q: What key changes will companies need to make?
A: The key things we are seeing, as we have some of our own clients going through this process, is when you do a big accounting change, like this, you end up having to recast prior-year financial statements and you need to be able to technically understand and put into your accounting systems the new ways of recognizing revenue.
You may have to redo your contracts. So you need extra legal focus alongside a deep technical accounting expertise.
What we’ve found is a real burgeoning business within our own accounting group of people hiring experts to come in and help them figure out this new revenue-recognition standard.
And then we need people to come in help recast old financial statements, help us rejigger systems. It really changes all the process flow around recording the financial statements.
Q: When do the new rules need to be adopted?
A: For calendar-year companies, all of the public companies adopt this year, so by the end of Dec. 31, 2017. For private, it is a one-year lag. We’re going to be seeing companies adopt and to make these changes probably next year.
Q: Does this give private companies an advantage?
A: What’s happening is public companies are beginning to prepare for this and making some disclosures in their quarterly public-company financial statements about the potential impact. And what we’re seeing is a bunch of SEC comments on whether the adoption of this pronouncement is being done under what the SEC believes are the right provisions.
So private companies get the advantage of, ‘Hey, I get to sit back and see what is going on with the public companies and learn from that. And we’ll just take what they learned and adopt it next year.’
Q: Many venture-backed companies find exits through M&A. Will the new rule impact M&A transactions?
A: A public company that is an acquirer has (likely) already gone through this adoption. When they go look at a company to buy, they’re going to do due diligence to be able to determine: have these guys adopted the pronouncement, have they done it in what we believe is an accurate way, and are they going to go onto the parent’s company’s systems. Or are the systems in place going to need altering. And that could impact the purchase price.
I don’t think it is going to be significant, but anything found in due diligence can be a little reduction in purchase price.
Q: Are SaaS companies pushed to recognize revenue earlier in the life of a contract and could it limit their revenue visibility?
A: What we have seen so far is, in general, this whole ASC 606, I won’t say it is every industry, but more than not we’re seeing revenue being pushed forward and less of it being deferred.
Drilling down specifically into SaaS, because the impact of this statement is not dramatic for most SaaS companies, the difference in what was deferred then vs. now is generally not huge. You may have a little shrinkage in what you can rely on for next year, but it’s not like you are going to be cutting it in a third.
Q: How expensive will preparation for the new rule be?
A: It depends. Part of it is, if you’ve got a young enough company, let’s say they have product, they’ve launched, they’re generating some revenue, but there is no imminent exit, meaning they’re not trying to sell themselves or go public in the short run, if they have a sophisticated finance team, they partner up with a solid audit team that can give them some guidance, with a little extra time and help – maybe they outsource with an extra person to help them digest it – it doesn’t have to be that expensive.
And part of this is because in the early days, you’re not relying on sophisticated systems to begin with. And you’re still formalizing your formal go-to-market. Your contracts tend to be not necessarily standardized at the earlier stages. You really have the opportunity to forge a new path without a lot of historical weight.
For a later-stage, it’s harder. You already have the systems in place. You kind of have gone to market in a certain way. You hopefully have standardized contracts. It takes recasting those things. I haven’t seen a budgeted estimate.
Q: Do you have advice to portfolio company execs and their investors?
A: Getting access to the experts can be challenging because now everybody is trying to implement all at once. My recommendation would be, you know it’s coming up, get somebody you know and trust engaged early on to get through it.
Heather Gates, managing director, Deloitte. Photo courtesy of the firm