Tech Startups Woo Investors with Unconventional Financial Metrics | Hacker News Reader

Tech Startups Woo Investors with Unconventional Financial Metrics

wsj.com

71 pointsjrs23536 comments

I started a b2b during the last bubble. It was common then if you brokered say a $10,000 sale to claim the entire value as part of your gross sales instead of just the commission you earned for facilitating it.

I fought it, never felt comfortable representing my company's financials that way. When the bubble burst it disappeared. Now sixteen years later this type of accounting has returned.

Brad Feld blogged today about something that was also very common in the late nineties:

“people don’t talk about what they’re making. all anyone talks about is raising money”

http://feld.com/archives/2015/06/get-information-entrepreneu...

There may not currently be a bubble, but a lot of the bad stuff from before is becoming standard practice once again.

Are that kind of practices legal under US GAAP, or any accounting regime? Or are there just no accountants on board?

(Got around the paywall: C-level execs are taking huge compliance risks by giving unauditable statements before and during flotation.)

With regards to a quote in the link: "Our purpose here isn’t to make money. Our purpose is to acquire and serve customers. Making money is the logical consequence of doing our jobs well, but it isn’t our purpose."

I am baffled. Think about what stakeholders you can service if making money is a (possible) consequence of doing your job well, but not your purpose. In my Peter Drucker-inspired econoverse, that's a pretty short lifespan you've got ahead of you. One day or another, that bottom line catches up with you.

Private companies do not have to follow or care about GAAP. They should, but there is no "legality" here.

Thanks, you're right. Did not know that US GAAP is adopted by the SEC. I'm more familiar with IFRS and Dutch GAAP which (at least partly) matter for any corporation that is registered in the Netherlands.

>>Are that kind of practices legal under US GAAP, or any accounting regime? Or are there just no accountants on board?

Regardless of the legality, responsibility should ultimately fall on the shoulders of the investor to require financial reporting be done in a way that is acceptable to that investor, before they hand over money to the company. This may not be as true in publicly traded companies, where many amateur investors are participating in the market. The same goes for angel investing, if only because many companies at that stage may be pre-revenue or even pre-product. However, at the VC level, millions of dollars are invested to scale supposedly sound businesses. VCs should be sophisticated enough to manage this risk, and if I were an LP looking to put my money in a VC fund, I would be very concerned about putting my money in a fund that didn't have some sort of required standard financial reporting practices for all portfolio companies.

I'm reminded most of Groupon, which repeatedly lied about being profitable, even trying to get their alternative metric of profitability (which deferred most of their cost of sale) past the SEC for the IPO.

I'm assuming that VCs are savvy enough to understand the financial metrics. The bigger problem is when firms start to use made-up metrics whilst crowdfunding from retail investors that aren't savvy and don't have the right to ask to see the real figures

I wonder if that kind of thing could lead to the crowdfunding marketplace doing some basic due diligence, though I suspect they don't want the risk.

Well, they could require that companies raising money get an audit done. That way, the crowdfunding platform isn't doing the due diligence - they're simply requiring that the company gets an accountants firm to do it. Auditing companies is a fairly common and well-understood process. I would imagine that the market for such services is fairly competitive, so the cost shouldn't be unreasonable.

I think that a problem with GAAP is that, while it's designed to represent a standardised view of a company's accounts, it can be quite complex and isn't necessarily particularly easy to understand, which can end up being counterproductive.

For example, out of curiosity, I went and looked up Hortonworks' Q4 2014 results[1] to see if they had, indeed, reached a $100m run rate by the end of 2014. Two revenue numbers are listed. GAAP revenue was $12.7m and "non-GAAP" revenue was $16.7m. The $4m difference turns out to be a "contra-revenue" booking relating to a Yahoo! warrant (effectively options that were issued to Yahoo!) that became exercisable when the company IPO'd (which was during that quarter). It appears that the Yahoo! warrant was granted as part of a deal in which Yahoo! committed to being a client Hortonworks and, hence, GAAP required that the $4m in cumulative revenue that Hortonworks had received from Yahoo! as a client, be deducted from the revenue for that quarter (even thought that revenue was generated over the course of several years), and that the rest of the $52m "cost" of the warrants (they effectively allowed Yahoo! to buy 3.25m shares for $0.01 per share, versus an IPO price of $16, yielding a "fair value" of just under $52m) be recorded as a cost of sales for that quarter, turning a non-GAAP gross profit of $6m into a GAAP gross loss of $46.2m.

I'm not an accountant but I did do introductory courses in financial accounting and management accounting as part of my MBA, and it took me a good half an hour to fully get my head around that particular adjustment - it's not until you dig into the numbers that you realise that the GAAP loss is the result of a one-off accounting adjustment, and doesn't fully reflect the underlying business. I can imagine that your average retail investor would be somewhat bemused when faced with two very different P&L numbers.

1: http://hortonworks.com/press-releases/hortonworks-reports-fi...

This was indirectly discussed here: https://news.ycombinator.com/item?id=9705832

... and included a link that discusses the WSJ article about half way down under the heading "Revenue": http://mattermark.com/important-financial-indicators-for-sta...

Run rate isn't an awful metric for a hypergrowth company. Billings or bookings isn't too bad for a SaaS company, to highlight which revenue was earned the most current year. The challenge is the terms aren't defined by GAAP, so company to company comparison is difficult.

The metric I've seen most abused is the Adtech example they've highlighted. Companies report "Managed" or "Gross" revenue, of which they only keep 15% "Net" to pay their bills. The latter is more meaningful.

In the end, any one metric can be gamed. This is why it's important to look at the metrics in total. Of course if someone is really cooking the books, they'll just make up all the #s. That's the hardest nut to crack.

It's not a bubble! This time is different!

Exactly. And that often goes with the other truth: "real estate never goes down".

There's some truth to this though. As long as the population numbers are going up, real estate would eventually catch up with them

I think if people were over-borrowed to rush to buy stocks, it would be fair to question the sustainability of the stock market on the medium term. This is exactly what is happening with housing.

This entire article is premised on flawed ideas.

First, it assumes that traditional cash flow models of publicly-traded companies are the appropriate measure for startup investment. But seed and VC investors aren't looking for current revenue - they're looking for potential revenue. They're gambling, and quite explicitly so. Most companies will fail to deliver the dream. Investors know this, which is why they limit their exposure in this high-risk field to what they can afford to lose.

Second, it assumes that investors are not savvy, and are easily manipulated by bogus numbers. Every decent investor I've seen has a pretty good bullshit detector. It's one thing to sell them a dream, it's another to sell them snake oil. And if you try to sell snake oil, you'll be passed over in favor of other companies with plausible stories.

Valuation models for publicly-traded companies do not use current earnings, they use forward looking indicators based on analysts' estimates like earnings forecast, earnings growth and target price. This is why companies like Amazon, Tesla or Linkedin have such high current price to current earnings ratios. The difference with startups is that future earnings are harder to predict. However, the valuation models should be the same once you've predicted future earnings.

Sometimes I am just thinking of opening SHORT sales for all these "amazingly good companies"...

Url changed from http://www.theverge.com/2015/6/10/8756837/startups-tech-bubb..., which points to this. Yes, I know it's behind a paywall, but this is an important article, it hasn't had a discussion here yet, and the standard trick for reading articles like this appears to work.

HN should just create an option to allow people to filter paywalled articles (or on title substrings more generally), that would satisfy everyone.

[Paywall] in the title would do it

Articles behind a paywall are at odds with the entire experience of collaborative link sharing on an aggregator. That's why I flag them.

I'm just an ordinary user but I'll do what can to make improve the site by pushing them down in the rankings, especially given that others feel the same: https://news.ycombinator.com/item?id=9329810

Thanks for being concerned for the quality of HN! We're grateful for users like you. But please don't flag stories only because of a paywall. Accounts that repeatedly do so lose their flagging rights. You should flag stories because of content, not provenance.

The HN guidelines explicitly call for original sources. We want the best, most substantive version of a story. Other things being equal, we all prefer non-paywalled articles, but when things are not equal, substance should win. Compare the WSJ piece to the originally submitted URL in this case (it's mentioned upthread). There's no question which one belongs on HN.

When there are standard workarounds to read the content, paywalls are just an inconvenience.

The more this comes up [1], the clearer it gets that we shouldn't ban paywalls. The NYT, New Yorker, Economist, WSJ, and others are major sources. HN would be poorer without them.

1. https://hn.algolia.com/?sort=byDate&prefix&page=0&dateRange=....

Sorry, what's the workaround for reading this article? Does it cost money?

In general, you can simply Google the title of an article and following the link in Google search results will circumvent the paywall.

Google demotes links in their search results if they don't allow "first click" access to the content.

Further discussion in this thread: https://news.ycombinator.com/item?id=9531941

Yeah, I tried that for this article and it didn't work. I thought there might be some other way. Thanks though.

Were you using encrypted Google, or via !g on DDG? The trick only works through the non-encrypted one.

Oh yeah, I had HTTPS-Everywhere on. Thanks a lot!

Happy to help! I myself just learned about that nuance the other day.

I'd argue that flagging paywalled pages is based on content and not provenance. If I follow a link and can't read the article then there is effectively zero content.

That's a good point and I agree. But the standard workarounds mean that the content is available. It's an annoyance to have to follow two links instead of one, or open a different window. But the cost/benefit of sacrificing good content to avoid that annoyance would be way off for HN.

FWIW, even the changed link on HN ( http://www.wsj.com/articles/how-tech-startups-play-the-numbe... ) didn't work for me, I still had to Google it first.

A referer Request Header thing maybe?

The link wasn't changed to evade the paywall.

Obligatory paywall workaround link:

https://www.google.com/search?q=tech+startups+woo+investors+...

Why has no one created a bot for this?

Fear of prosecutorial discretion and the U.S. Legal systems inability to differentiate between criminal hacking and violation of TOSes?

https://news.ycombinator.com/item?id=9531941

Reply on news.ycombinator.com