When growing a startup, managing finances is important. Not just for day-to-day operations but also for securing funding, building investor confidence, and ensuring regulatory compliance. Especially when raising funding through equity crowdfunding, a startup may come across financial reviews and financial audits. While both examine a startup’s financials, they serve different purposes and can vary in terms of scope, cost, and time. In this blog, learn more about financial reviews vs. financial audits, the use cases for each, and how to determine which route may be best for your startup.

Financial Review vs. Financial Audit

Financial Review

A financial review is a limitation examination of a startup’s financial statements, typically conducted by an independent certified public accountant (CPA). A financial review may provide “moderate assurance” that the financial statements are free from material errors. It involves analytical procedures and inquiries, but does not include in-depth testing of transactions or internal controls.

Key Characteristics:

• Less Rigorous: The CPA conducting the review does not verify each transaction within the financial statements but instead performs analytical checks and asks questions of management.
• Lower Cost: Since a financial review typically requires less time than a financial audit, a financial review may come at a lower cost.
• Faster Turnaround: Due to the lesser time constraint, financial reviews may be able to be completed in weeks rather than months.
• “Limited” Assurance: After the review, the CPA expresses that they are not aware of any material modifications that are needed to comply with accounting standards.

Why a Startup Might Need a Financial Review

Early-stage startups that are seeking seed funding may opt for a financial review to provide confidence for investors without the time and expense of a financial audit. Additionally, some venture capital firms, angel investors, or equity crowdfunding platforms may require a financial review before investments can be made.

Financial Audit

A financial audit is a comprehensive examination of a company’s financial records, internal controls, and accounting standards. Typically conducted by an independent CPA, an audit may provide “reasonable assurance” that the financial statements are accurate and free from material errors.

Key Characteristics:

• Highly Rigorous: The CPA conducting the audit tests transactions, verifies balances, assesses internal controls, and may even physically inspect assets.
• Higher Cost: Due to the depth and time of work, financial audits can be more expensive than financial reviews.
• Longer Process: Due to the amount of time needed, a financial audit can take several weeks to months, depending on complexity.
• “Reasonable Assurance”: The auditor issues an opinion at the end of the financial audit on whether or not the financial statements are presented fairly.

Why a Startup Might Need a Financial Audit

For certain fundraising methods, like Regulation A+ (Reg A) or raising larger amounts through Regulation Crowdfunding (Reg CF), an audit may be mandatory for a startup. Additionally, later-stage investors may require audited financials before closing a round as part of their due diligence.

Financial Reporting Requirements & SEC Exemptions

As mentioned before, there are sometimes requirements for financial reviews vs. financial audits when fundraising through certain SEC exemptions. Regardless of whether financial statements are self-certified, reviewed, or audited, they should be prepared in accordance with U.S. generally accepted accounting principles (GAAP) and include balance sheets, statements of comprehensive income, statements of cash flows, statements of changes in stockholders’ equity, and notes to the financial statements. If the financial statements are not audited, they must be labeled as “unaudited.”

Reg CF

Raising capital through Reg CF has varying levels of financial disclosure requirements depending on how much capital a startup is raising. The guidance below applies to financial statements for the longer of the two most recently completed fiscal years, or from inception through the end of the most recently completed fiscal year.

$124,000 or less

If a startup is raising up to $124,000, the reporting requirements are not as extensive as larger amounts of funding. Startups will need to provide financial statements that include the amount of total income, taxable income, and total tax (or equivalent line items) as reported on federal income tax. The financials need to be certified as accurate by the principal executive officer of the issuer.

However, if the startup already has independently reviewed or audited financial statements, it needs to provide those financials.

Between $124,000 and $618,000

If a startup is raising more than $124,000 but not more than $618,000, it needs to provide  financials reviewed by an independent CPA. However, if the startup has independently audited financials, those must be provided.

Between $618,000 and $1,235,000 (and has not previously raised through Reg CF)

If a startup is raising more than $618,000 but not more than $1,235,000, and has not previously sold securities through Reg CF, the startup must provide independently reviewed financials, unless audited financials are available.

More than $618,000 (and has previously raised through Reg CF)

If a startup is raising more than $618,000 and has previously sold securities under Reg CF, the startup must provide audited financials.

More than $1,235,000 (regardless of previous Reg CF raises)

Whether or not a startup has previously raised through Reg CF, if it is raising more than $1,235,000, the startup must provide audited financials.

Reg A

The financial reporting requirements for Reg A differ whether the startup is raising under Tier 1 or Tier 2. As with Reg CF, financial statements must be provided for the longer of the two most recently completed fiscal years, or from inception through the end of the most recently completed fiscal year, the most recent of which is less than none months old. If interim financial statements are needed, they must cover a period of at least six months.

Tier 1

Regulation A’s Tier 1 allows startups to raise up to $20M in a 12-month period. Audited financials are not required unless the startup has previously had a financial audit for other purposes.

Tier 2

Regulation A’s Tier 2 allows startups to raise up to $75M in a 12-month period, and audited financials must be provided.

Which Type of Financial Preparation Should a Startup Choose?

The decision on whether a startup should choose a financial review vs. financial audit is dependent on various factors like fundraising types, fundraising goals, and the purpose of the financial preparation. If pursuing a financial review or audit for fundraising purposes, the startup should consult with the broker-dealer or funding portal they plan to conduct the offering under to see what requirements the SEC has compared to the requirements the individual platform might have.

Final Thoughts

For startups, financials could be considered the backbone of fundraising and growth. Ensuring that financial statements are accurate and up to date play a large role in investor due diligence, investments, and compliance. While financial reviews may be less time intensive and cheaper, startups should consider their goals and use cases for the review or audit when making the decision. If your startup is unsure which path to take, consider consulting with a CPA or legal advisor who is familiar with startup funding.

Is your startup looking to raise capital? MicroVentures may be able to help. Apply today to raise capital with MicroVentures!

Want to learn more about fundraising for a startup? Check out the following blogs to learn more:

• Flexibility vs Ownership: Revenue-Based vs Equity Financing
• Cap Tables 101: The Foundation of Startup Investment
• Raising Capital with MicroVentures
• A Startup Guide: Preparing for Due Diligence

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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.