
Tech Startups Woo Investors with Unconventional Financial Metrics - jrs235
http://www.wsj.com/articles/how-tech-startups-play-the-numbers-game-1433903883
======
rmason
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...](http://feld.com/archives/2015/06/get-information-
entrepreneurial-ecosystem-hbo-youre-screwed.html)

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

~~~
wjnc
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.

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

~~~
wjnc
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.

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notahacker
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

~~~
jonlucc
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.

~~~
jackgavigan
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...](http://hortonworks.com/press-releases/hortonworks-reports-financial-
results-fourth-quarter-fiscal-year-2014/)

------
scriptman
This was indirectly discussed here:
[https://news.ycombinator.com/item?id=9705832](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...](http://mattermark.com/important-financial-indicators-
for-startups-at-every-stage-of-growth/)

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mathattack
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.

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

~~~
cm2187
Exactly. And that often goes with the other truth: "real estate never goes
down".

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

~~~
cm2187
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.

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beat
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.

~~~
rockinghigh
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.

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

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dang
Url changed from [http://www.theverge.com/2015/6/10/8756837/startups-tech-
bubb...](http://www.theverge.com/2015/6/10/8756837/startups-tech-bubble-
profit-loss-ipo), 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.

~~~
smtddr
FWIW, even the changed link on HN _([http://www.wsj.com/articles/how-tech-
startups-play-the-numbe...](http://www.wsj.com/articles/how-tech-startups-
play-the-numbers-game-1433903883) ) _ didn't work for me, I still had to
Google it first.

A referer Request Header thing maybe?

~~~
foobarqux
The link wasn't changed to evade the paywall.

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colinbartlett
Obligatory paywall workaround link:

[https://www.google.com/search?q=tech+startups+woo+investors+...](https://www.google.com/search?q=tech+startups+woo+investors+with+unconventional+financial+metrics)

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devbug
Why has no one created a bot for this?

~~~
jrs235
Fear of prosecutorial discretion and the U.S. Legal systems inability to
differentiate between criminal hacking and violation of TOSes?

