
Financial Misstatements - edward
http://blog.samaltman.com/financial-misstatements
======
kevin
Here's the biggest offenders I see when talking to founders:

    
    
      revenue vs GMV
      (if you give GMV, give me your cut/margin)
      contract vs LOI
      burn vs expenses
      users vs customers 
      (customers pay)
      signups vs users vs active users
      (you should give active with time interval and measurement of active. 
       eg. logged in last 30 days)
      profitable vs cash flow positive
    

Others people should know:

    
    
      diff between retention rate vs churn rate
      (both should be given with time interval. 
       eg. 30 day retention rate is...
           monthly churn rate is...)
      voluntary churn vs involuntary churn
      gross vs net
      top line vs bottom line

~~~
Havoc
>“GMV” (gross merchandise volume)

Interesting...been in finance all my life & dealt with pretty much every
industry out there...never heard this one before. Must be some type of startup
slang so to speak.

~~~
sumanthvepa
It's a term of the trade in the retailing (and by extension e-commerce)
industry. It refers to the value of the goods sold. If a retailer sells a
widget for $100 at 50% margin, then the GMV is $100 and revenue to the
retailer is $50.

~~~
Havoc
>It's a term of the trade in the retailing

No its not. I've seen dozens of retailing operations in multiple countries.
None use this term, which brings me smoothly to my next point...

>It refers to the value of the goods sold.

aka CoGS (Cost of Goods Sold) (or CoS in some regions). Unlike GMV you'll
actually find that on the financial statement of major retailers. As I said:

>Must be some type of startup slang so to speak.

Would be curious to hear if there is some actual business reason that warrants
giving this a new name in the startup context though...

~~~
waterlesscloud
Wait... I thought COGS referred to the production costs of goods sold. The
direct material and labor costs. For example, in a restaurant it would involve
food costs and wages for cooks.

GMV sounds like it refers to what in this example would be revenue from the
finished food. A burger COGS is meat+bun+cook, a burger GMV is the menu price.

Am I wrong in my understanding?

~~~
Havoc
No. Its a bit of a regional difference. UK affiliated people prefer "cost of
goods sold" while the rest of the world uses "cost of sales". They're
essentially interchangeable with CoGS leaning towards enterprises that produce
physical goods.

>GMV sounds like it refers to what in this example would be revenue from the
finished food.

GMV was pulled out of thin air & means nothing at all, aside from CoGS/CoS
with a lick of startup paint. Anyone that reckons otherwise please step
forward with a coherent argument...

------
evo_9
Mr. Altman is talking about the basic misunderstanding of these terms and it's
surprising to me that he didn't take a bit of time to define the terms
himself. Maybe I'm naive and those terms are a lot harder to define than I'm
imagining, but even then some references linking to other sites could have
been provided.

I really enjoy reading Sam's posts and I'm usually bookmarking and/or
forwarding his articles to a ton of friends. This one is a nice amuse-bouche
but I guess I'm use to getting a full meal from Sam. Maybe a quick update with
some links is all it needs? Good read otherwise.

~~~
skilbjo
I agree. I'm a CPA and some of these terms (GMV) I've never heard before (must
be because I'm in a different industry - payments, and we use TPV - total
payment volume), and others (burn) are ambiguous to my accounting brain.

Is that cash flow used to fund operations? Is that the accrual based operating
expenses? Is that the difference in cash between this month and last month?

------
dboreham
This post sounds fishy to me. If the "financial statements" are sufficiently
important for the fine details to matter, then they need to be produced by
someone who knows exactly what they are doing (a properly qualified
accountant). If they aren't important (why are the financial statements for a
YC _applicant_ important?? surely they have zero revenue typically and nobody
believes their projections), then who cares if the terminology is slightly
wrong? Certainly if I were given such a document, I'd ask who prepared it and
go from there as regards how accurate I expected it to be.

Also, if your role is an incubator investor, isn't it your job to educate the
inexperienced founders about things like this?

fwiw I don't understand how anyone could confuse LOI with executed contract. I
mean, really the only way that the concept of a LOI can arise is when you ask
"can we get a contract in place?" and the answer is "not at this time" so you
counter with "how about an LOI?". Hard to get confused about that..

------
cryptoz
There are so many startup accelerators that take a team of engineers / product
people and do their best to make businesspeople out of them. I'm one of those
CEOs, for sure, and learning about the financial world, accounting, and trying
to make sure to not mis-speak was quite difficult.

The primary training I received during the accelerator helped a lot, but it
was more along the lines of how to more accurately model in excel. It was up
to the CEO (?CFO? if you're lucky) to get all this exactly right, and it's not
easy.

I think that when an accelerator knows that its teams are not well-versed in
the financial part of running a startup, there should be more emphasis on
helping them learn. It's daunting to try to do that alone.

~~~
codemac
What are the reasons startups can't hire good finance people? Or at least
contract with an expert?

Is it a difficulty in judging their abilities when it's not your area? Is it
something where only at a certain size would it be worth the reduced financial
risk to have someone on it? Learning from scratch has to be the slowest,
highest risk way of doing it -- which is the exact opposite of what a startup
should be optimizing for (reduce risk where possible, move fast)

It seems like helping identify business talent is what an accelerator should
be helping with, not becoming a half assed B-school for engineers..

There's some implicit assumption here that learning from scratch is better
than hiring talent, and I think that's a mistake.

~~~
dandare
"What are the reasons startups can't hire good finance people?"

I think the reason is that you are in stage where the CEO personally empties
the rubbish bins in the office, that's why.

~~~
dllthomas
Offloading finance should arguably come before offloading janitorial. You can
be thinking about other things while emptying rubbish bins.

~~~
logicallee
you're a company. you're built to make something and grow it. outsourcing
financials (I don't mean getting help with them, but actually offloading them)
is in some ways like outsourcing development.

the "CEO" personally does finances for the same reason the "CTO" personally
codes. If either of them can't do something they learn it.

Sam is saying: learn these words.

~~~
dllthomas
I do want to make a distinction between "offloading" and "outsourcing".

That said, you may very well be correct. My point was simply that, if it's a
good idea, it's mostly _not_ for the same reason that has the CEO emptying
waste baskets.

------
tkiley
I agree with Sam's message, but I sympathize with founders who make mistakes
here.

Founders are told to hustle, to aggressively push themselves and their visions
in order to build momentum for their businesses. Founders are encouraged to
bend - if not break - the rules in order to get things done.

First-time founders are thrown into the world of finance with a good deal of
ignorance about the meanings and conventions of specific financial terms,
combined with a culturally ingrained bias towards spinning things as
positively as possible. Broadly speaking, this seems like a recipe for
disaster.

~~~
rokhayakebe
_mistakes_

Color me stupid, but I am sure the vast majority of founders know exactly what
they are doing when they give GVM in place of revenue.

For example no one would buy a home for $200M, sell it for $201M and say I
made $201M last year.

~~~
tempestn
Not necessarily; many would consider $201M the revenue and $1M the "profit" or
"earnings" in that case.

~~~
dkural
but they'd know they didn't make 201M - and conceptually that them buying and
selling that house doesn't value them like a 201M revenue publicly traded
company with billions in market cap. Founders know exactly what they're
overselling. They do it for spin.

------
t23
I'd recommend the following books: Financial Statements Step by Step
([http://www.amazon.com/Financial-Statements-Step-Step-
Underst...](http://www.amazon.com/Financial-Statements-Step-Step-
Understanding/dp/1601630239))

Financial Intelligence ([http://www.amazon.com/Financial-Intelligence-Revised-
Edition...](http://www.amazon.com/Financial-Intelligence-Revised-Edition-
Managers/dp/1422144119/ref=pd_bxgy_14_img_z))

Financial Intelligence for Entrepreneurs ([http://www.amazon.com/Financial-
Intelligence-Entrepreneurs-R...](http://www.amazon.com/Financial-Intelligence-
Entrepreneurs-Really-
Numbers/dp/1422119157/ref=sr_1_1?s=books&ie=UTF8&qid=1440176755&sr=1-1&keywords=financial+intelligence+for+entrepreneurs))

------
mynegation
I can recommend Brian Bushee's accounting course on Coursera:
[https://www.coursera.org/course/whartonaccounting](https://www.coursera.org/course/whartonaccounting)

[http://www.investopedia.com/](http://www.investopedia.com/) is helpful for
occasional reference

~~~
rglover
Thanks! Signed up for the next session.

------
chollida1
[https://en.wikipedia.org/wiki/Gross_merchandise_volume](https://en.wikipedia.org/wiki/Gross_merchandise_volume)
[https://en.wikipedia.org/wiki/Letter_of_intent](https://en.wikipedia.org/wiki/Letter_of_intent)

for people like me who weren't aware of the term.

This is yet another way in which Y Combinator can differentiate themselves as
a place for startups. A once a week course on this type of material would
probably be very useful for most founders, I'm working under the assumption
that most Y Combinator founders are first time founders.

As a side note, it feels like this type of communication straddles the
boundary between something that could have been a tweet vs a blog post.

------
joshjkim
Interesting idea: VCs should have in-house finance folks specifically meant to
work with portfolio companies who spent a few days a month for year 1 after
investment, or until the company gets it own finance team. Most VCs do less
than 10-15 deals a year, so this seems tolerable and a relatively low cost way
of to really know what's going on with the portfolio. (I know some VCs already
kind of do this (Vantage Point). Also, harder for YC, given # of investments,
so maybe not as applicable for true seed funds but still might be worth it -
I'm sure they could get 5 mid-career CPAs for the price of one partner, and
they would love the job! I think)

The fun part is that then the VCs will have a direct line into the company's
nitty-gritty operations, which really they are entitled to receive anyhow
(though usually they just take the board deck at its word..which is not always
good).

This might suck for the company since you have the VC in-the-know on your
nitty-gritty (though I'd argue that if you don't want them in-the-know, you
should not have taken their $$...though I understand it's more complicated
than that haha), BUT that might also serve to incentivize the company to build
out the finance team quickly, and also give the management team a taste of
what a good finance person can provide (assuming the person the VC provides is
good, which they should be if they are to be trusted with multiple portfolio
companies).

~~~
OliverJones
Not such a great idea, in my opinion.

There are honest and competent people willing to work one day a week as
contract CFO. Such a person works as part of the management team and doesn't
have divided loyalty (management / investors).

~~~
joshjkim
you are right, I've worked with a few. Problem is that it's a cost to the
company they often don't want and they don't value the work (I think this is
what SA is trying to change). Also, vetting/hiring folks etc. is it's own
burden. VC pushing this gets rid of the friction and forces founders to take
this seriously.

Agreed they may have divided loyalty, hopefully mitigated by a very temporary
relationship and the fact that at early stages, VCs and founders should be
super aligned, at least around the ops numbers (sale decisions, etc. are a
totally different ballgame for sure).

------
w1ntermute
It's pretty amusing to see this post coming from a guy who's publicly stated:

> I can't read a balance sheet or income statement or anything like that. I
> have to have someone explain it to me, every Board meeting.

[http://www.econtalk.org/archives/2014/07/sam_altman_on_s.htm...](http://www.econtalk.org/archives/2014/07/sam_altman_on_s.html)

~~~
domdip
There's no hypocrisy there. He's probably had to personally be super-cautious
about opening his mouth about things like this.

------
smacktoward
This post leaves a bad taste in my mouth, at least to the degree it's talking
about executives of YC companies.

I mean, the whole model of YC is to take kids straight out of college (if not
before) and turn them into startup CEOs. If those CEOs come out of that
process not understanding the legal obligations of their new position, whose
fault is that, exactly? It's not like they're bringing decades of business
experience to the gig. The only thing they know about what being a CEO
requires is what YC teaches them.

If their only preparation for the post is YC, and they're ending up ignorant
of stuff that could get them slapped with a felony charge, I would think that
would say more about YC than it does about them.

~~~
tobyjsullivan
My impression of YC has never been that it is some hand-holding after school
special. This is an investment firm in the world of business and the world of
business is very serious. As a startup founder, you are treated as an adult
and that includes both the freedoms and responsibilities implied.

That said, you may have a point here. If there is a recurring issue that some
founders are too immature for their own good and might be a risk to their own
personal safety (e.g., committing felonies out of pure ignorance), YC should
probably be intentional about filtering those people out during applications.
But this article isn't just about YC candidates and that's not a solution for
the whole industry.

~~~
gohrt
It's strange that you think that an investor who _owns 7% of a company_ is
"being serious" by declining to do any diligence about _illegal behavior_
undertaken by management.

~~~
dang
You have no basis for that statement.

~~~
mildbow
Isn't the whole article pretty much basis for that ? :(

If sam is saying YC founders are using terms wrong, doesn't that imply that YC
_was fine with_ those terms?

So confused.

Anyway, the simple fix would be to just have a 1-3 day finance bootcamp to
make sure everyone speaks the same language. Rather than getting everyone to
try to being kinda-sorta competent.

~~~
dang
> Isn't the whole article pretty much basis for that

For "declining to do any diligence about illegal behavior"? Of course not. Why
did this topic come up in the first place?

Re lack of diligence, it's astonishing how people jump to make mean, false
statements without a second's pause to consider the obvious.

------
Maro
There's a great book called 'The HBR Guide to Finance Basics for Managers',
about 200 pages:

[https://hbr.org/product/hbr-guide-to-finance-basics-for-
mana...](https://hbr.org/product/hbr-guide-to-finance-basics-for-
managers/an/11185E-KND-ENG)

It doesn't specifically address the terms in the OP, but it should be the
starting point for non-MBAs (like myself) to start understanding basic
Finance.

In my experience, if you're a co-founder and you don't understand basic
Finance and let your Finance department do whatever it's doing you may be
setting yourself up for trouble. The OP described the other case of simply
saying non-sense because you don't understand the terms :)

------
sama
(By the way, we do teach this stuff at YC. But obviously we only fund a small
percentage of the startups in the world.)

------
logn
> One particularly bad one is misunderstanding or misusing basic financial
> terms. I started noticing this in Y Combinator applicants a couple of years
> ago [...] I’ve seen people use GMV for revenue or refer to an LOI as a
> contract many times in the past year when talking to investors. This is a
> felony.

Not sure who the target audience is. If a business person is willfully
deceiving people, let's call that out. But if a programmer is using financial
jargon they don't understand, then let's educate them.

It's not hard to read this blog post and come away believing that if you use
the wrong acronym accidentally the author thinks you're a felon. I'm sure
that's an overstatement, but overall this could have been an article that was
educational yet had a serious warning. Instead it kind of stirs drama and
fear. That's fine but I can't help but compare PG's essays which are a delight
to read and get lost in.

------
001sky
_" This is a felony."_

This is probably a too-broad-brush use of the word.

Other than that, I like this essay.

People should be taught financial literacy early and accurately. Like learning
maths notation: It's useful, compact and efficient. But...it must be precisely
grasped/implemented to be of any benefit to speaker or the audience.

------
pyrrhotech
I like Sam, and I even agree with him in this post. However, I don't think
everything he blogs about needs to shoot straight to the number one spot on
HN. I'm not sure if this is the community's voting or the YC algorithm's bias,
but it would benefit the community if we could stop the fawning and treat his
posts like we would anyone else's.

------
jsprogrammer
>This is a felony and it’s called fraud, even though it’s usually
unintentional.

This is incorrect. Fraud requires intent. Otherwise it's just negligence.

Should probably throw a legal dictionary in with the financial one.

~~~
tptacek
That's a valid point, but if you think about what it's like to raise money, do
you _really_ want to be in the position of establishing --- to a prosecutor's
satisfaction, since being dragged into court for this is game-over --- that
you were unaware of the materiality of these distinctions when you improperly
made them to potential investors?

From model jury instructions, which might be misleading here: the "intent" a
prosecutor needs to establish is that you knowingly said something false, in
the process of seeking something of value, that the falsehood was material to
the decision of whether to give the thing of value to you, and that the other
party later gave you that thing.

The bigger issue is it's very very very very very unlikely that a tiny startup
is going to be prosecuted for attempting to defraud an accredited investor.

~~~
rbcgerard
I agree, but there is also the civil aspect, and while its exceedingly
unlikely that this would become a criminal matter, the civil liability could
be substantial...

------
davidw
Brad Feld had something similar to say recently:

[http://feld.com/archives/2015/07/dont-try-fake-
language.html](http://feld.com/archives/2015/07/dont-try-fake-language.html)

------
jdoliner
From the TC article about Uber today:

> This year, the firm expects to clock $10.84 billion in revenue which —
> calculating the 20 percent commission that it takes — should bring in around
> $2 billion in revenue for the year.

------
jamram82
So where can one learn about financial terms or processes before running a
company ?. Most people are familiar with AWS than with SEC.

------
OliverJones
A voice recognition company was in the process of IPO in the mid 1990s. They
had some big purchase orders from institutional customers. The trouble was,
those POs had side letters giving the customers the right to return the
products for credit if they didn't work correctly.

Not disclosing those side agreements to investors was treated as felony
securities fraud. It made the company seem more valuable than it really was.

That's the whole dealio. Don't cook the books. Don't make stuff up. There's
enough that can go wrong even if you are transparent with investors about your
deals.

~~~
tptacek
That's a nutshell description of "cash flow positive" versus "profitable",
right? It's about revenue recognition.

------
api
Some of the more extreme stuff is the fault of "stretch the truth till it
breaks" ideology in business culture. This stuff is dubious in any form IMHO,
but when naive first-timers without MBAs pick it up it easily devolves into
outright fraud. Someone who knows finance, law, and accounting inside and out
knows when and where to stop stretching, but non-experts in these areas do
not.

I've heard some jaw-droppers myself in conversations with other
founders/entrepreneurs over the years. It's okay to put a positive spin on it,
but it's not okay to lie. You can't say you are "cash flow positive" if you
are not in any way shape or form collecting actual cash from anyone.

If you don't understand MBA-level accounting and finance, then the safest and
most honest thing to do is stick to concrete numbers and things you clearly do
understand. Revenue is actual _dollars_ that land in your bank account-- real
money that really exists. Profit is revenue minus expense. Customers are
actual people or businesses who have given you money for an actual thing.
Contracts are actual promises to do so in the future for some length of time.
Users are people who are actually handling, running, or consuming your product
_right now_ , etc.

It's also perfectly okay to say "I'm not an accountant" in response to
questions you don't understand. Your prospective investors are looking for
someone to build a product and sell it, and if you can do that then that's
your expertise. Accountants and lawyers can be hired on a consulting basis
just like any other domain expert. It's okay not to have expertise in all
areas as long as your expertise is where it counts and you have
traction/results.

Investors will appreciate that too, since anyone operating as a VC or serious
angel will see right through any nonsense you spew. It will simply discredit
you, and any investor who doesn't have very sensitive radar for blowhards and
con men will not be an investor long.

------
mathattack
I've seen this is in many businesses. The biggest offense is gross vs net
revenue. "Oh, we're an X million revenue firm" is frequently tossed out, when
the company only keeps 15% of that to pay the bills. This is especially
prevalent in AdTech. I used to think this was lack of financial knowledge on
the part of the founders. Lately I've started thinking it's deliberate.

I see Virtual being an example of this too, though not in AdTech.

Some of this does fall on the VCs. It's very important for the VCs to dig into
financials before investing, and asking for precise definitions. It also
highlights the need for professional financial talent in startups.

------
snake117
After reading this and going through some of the comments, it may be worth
while for YC to hold a small online course, or at least make a small business
wiki, that discusses these terms and other concepts specifically in the start-
up domain. I mean especially if misusing these terms, unintentional or not,
can be considered as a felony, then it would really be worth while to at least
give them some information to read up. Even though the ideal team of founders
is one CompSci and one business, it seems that some of the business gurus
posting here have a hard time defining a few of these terms, like GMV. That's
just my two cents.

------
7Figures2Commas
> Although investors should be doing more diligence than is currently in
> fashion, this issue is on the founders to fix.

What incentive do founders have to "fix" this when investors aren't doing
adequate due diligence?

~~~
tptacek
The fact that they can be prosecuted for it.

~~~
7Figures2Commas
How many Silicon Valley startup founders have faced felony charges for making
financial misrepresentations in recent years?

~~~
jbenz
If you're choosing between "should I commit a felony or not" should it matter
how often other are charged with it? What happens if law enforcement suddenly
becomes more interested?

~~~
7Figures2Commas
Have you considered the possibility that founders aren't being charged with
felonies left and right because they're not committing felonies left and
right?

------
krallja
Look what A16Z just posted:
[http://a16z.com/2015/08/21/16-metrics/](http://a16z.com/2015/08/21/16-metrics/)

------
fredgrott
Note that the freelancer startups do this emphatically...

UpWork Toptal Gun.io

all list Revenue as total amount via gigs posted not as total amount actually
awarded via finished gigs..ie project revenue on system which means that they
are over or understating their actual earhed revenue from project fees

Easy to catch as in accounting terms you would list the full project revenue
listed on system times the percent project fees as unearned revenue and the
booked earned project fee revenue as earned revenue.

~~~
bbeneschott
Background: I am the COO of Toptal

This is simply not true for Toptal. Our publicly stated $80,000,000 ARR is top
line.

[http://www.toptal.com/press-
center/top-3-percent](http://www.toptal.com/press-center/top-3-percent)

For additional clarification:

You don't post "projects" on Toptal. Everything we do is time & materials, so
the concept of misrepresenting financials based on posted projects simply
isn't possible. ARR is calculated by actual sales right now multiplied out for
a year of time.

------
rbcgerard
I find most people can't name the summery lines of an income statement
(Revenue>COGS>gross profit>sg&A>operating profit> etc.) let alone a balance
sheet or cash flow statement. but frankly the one annoys me the most is is the
way "cash flow" is misused.

BTW this comes into play
[https://en.wikipedia.org/wiki/SEC_Rule_10b-5](https://en.wikipedia.org/wiki/SEC_Rule_10b-5)

~~~
Nicholas_C
Not a startup guy but a finance guy, how is cash flow misused?

------
edpichler
Accounting is so important and so underrated.

With a good accounting you can check the health of any company with just
minute reading of the statements, cash flow, profit/losses, debits for short
term, investments, etc.

With accounting you can easily know how your investments are going, when you
have many and other people administrating.

You can also use accounting to invest in good companies for long term, and for
this, I recommend Peter Lynch books.

------
BreakoutList
[https://quip.com/32zVAMYAi29n](https://quip.com/32zVAMYAi29n)

------
DrNuke
It's a learning process. A lot of times the Bay Area (like some other places
in the world, for different endeavours) is the first real-life encounter with
excellence and some times with geniality. Experiencing failure will make
felons better, if they survive rejections, mature and learn from mistakes.

------
Havoc
>misunderstanding or misusing basic financial terms

Well if you stick the average finance guy in front of a python JIT compiler
anyone looking over his shoulder will conclude he's an idiot. Yet somehow the
average IT guy thinks it just takes a bit of terminology to "get" the finance
side.

------
clairity
this is where having an MBA (or undergrad business degree) can be helpful.
note, i'm not saying you need a business degree to be a founder, just that it
can help if you already have it. =)

in business school, you learn that much of finance & accounting is
storytelling with numbers, but with the added twist that there are legal
consequences for crossing over (and sometimes, just into) the gray area.
that's what sam is pointing out, where the gray area ends and the legal
consequences start.

as others have pointed out, quantitative finance & accounting classes can be
very helpful:

    
    
      * financial accounting
      * managerial accounting
      * financial markets
      * investment finance
      * corporate valuation
      * entrepreneurial finance

------
codezero
What are some books or resources to get a crash course on these terms and
their context?

~~~
aet
The Wall Street MBA by Advani

------
jknightco
Can someone clarify the difference? Using Uber as an example: their GMV is the
sum of all fares, whereas revenue is the 10% they take off that number—is this
correct?

------
jbverschoor
And walking away from a handshake deal is breach of contract.

~~~
bengali3
but only if the contract period was for less than 1 year, iirc. and also the
issue of authority-to-bind comes into play as well..

for protection from a verbal deal going bad, see also:
[https://en.wikipedia.org/wiki/Estoppel#Promissory_estoppel_2](https://en.wikipedia.org/wiki/Estoppel#Promissory_estoppel_2)

------
mcarthur_gill
Anybody else have solid resources to learn this stuff?

------
GFK_of_xmaspast
"""I’ve seen people use GMV for revenue or refer to an LOI as a contract many
times in the past year when talking to investors. This is a felony."""

How come it's only "disruption" when it happens to somebody else.

