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Accounting for Venture Capital Firms

Dec 22, 2021

Venture capital is a form of private equity and a type of financing that investors provide to startup companies and small businesses. This especially pertains to companies with an expectation to have extraordinary growth potential or have had remarkable recent growth. Venture capital is generally provided by investment firms and banks; however, it does not always take monetary form. In many cases, venture capital can be provided in the form of technical or managerial expertise.

Venture capital is becoming very popular, and in some eyes, an essential source for raising money. Especially for those without access to bank loans, capital markets, or other debt instruments. Although this is risky for investors, there is potential for significant returns. This is the contradicting payoff that keeps investors actively participating in these processes. As an investor, you can even receive equity in the company and have a voice in company decisions.

Venture Capital Accounting Standards

When accounting for VC firms, you must abide by the accounting standards put in place. The issuers of these standards are the Financial Accounting Standards Board (FASB), and the International Accounting Standards Board (IASB). However, depending on your jurisdiction, there may be other standards-issuers.

When writing these standards, venture capital was definitely not top of mind. This creates the need to modify the format for venture capital fund accounting to clearly illustrate the operations and financial situation of the firm. As far as financial statements are concerned, there are deviations in the terms the venture capital firms have with each company it invests in, the purpose of the invested funds, and the needs of their investors. Some of the most important venture capital accounting needs include: 

  • Tax planning that includes state, local, and international tax consulting services, strategy, and structure
  • Internal audit assessments
  • Full-scope auditing
  • Financial modeling, projections, and other complex financial projects
  • Various business valuations
  • Transaction advisory services
  • Purchase price allocation
  • Systems development, such as accounting, internal control procedures, and budgetary systems

Venture capital fund accounting may also be affected by the amount of control the fund has over an entity. For example, under the U.K generally accepted accounting principles (GAAP), equity accounting is required if the investment provides the fund with a 20-50% minority stake in the company and is not part of a larger portfolio. Whereas the U.S. GAAP does not require equity accounting for these instances.

However, the International Financial Reporting Standards (IFRS) require equity accounting when they are not valued fairly through a profit and loss. The accounting standard for VC firms also affects the treatment of partner capital. Under U.S. GAAP, partner capital will be treated as equity unless there is an agreement in place stating a specific time of investment redemption.

Keeping Track of LP Ownership Percentages

Accounting for VC firms can become somewhat complicated compared to bookkeeping for a startup. At the most basic level, you must keep an accurate record of what the fund owns, what its cost basis is, and what its valuation is, as well as the cost of running the fund.

Fund managers must keep track of which limited partnership (LP) owns what percentage of each holding within the fund. Additionally, they must continue to make rolling capital calls over their lifespan. These private company holdings are completely liquid with multi-year holding periods until they reach liquidity, but are almost impossible to value accurately until then. In a perfect world, LPs will all come in simultaneously, but we know this is very unlikely. Most LPs will come in at slightly different times; for example, the last LP might come in well after the fund investment start date. This then brings up the issue of devising a fair method for allocating the early investments to the later LPs, creating the need to rebalance who owns what percentage of the holdings.

Calculating GP Profit Shares

Another fairly complicated issue related to accounting for VC firms is the calculations of general partner (GP) profit shares.

The reasoning behind this pertains to hurdle rates. This ensures that LPs capital is paid back in full before GPs are paid anything. One must continually update valuations of holdings, exit proceedings held in escrow, lock-ups, and holding periods. These are based upon the IPOs, and circumstances where portfolio companies have yet to be sold in the conclusion of the fund and must be distributed accordingly to LPs.

Finally, rules for which portions of fund money are subject to management fees, and for how long often, become somewhat complicated. LPs do not want to overpay fees or create wrongful incentives. As a result, management fees must be calculated and deducted from the fund or moved between fund accounts.

Keeping track of LP ownership percentages and calculating GP profit shares must meet completion in the most convenient and tax-efficient manner possible. This will do away with any possibility of incorrect taxation on income. Properly designing and operating a venture capital fund is an extremely complex process. It requires excellence in many legal, accounting, and tax concepts. Ideally, you should seek help and assistance from experts in this field. They will confirm that the fund structure and documents are correct, creating a clear and fair allocation. 

The SoftLedger Solutions

Although a tool like Excel is flexible and has robust analysis capabilities, it does not have the functionality necessary to manage financials for multiple subsidiaries, properties, or other entities in a convenient and efficient way.  Reporting on investments in a timely and accurate manner is no small feat. If your consolidation accounting software isn’t capable of handling multiple companies, it could be holding you back from getting the information you need. 

With SoftLedger’s multi-entity accounting system, you can quickly and easily consolidate multiple companies, geographic regions, investments, and more. As for recording transactions concerning your various business segments, the journal entries in relation will instantly roll into your financial statement. With our consolidation accounting software, your reporting is always only a few clicks away. Further, our intercompany elimination tool calculates and books your intercompany eliminations automatically.

No matter what size firm you are operating, correct equity allocation and taxation on income must be accurate. If you’d like to learn more about SoftLedger’s venture capital accounting software, book a demo with one of our team members today!

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Ben Taylor
CEO & Co-Founder at SoftLedger

A CPA with more than 10 years of varied public and private accounting experience, Ben has led many complex financial projects to successful outcomes.

He began his career at Ernst & Young, followed by in-house management roles at Fannie Mae and other public companies.

Ben holds a B.S. in Accounting from the University of Maryland.

Frequently Asked Questions

Yes, users have the option to use their own chart of accounts or SoftLedger’s standard chart of accounts when getting started with SoftLedger.  SoftLedger’s flexibility allows users to make changes to their charts by easily adding new accounts.

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