Recently, I overheard a conversation between an entrepreneur and his mentor. The entrepreneur had an idea for a company but was concerned about the legal framework necessary to be in business. The mentor told this young man not to be concerned about business cards, incorporating, or any other compliance activities until he actually had a customer and a proven model. Once these were up and running, there would be plenty of time to think about the legal and compliance framework necessary for business.
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Some software founders may have received this same advice for their company. Based on this advice, the founders may have purchased QuickBooks and began to record their accounting transactions within its databases. However, the company may now have reached a point where compliance is more valuable than the cost savings of noncompliance and it is time to migrate off of QuickBooks. To illustrate this point, let’s determine the costs/benefits between compliance and noncompliance regarding Vendor Specific Object Evidence of Fair Value or VSOE.
Benefits of VSOE Noncompliance: The main benefit of not complying with the revenue recognition rules regarding VSOE is the cost savings. These cost savings may include software expense savings since the business will continue to use QuickBooks instead of a GAAP compliant system. Other cost savings may include not having to hire additional full time employees to track VSOE within a spreadsheet.
Costs of VSOE Noncompliance: Investors, Bankers, and vendors desire to work with businesses that are financially stable. All of these groups are usually willing to take a discount in some form (lower interest rate, better terms, etc.) because financial stability lowers the risk of interaction. Companies that choose not to comply with VSOE revenue recognition rules should expect the cost of capital to be more expensive since they cannot provide proof of stability.
Benefits of VSOE Compliance: As noted above, software companies that comply with VSOE rules should expect a discount for cost of capital. However, there are even more benefits than lower borrowing costs. By establishing VSOE, software companies have created a tight band around pricing. Based on the bell curve approach, to maintain VSOE the final price cannot move more than +/- 15%. This reduces the amount of discounts that are given to customers too freely by the sales team. In addition, VSOE compliance can make the company an attractive merger or takeover target if the founders are interested.
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Costs of VSOE Compliance: VSOE compliance is complicated and will require some cost outlays to obtain. If management insists upon staying with QuickBooks, the accounting group may have to increase their employee headcount so that they can properly track all of the proper calculations within spreadsheets. Or, if the company is ready to switch from QuickBooks, they may have to spend some capital on purchasing a new system.
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In our opinion, the benefits of VSOE compliance clearly outweigh the costs of compliance and the costs and benefits of noncompliance. For managers that are weighing the costs and benefits of staying with QuickBooks verses moving to another system, you might want to consider NetSuite. Besides all of the above mentioned benefits of VSOE compliance, other cost savings include a reduction of IT costs since the system is cloud based. If you would like to learn more, please contact us.