Last reviewed October 7, 2026 · By the NYBACS advisory team
Short answer
The most common audit issues in early-stage companies are equity and financing instruments recorded incorrectly (SAFEs, convertible notes and option grants), revenue booked on a cash basis instead of when earned, unrecorded liabilities, missing lease accounting, undocumented founder and related-party transactions, and weak support for opening balances. Startups with limited runway also face going-concern evaluation, which affects disclosures and can add an emphasis paragraph to the auditor's report.
Key takeaways
- SAFEs and convertible notes are often not simple equity under US GAAP; their terms determine whether they are presented as liabilities, equity or something else.
- Stock options granted to employees and advisers create stock-based compensation expense under ASC 718, even when no cash changes hands.
- Private companies apply the ASC 842 lease standard, so material office or equipment leases usually belong on the balance sheet as a right-of-use asset and a lease liability.
- Under US GAAP, management must evaluate whether there is substantial doubt about the company's ability to continue as a going concern within one year after the statements are issued.
- First-year audits must also address opening balances, so errors from earlier unaudited years can surface in the first audit.
Financing instruments recorded the way the founder thinks of them
Founders usually think of a SAFE as "equity we haven't priced yet" and record it in an equity account. Under US GAAP, the classification depends on the instrument's terms, including what happens on a liquidity event or dissolution, and many SAFEs end up presented outside permanent equity. Convertible notes carry interest and maturity terms that need to be accrued, and conversion features may need separate analysis.
The audit issue is rarely the cash. It is the classification, the accounting at conversion, and the lack of a memo explaining the treatment. Expect the auditor to read every financing document in full, so keep signed copies and side letters together, and document the accounting conclusion before fieldwork.
Warrants issued to lenders or partners, and side letters granting pro rata or most-favored-nation rights, belong in the same review. They are easy to overlook because they rarely involve a separate cash payment, yet they can affect both classification and the equity disclosures in the notes.
Stock compensation and the cap table
An option grant is recorded as an expense over the vesting period, measured using the grant-date fair value. Early-stage companies frequently grant options with no expense recorded, no valuation support, or with the board approval dated after the grant date in the cap-table platform.
Auditors reconcile the cap table to the equity accounts and board consents. Typical breaks include:
- Shares issued to founders or advisers without a board consent on file.
- Option grants recorded in the cap-table platform but never approved by the board.
- Exercise payments or early-exercise arrangements not reflected in the ledger.
- An independent valuation that is out of date for the grant dates used.
Revenue and liabilities in the wrong period
Cash-basis habits create two mirror-image problems. On the revenue side, annual subscriptions paid upfront are recognized immediately instead of over the service period, so deferred revenue is missing. On the expense side, December services billed in January are left out of the year, so liabilities are understated.
Auditors look for unrecorded liabilities by examining payments and invoices after year-end. Legal fees, contractor invoices and cloud-hosting bills are frequent finds. Revenue recorded net of payment-processor fees, refunds or marketplace commissions is another regular adjustment, because the gross-versus-net presentation depends on the arrangement.
Leases, capitalized costs and other accounting policies
Early-stage companies often have one or two leases (an office, a co-working commitment, equipment) and assume they are just rent expense. Under ASC 842, a lease longer than 12 months generally brings a right-of-use asset and lease liability onto the balance sheet, with discount-rate and term judgments to document.
Software companies also face questions about whether development costs should be capitalized or expensed, and hardware or e-commerce businesses about inventory costing and counts. Each is an accounting policy that should be decided, written down in a short memo and applied consistently, rather than inferred by the auditor from the ledger.
Going concern and related parties
A startup burning cash with less than a year of runway must evaluate whether substantial doubt exists about its ability to continue as a going concern, considering management's plans such as committed funding. If substantial doubt exists, disclosures are required and the auditor's report typically includes a going-concern paragraph, which investors and lenders will notice. Preparing a cash forecast and evidence of committed funding before fieldwork makes this evaluation easier to support.
Related-party issues are equally common in founder-led and foreign-owned companies: expenses paid personally by founders, loans to and from owners, and charges from a parent or sister company. Each must be identified, recorded and disclosed, and undisclosed related parties discovered during the audit raise wider questions about the completeness of the records.
Common mistakes to avoid
- Recording all SAFEs and convertible notes as share capital without reviewing their terms.
- Granting options without recording stock-based compensation expense or holding a current valuation.
- Treating a multi-year office lease as monthly rent with nothing on the balance sheet.
- Recognizing annual prepaid subscriptions as revenue on the day cash is received.
- Leaving founder-paid expenses and owner loans out of the books.
- Approaching a first audit without evidence to support balances carried over from earlier unaudited years.
NYBACS 360° support
How NYBACS helps
- Inventories every SAFE, note, warrant and option grant and reconciles them to the cap table and equity accounts.
- Coordinates with valuation providers and the auditor's expectations so stock-compensation records are complete.
- Rebuilds revenue on an earned basis with a deferred revenue schedule reconciled to billing data.
- Prepares lease schedules and short accounting-policy memos for management approval.
- Builds a 12-month cash forecast and funding evidence pack that management can use in its going-concern evaluation.
Frequently Asked Questions
Will a going-concern paragraph stop us raising money?
Not necessarily, and it is common for venture-funded companies between rounds. It does signal limited runway, so investors and lenders will ask about funding plans. Completing a round before the report date can change the evaluation.
Do we need a valuation to grant options?
For US tax purposes, options are usually priced using an independent valuation to support that the exercise price is at fair market value under Section 409A. The same valuation typically supports the stock-compensation expense, and auditors will ask for it.
Our SAFEs are post-money SAFEs. Does that change anything?
The specific terms matter more than the label, and post-money and pre-money SAFEs can share similar features relevant to classification. Have the treatment documented by a qualified accountant and agreed with the auditor early.
Are audit adjustments a sign of a failed audit?
No. Adjustments are common, especially in first audits. Repeated or large adjustments, though, can lead the auditor to report control deficiencies to management and the board.
