Back in February, the Hustle Fund team flew from all over the world to convene at our semi-annual in-person team offsite. One of the things we talked about the most was the fund audit.

This topic created so much stress and frustration that a large part of me wanted to escape to the kitchen and eat cookies while the rest of the team discussed.

The other part of me had questions:

• What is the audit for?
• Why is it so awful?
• Do we have HAVE to do it? Even if we're a small, early-stage fund?

A few weeks ago I finally got these big hairy questions answered. And today I wanna share them with you. Let's dive in.

Super quick overview of a fund audit

Last week we talked about Fund Admins and how part of their job is to run quarterly reports on the portfolio. These reports track each portfolio company's current valuation and revenue.

The purpose of these quarterly reports is to share updates to our investors. It also serves the purpose of making the big, hairy, annual audit a little bit easier.

The big hairy audit happens once a year between December-April.

This audit is run by a 3rd party auditor – typically an audit firm. The auditor digs deep into each portfolio company to certify that the valuations of each company are accurate.

The result is a 30+ page report that goes to all of our investors, and our tax accountant.

What's the process?

Auditors don't go directly to our portfolio companies to get this information.

No, no. It's our job as VCs to hand over this information. And every year the information the auditors want to collect is a little different. Luckily, most auditors check in about once a quarter with updates on what they'll be looking for in the annual audit.

This helps the Fund Admin compile those quarterly reports with relevant information. The quarterly reports help our team and our portfolio company stay on top of the most important pieces of data throughout the year

But even with those regular check-ins, the annual audit is time consuming, tedious, and expensive.

Why is it so awful? Reason 1: Time consuming

The job of the auditor is to verify the valuation and health of a VC fund's portfolio companies. In order to explain the valuations, auditors ask their VC clients: how do you justify this valuation? What's the revenue, burn rate, total amount of funds raised?

They ask this about every single company in your portfolio, and they may write a report on some companies.

If you have a small portfolio, this might not be too terrible. But if you have a large portfolio like Hustle Fund, it can take months to collect this information. This is largely because founders can be notoriously hard to track down. Many founders don't send regular investor updates. And if things aren't going well, founders may ghost investors altogether.

Which, you know... makes it really hard to collect any information.

If a fund can't get a hold of a founder after multiple attempts, the auditor will likely suggest we reduce the valuation. But not always. Every conversation is a case-by-case decision. Woof.

Reason 2: It's complicated

If you're a Series C fund, audits are pretty cut and dry. This is because later-stage rounds are priced rounds... meaning that funds get actual shares with an actual price attached to each share. Calculating valuation is pretty easy when you have all the numbers in a spreadsheet.

Five million shares priced at $1.50 per share? Beep boop boop this company is valued at $7.5 million. But early-stage investors don't have that luck.

Early stage investors write checks into SAFEs or Convertible Notes. There aren't any shares yet. Once the company raises their Series A, those documents convert into shares.

So when auditors ask early-stage investors "Why is the valuation listed at $8 million?" there's not a whole lot of data to share. We have to go to the founder and get information on their burn rate, their revenue, their projected revenue, their latest fundraise.

And we're hoping those founders have done a good job tracking this information. Many of them have not. This is why audits are awful. There's a ton of chasing people down for information that doesn't feel all that relevant.

Why do we even do audits?!

The major reason we have to do audits is for tax purposes. The audit report is sent to a fund's tax accountant, who then tells all the LPs what taxes are owed.

Another reason a fund does an annual audit is because big institutions require them.

Even if the companies in your portfolio haven't had any exits yet, institutions that invest in funds want to see valuations on a regular basis to judge the status of their investment.

Now, if you're an emerging fund, there's a good chance that you're raising your Fund I from family offices and individuals with high net worths. You probably don't have many (or any) big institutional investors. So maybe you're thinking "great, I can skip this audit!".

Nope. Tax accounting aside, audits can actually have a big impact on your fundraising strategy.

Here's why: high net worth individuals who invest in VC funds often have financial advisors. Those advisors want to see how the fund is performing before recommending that their client makes an additional investment into the fund.

So even thought audits are SUPER time consuming, doing them early on in your fund's lifespan will show that you have a track record of auditing your companies.

It also provides a more 'objective' method for people to understand how well your fund is performing.

On a personal note...

The cost of running an annual audit is hefty. Heck, all back-office operations roles are a big expense for a fund.

So even though you may have a great vision for a fund, and all the right operational experiences to be a great VC, a back-office expense like an audit might prevent you from launching.

At Hustle Fund, we believe this stinks. Majorly.

That's one reason we launched Angel Squad. To train people on how to invest. Angel investing can be a gateway to earn meaningful wealth, and could be your ticket to starting a VC firm.

Ok, enough soapboxing.

I hope this was helpful, even if it is a bit depressing.

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