Successfully Navigating the First Audit – A Guide for Start-ups

Anyone setting up a business tends to think first about their products, customer base and growth – administrative matters such as proper bookkeeping and auditing usually only come into focus later on. Attention turns to these aspects at the latest when the annual accounts are audited for the first time. The following article explains, from a start-up’s perspective, when an audit is required, how a limited audit is carried out, and which issues new companies should pay particular attention to.

Under Art. 727 et seq. of the Swiss Code of Obligations (CO), every legal entity is, in principle, required to have its annual accounts audited. If a company does not meet the requirements for an ordinary audit in accordance with Art. 727 CO, it must have its annual accounts reviewed in a limited audit. However, Art. 727a para. 2 CO allows companies to opt out. This means that with the consent of all the shareholders, a limited audit may be dispensed with if the company does not have more than ten full-time employees on annual average.

If a company decides to appoint an auditor, the choice of auditor lies solely with the general meeting. This power cannot be delegated to another body. The mandate only becomes legally valid once the chosen auditors have accepted the appointment. A limited audit may also be undertaken voluntarily where it is not required by law, for example by means of a corresponding resolution by the general meeting or a provision in the articles of incorporation.

What the auditors check
A limited audit focuses on the annual accounts (comprising the balance sheet, income statement and notes) and the proposal for the appropriation of retained earnings. To conduct their audit, the auditors rely on interviews, analytical procedures and the verification of appropriate documents. A limited audit involves less extensive audit procedures than an ordinary audit and consequently provides a lower level of assurance. A limited audit does not include audits of operational processes and the internal control system or in-depth investigations to uncover criminal acts.

To ensure that the audit runs smoothly, companies are usually provided with a checklist by their auditors, setting out the documents required for the audit. These include bank statements as at the balance sheet date to provide evidence of cash and cash equivalents, details of the valuation method used for accounts receivable, and explanations of any material changes such as differences in revenue compared with the previous year.

As the ordinary general meeting must be held annually within six months of the end of the financial year in accordance with Art. 699 para. 2 CO, it is advisable to plan the audit well in advance and to clarify any outstanding issues with the auditors as soon as possible.

The benefits of an audit for a start-up
Even with a reduced scope of audit, a limited audit still ensures credibility. This helps to build greater confidence in the reported figures among banks, business partners and public authorities. If additional assurance is required regarding specific matters, supplementary audit procedures or separate engagements may be agreed with the auditors. The audit report is intended mainly for the general meeting.

Common pitfalls
When the first audit is due, a start-up is usually still in the process of being set up. This makes it all the more important for the auditors to assess the risks carefully, basing their assessment on reliable and verifiable facts. The key assessment criteria are an adequate capital base, sufficient liquidity and the ability to continue as a going concern. However, particularly in the early stages, these factors are often not yet fully established.

The equity position deserves particular attention right from the start. Start-ups often stand out for their innovative business models and ambitious growth targets, but periods of financial strain are not uncommon. In order to strengthen their equity capital, many start-ups capitalise services they provide themselves, for example in connection with software developed in-house. This is generally permitted, although the principle is sometimes applied too liberally in practice. It is therefore advisable to consult the auditors at an early stage to check the eligibility for capitalisation and valuation, and to ensure that the services provided are documented in a comprehensive and transparent manner.

Capital increases are also a viable option for strengthening equity. Flexible instruments are becoming more and more important alongside traditional ordinary capital increases. In a public limited company, a capital band allows the board of directors to raise capital independently within a defined framework and timeframe. Contingent capital is frequently used in relation to employee share schemes or convertible loans. The choice of instrument depends on the financing requirements, the company’s valuation, the investor structure and the desired level of flexibility. In any case, what matters is that the chosen instruments are implemented carefully, in a legally sound and transparent manner.

If the company is threatened with insolvency, or if there is a loss amounting to half the share capital or overindebtedness, the stringent requirements of Arts. 725, 725a and 725b CO apply. The board of directors must continuously monitor solvency and the financial position and take timely action. If there is a loss amounting to half the share capital, measures must be taken to rectify the situation. If there is reasonable suspicion of overindebtedness, interim financial statements at going concern values and sale values must be prepared and audited without delay. If the overindebtedness of the company is confirmed and there are no legal grounds for deferring notification, the court must be notified. It is precisely in situations like these that early consultation with the auditors is worthwhile.

If the company does not have an auditor, the board of directors must appoint a licensed auditor in the cases provided for by law. Where half of the share capital has been lost, the most recent annual accounts must be subject to a limited audit prior to their approval by the general meeting; where there is justified concern regarding overindebtedness, the interim financial statements must be audited. In this case, the report is addressed to the board of directors.

Conclusion
The first audit is often an important milestone for company founders. Companies that prepare well in advance, communicate openly with the auditors and clarify any queries promptly can also navigate a limited audit efficiently. Audited annual accounts build trust with banks and investors and increase transparency for all stakeholders, thereby paving the way for future funding rounds.