The Hard Thing About Audits
It’s not often you read a book by a technology CEO and come across an out-and-out attack on auditors. But this is what you’ll find if you read The Hard Thing About Hard Things, Building a Business When There Are no Easy Answers by Ben Horowitz, one of the founders of prominent venture capital firm Andreessen Horowitz.
In this frank and fascinating book, Ben Horowitz shares valuable advice on what it takes to be a successful CEO of a technology startup. AH has carved out a reputation as a VC firm that takes a great interest in supporting and nurturing its CEOs, with a bias towards maintaining a startup’s original technical founder in the CEO role as long as possible.
Ben’s views on the CEO job are based on his own tumultuous experience as CEO of Loudcloud, a server software company that went through a near-death experience, but ultimately ended up successful, when the company, renamed Opsware, was sold to HP for $1.65 billion. At the last minute, the sale almost fell through.
According to Ben, as they were getting close to finalizing a deal, with HP and another software company in the bidding, Opsware auditors Ernst & Young told them that they had to change the revenue recognition on three large deals from upfront recognition to recognizing it ratably over the life of the contract. If Opsware changed revenue recognition on those deals, its quarterly guidance would be significantly reduced, and it was likely that the bidders would pull out. Ben pointed out to E&Y that when the deals had originally been signed, Opsware had understood revenue recognition was sensitive and had had the E&Y partner audit the deals, and he had approved the upfront recognition. But now, a different E&Y partner was calling the shots, and he was overruling his own colleague. The Opsware CFO had worked at E&Y for 15 years prior to joining Opsware and had recommended E&Y as their auditor. According to Ben:
“My CFO, Dave Conte, was pale as a ghost. Hundreds of people had worked for eight years to get to this point and it looked like all that work would be flushed down the toilet by the accounting firm that Dave handpicked….I was furious at everybody but I knew that nothing that I could say would help the problem or make Dave feel any worse than he already felt. I turned to Jordan Breslow, my general counsel, and said: `Do we have to disclose this to the acquirers right away?’ Horrifyingly, he said `Yes.’”
Ben and team were able to convince the E&Y partner that if certain language was changed in the three contracts, then the upfront recognition would be acceptable. E&Y gave them 24 hours to try to talk the customers into the contract amendments. The Opsware team succeeded. But the uncertainty caused by these last minute efforts resulted in one bidder dropping out. The deal got done with HP. Says Ben:
“We had a deal. A deal for about $100 million less than if our so-called partner had not stabbed us in the back, but a deal nonetheless. I still hate Ernst & Young.”
Clearly, E&Y did nothing illegal, or even wrong. Interpretation of accounting rules for customer contracts change over time, and E&Y needs to keep updating the application of rules and conventions to represent the business realities as understood by companies, investors, and others. Given the same facts, smart people can still disagree on the “right” application of accounting rules.
So what’s the lesson? Accounting, like working with auditors, is just one of those “hard things”. Rules change from time to time and what is acceptable today may not be tomorrow.