Independent accountant’s reports: signaling and early-stage venture funding

Abstract

Purpose This paper aims to examine whether the ability of early-stage ventures to obtain external funding and the amount of additional information provided to potential investors are affected by the level of assurance (audit, review or compilation) received from independent accountants on the ventures’ historical financial statements. The assurance level provided should differently impact potential investors’ willingness to invest in a new venture and need for additional information during due diligence evaluation of the organization and entrepreneur. Design/methodology/approach To examine the relative effects of the signal provided by these levels of assurance on investment decisions, a survey is administered to collect data regarding an investment-related decision scenario. The three levels of assurance in independent accountant’s reports (audit, review or compilation) is manipulated when eliciting participants’ responses. Findings Results indicate that respondents perceive the signal provided by compilation reports, review reports and audit reports as increasing in reliability and are more likely to invest in a venture providing reports with that increasing reliability. Audited financial statements are viewed as the most reliable and provide a positive signal to potential investors and lenders. Consequently, potential investors may require less additional information from entrepreneurs with audited financial statements when conducting due diligence investigations. Research limitations/implications Subjects used (Master of Business Administration students, with an average work experience of over six years, including some with investing experience) may not be the best proxies for early-stage investors. Originality/value This is the first study to examine the relative effectiveness of signals provided by the independent accountant’s audit, review and compilation reports in assisting early-stage business ventures and entrepreneurs raising funds, and dealing with due diligence requests for additional information. Results indicate that engaging an auditor for independent assurance on financial statements can benefit entrepreneurs by increasing the likelihood of obtaining necessary funds and decreasing the amount of additional information needed by potential investors.