Internal Controls for Startups: Practical Stage by Stage Guide to Financial Compliance

Foundational Understanding of Internal Controls

What does 'internal controls' actually mean for a startup? At its core, an internal control is a process or rule designed to safeguard assets, ensure financial reporting is accurate, and promote operational efficiency. It’s the system that helps prevent a simple mistake from becoming a catastrophic one. A strong control environment gives investors confidence and provides leadership with reliable data to steer the business.

Controls are typically categorized into three main types:

• Preventive Controls: These are proactive and designed to stop an issue before it happens. Think of requiring manager approval in a platform like Ramp before a corporate card purchase is made or setting spending limits on employee cards.
• Detective Controls: These are reactive and designed to identify a problem after it has occurred. A classic example is the monthly bank reconciliation in QuickBooks, which can uncover incorrect transactions, missed invoices, or potential fraud.
• Corrective Controls: These are actions taken to address an issue identified by detective controls. An example would be making an adjusting journal entry to fix a miscategorized expense or implementing a new approval rule after discovering a policy violation.

For a lean startup team unable to implement perfect Segregation of Duties, where different people handle transaction initiation, approval, and recording, compensating controls become essential. This is often a detailed review by a founder or senior manager, which compensates for the lack of staff to separate duties formally. For instance, if one person pays the bills and records them, a founder should review the bank statement and payment list each month. See AICPA guidance on segregation of duties for formal definitions.

Most formal internal control systems are based on the COSO framework, which is the standard auditors use. While you do not need to be an expert on COSO, understanding its five components helps contextualize why certain processes matter: the control environment (your company culture), risk assessment, control activities (the rules), information and communication, and monitoring. The reality for most early-stage startups is more pragmatic: build a simple, effective system that addresses your biggest risks first.

The Startup Financial Control Playbook: 3 Phases of Growth

Building effective financial controls for startups in the US is not a one-size-fits-all task. The right approach evolves with your company's size, funding stage, and complexity. We have broken the process down into three distinct phases that map to a typical startup's lifecycle.

Phase 1: The Founder-Led Foundation (Pre-Seed to Seed / <15 Employees)

In the earliest days, speed and survival are paramount. The finance function is often a founder with a QuickBooks login and a spreadsheet. At this stage, the goal is not to build a fortress but to create a basic structure that prevents common, costly errors and satisfies initial compliance needs. The key pain point is the inability to segregate duties, which places the company at risk of error and misappropriation of assets.

The primary compensating control here is intensive founder oversight. Since one person may handle everything from paying bills to recording revenue, a second founder or a key manager must review financial reports and bank statements monthly. This simple detective control can catch significant issues early. The goal is to establish a system for safeguarding startup assets from day one.

To build a solid foundation, focus on centralization and automation to create clear audit trails:

• Centralize Spending: Instead of using personal cards or ad-hoc payment methods, centralize all company spending onto a single corporate card and spend management platform like Ramp or Brex. This provides real-time visibility and enforces spending policies automatically.
• Manage Vendor Payments: Use a tool like Melio or Bill.com for paying vendors. This creates a digital approval workflow and audit trail, avoiding the need to give employees or contractors direct access to company bank accounts. Implement basic vendor onboarding controls, such as requiring a W-9 form and verifying bank details before making the first payment.
• Automate Payroll: Payroll should always be run through a dedicated service like Gusto or Rippling. This ensures tax withholdings, payments, and filings are handled correctly, mitigating a major area of compliance risk for US startups.

From a legal standpoint, the requirements are straightforward but non-negotiable. Primary legal requirements at this stage focus on accurate tax filing and maintaining corporate registration, such as paying the Delaware Franchise Tax on time. A clean, well-managed QuickBooks file is your best asset for this. The monthly close process can be simple: reconcile all bank and credit card accounts, book payroll entries from your provider, and review the profit and loss statement for anything that looks incorrect. This is not about perfect US GAAP compliance yet; it is about maintaining a reliable record of cash flow and business activity.

Phase 2: Systematizing for Scale (Series A / 15-75 Employees)

Closing a Series A round is a major milestone that fundamentally changes financial expectations. With institutional investors on board, the era of informal, founder-led finance is over. The priority shifts to creating scalable, auditable processes. Often, the key trigger for this change is a new requirement in the investment agreement for an annual financial statement audit conducted by an independent CPA firm.

This is where Segregation of Duties (SoD) moves from a theoretical concept to a practical necessity. With a growing team, you can and should separate financial responsibilities to reduce the risk of fraud and error. You do not need a large finance team to achieve this; modern financial tools can enforce SoD systematically.

A scenario we repeatedly see is the vendor payment process. A properly segregated workflow looks like this:

1. Initiation: A marketing team member receives an invoice from a contractor and uploads it to a system like Bill.com or Airbase. They code it to the correct expense account based on the department budget.
2. Approval: The system automatically routes the invoice to the head of marketing. They review it against the budget and contract, then approve it within the platform. Crucially, they cannot process the payment themselves.
3. Processing: An outsourced accounting partner or a junior operations person is responsible for scheduling the approved payments. Their role is limited to paying bills that have gone through the proper approval workflow.

This system-enforced process ensures no single person can initiate, approve, and pay a vendor, dramatically reducing risk and providing auditors with a clear, documented trail. This is a core component of US startup accounting best practices.

Beyond SoD, startups at this stage must formalize other key areas. An official expense reimbursement policy should be implemented and managed through tools like Expensify or the built-in features within Ramp. The monthly close becomes more rigorous, involving accrual adjustments for expenses incurred but not yet paid and detailed balance sheet reconciliations to ensure the books are compliant with US GAAP. For SaaS companies, revenue recognition can be nuanced; get early guidance on applying ASC 606 to your contracts.

Auditors will also focus on areas beyond core accounting. For US companies, auditors specifically test IT General Controls (ITGCs). These are controls related to the IT systems that underpin financial reporting. A critical example is the timely removal of system access for terminated employees. This means your employee offboarding process must be systematic. When an employee leaves, a checklist should ensure their access to QuickBooks, bank accounts, and other sensitive systems is revoked immediately, a process easily managed with HR platforms like Rippling.

Phase 3: Formalizing for Compliance (Series B+ / 75+ Employees)

By Series B, a startup typically has a dedicated finance leader, such as a Controller or Head of Finance, and operates with a much higher degree of complexity. The challenge is no longer just about getting the numbers right; it is about proving they are right through documented, consistent, and well-controlled processes. The focus shifts from ad-hoc systems to a formalized control environment that can withstand intense scrutiny from investors, partners, and future acquirers.

At this stage, your startup will encounter more advanced compliance requirements. For example, companies handling sensitive customer data, particularly in SaaS and Biotech, may require a SOC 2 audit. This audit assesses your controls related to security, availability, processing integrity, confidentiality, and privacy. While it is an IT-focused audit, it has significant overlap with financial controls, especially around system access, change management, and vendor management.

Looking further ahead, the ultimate benchmark for public companies is the Sarbanes-Oxley Act. SOX requires public companies to have formally documented and tested internal controls over financial reporting. While a Series B startup is years away from this, adopting a "SOX-lite" mindset is a powerful strategic advantage. This means formally documenting key financial processes, from revenue recognition to financial closing. It involves creating clear approval matrices for expenditures and system access. It is about building the muscle memory for a compliant culture long before it becomes a legal mandate.

Key controls to formalize at this stage include:

• Revenue Recognition: Your policy for revenue recognition must be documented and consistently applied according to US GAAP. This is especially critical for SaaS businesses with complex multi-year contracts or Biotech companies with milestone-based payments.
• Financial Close and Reporting: The monthly close process should be formalized with a detailed checklist, timeline, and review process. Financial statements should be formally reviewed and approved by leadership before distribution to the board or investors.
• System Access and Integrity: Your tech stack, while likely still centered on QuickBooks and integrated tools, must be managed with an eye toward data integrity. This includes implementing formal change management procedures and conducting periodic reviews of who has access to sensitive financial systems.
• Budgeting and Forecasting: A formal annual budgeting process, coupled with regular variance analysis (budget vs. actuals), becomes a critical control for managing financial performance and holding department heads accountable.

Practical Takeaways for Setting Up Financial Controls

Navigating financial controls is a process that maps directly to your startup's growth. Rather than seeing it as a monolithic task, approach it with a stage-appropriate mindset that addresses your most pressing risks without creating unnecessary friction.

For Phase 1 (Pre-Seed/Seed) startups: Your mantra should be centralize, automate, and review. Get all spending onto one platform like Ramp. Use a dedicated payroll provider. Most importantly, leverage intensive founder review as your primary compensating control. Your goal is good-enough data, basic tax compliance, and preventing large errors, not a perfect audit trail.

For Phase 2 (Series A) startups: The game is now about audit readiness. Introduce system-enforced Segregation of Duties for key processes like cash disbursements and payroll. Formalize your monthly close to be compliant with US GAAP, including accruals and balance sheet reconciliations. Pay close attention to IT General Controls, particularly the timely removal of system access for former employees. Documentation of key policies, like expense reimbursement, begins here.

For Phase 3 (Series B+) startups: Think like a public company to build a scalable foundation. Formally document all critical financial processes in flowcharts or narratives. Prepare for advanced compliance audits like SOC 2 if they are relevant to your business model. Your internal controls should be consistently operated, documented, and regularly reviewed for effectiveness. The focus is on demonstrating control, not just having it.

In practice, we see that the most successful founders treat internal controls not as a compliance burden, but as an essential part of their operational infrastructure that enables faster, more confident scaling.

Final Word

Building a robust system of internal controls is not a one-time project but an evolutionary process. What a five-person team needs is fundamentally different from what a 75-person company requires. The key is to implement the right level of control at the right time, using modern tools to automate processes and enforce rules without slowing the business down.

By starting with a simple, centralized foundation and layering in more formal processes as you raise capital and grow your team, you can build a resilient financial operation. This pragmatic approach not only prepares you for audits and due diligence but also provides the reliable financial data needed to steer your startup toward its next milestone. It’s an investment in stability, scalability, and investor trust. Learn more about designing controls as you grow at Internal Controls.

Frequently Asked Questions

Q: When should a US startup hire its first in-house finance person?
A: This typically happens around the Series A or B stage, or when operational complexity grows significantly (e.g., over 75 employees, international sales). The first hire is often a Controller or Head of Finance, who transitions the company from basic bookkeeping to building scalable financial systems and strategic analysis.

Q: What is the most common financial control failure at an early-stage startup?
A: A lack of segregation of duties combined with poor cash management is the most frequent failure. This often manifests as one person handling vendor payments from initiation to execution without any oversight, creating significant risk of both unintentional errors and deliberate fraud. Centralizing payments through a modern platform can mitigate this.

Q: How can startups enforce financial controls without slowing down the team?
A: The key is leveraging technology to build controls directly into workflows. Spend management platforms like Ramp can enforce expense policies automatically. Bill pay systems like Bill.com can digitize approval workflows. This approach makes compliance the path of least resistance, rather than a separate, bureaucratic step for employees to follow.