Most legendary startups have historically had two key founders – Page and Brin, Gates and Allen, Jobs and Wozniak come to mind. Usually, one is an outward facing evangelist, while the other focuses internally on technology and/or operations. It goes without saying that team is perhaps the biggest (and often the only) criterion for an investment decision, and having as complete a team as early as possible should be the goal. There is also a school of thought whereby an A team with a B product almost always beats a B team and A product. I completely subscribe to that mantra, and have been on winning and losing sides of that combination over the years. Typically a startup focuses on adding members to the team focused more on product definition and development, followed by sales, marketing and business development. Sprinkled in between is junior accounting and finance talent. Over the years I have gotten real appreciation for a key additional team member who is essential, and one that needs to be brought on board earlier in the life cycle of a startup that most founder originally contemplate – the CFO or at least a senior finance person. While this is usually not one of the earliest hires in the journey of a startup, I believe it should be. I have become a bigger believer in that philosophy over the years, especially in India.
You may ask me why…why is a senior finance resource so crucial, especially early in the lifecycle of a company. In the last few years, I have been through several situations where the presence of a credible CFO would have made a significant positive difference, in terms of more efficient operations, more effective fundraising processes, overall more constructive relationship between management and investors/Board and finally, the eventual outcome of that investment.
Following are the reasons for making sure a credible finance resource, ideally a strategic CFO, is on board, sooner rather than later:
1. It’s extremely important to set the right foundation for a company to scale – with the right systems and processes. Especially if the business has some complexity, in terms of geographies, supply chains, business models, and/or funding structure. A strategic CFO with relevant experience can make sure internal controls, compliance, governance and supplier/customer facing systems are in place. Spending time and energy to get those right up-front pays significant dividend downstream as the company and its operations scale.
2. Reporting: One of my pet peeves is getting regular business updates, ideally through a simple, easy to digest, visually appealing dashboard. Some companies do a stellar job, but most struggle both in terms of content, format and timely delivery of that material. As an investor, I have been on both ends of the spectrum. It’s a true delight when the information comes as promised. And it’s an unnecessary headache, when one has to send constant reminders and frictional emails to management to extract that information. Lack of information flow sends one of two signals to investors – either management does not know how the business is actually functioning (and therefore does not have a handle on their business); or management is unwilling or incapable of sharing that information on a timely basis. It sends massive red flags to investors, creating tension and unproductive Board meetings. Having a CFO, who is detail oriented, and for whom timely delivery of promised information is sacrosanct, is extremely important. As I have said in my earlier posts, having that foundation actually helps define the culture of an organization – that we will under-promise and over-deliver rather than the other way around. It creates drive, motivation, collaboration and accountability.
3. Governance – one of the most overlooked aspects of running a startup. Having a seasoned CFO, who understands how to manage internal and external audits, have financial controls, and interact with the Board as a whole is incredibly helpful, both to the CEO and the Board. As an investor, especially an overseas investor, seeing a reputable finance executive on the organization chart gives comfort that compliance and governance are going to be taken care of. In a jurisdiction like India, where regulatory environment is dynamic with unsuspected twists and turns, someone with some heft, who has been through those challenges, can help management maneuver through the predictably unpredictable ups and downs. As increasingly more foreign investors look towards India, and as scandals become front page news, startups will need to answer the question “how do we know that management is above board?” A credible CFO helps pre-empt that question. I still remember one of my India Board roles while at DFJ, where the CFO of fairly large Indian company would create a slide as part of the Board packet that would highlight compliance issues that the company was dealing with. In that slide he would also specify personal liability that Directors of the company faced if the company were non-compliant for a prolonged period of time (including financial penalties and jail time!). The point he was trying to drive home was that there were certain issues that everyone needed to be aware of, and that those issues had to have priority resolution workstreams. Else, we could end up in, what my business school professor termed “the steel chateau”. That one slide also ensured that the investors read the Board deck prior to the meeting.
4. Checks and balances – In an ideal situation, the CFO acts as an internal check and balance for the CEO, asking tough questions, especially as they relate to fiscal discipline, overall spend, pro-forma business plan creation and execution. The CFO is the one who is responsible (along with the CEO) for the operating plan. The right CFO will and should ask the tough questions around the likelihood of hitting the numbers, and contingency planning in case the company misses plan (which, by the way, is the norm, not the exception). Often startups make a mistake of hiring someone in finance who simply agrees with pretty much anything the CEO says or does. That is a mistake. You need a strategic thinker, not a “head nodder”. Again, the title need not be a CFO, per se, but a Controller or another relatively senior finance manager, but one provides the check and balance that I mention above.
5. Operational efficiency: a strategic and experienced CFO can be instrumental in negotiating supplier contracts, and coming up with creative structures to positively impact the bottom line, optimize working capital and be a tough negotiator around debt and equity financing options.
6. Giving prospective investors comfort. With the right CFO, investors check the box on all of the above – that internal systems of control, reporting, managing are in place; that the monthly MIS will come on time; that underlying KPI’s and metrics will be measured; cohort analyses done; pro-formas will be in place; contingency plans created and constantly updated. During a fundraise process
As the above points highlight, the CFO plays an important role beyond simple accounting and number crunching. He/she can and should be the sounding board for founders, and be a pragmatic buffer between the founders and the Board/investors. A strategic CFO can be the CEO’s right hand person who helps create and monitor the business plan, including the overall fundraising strategy, which is an essential part of a startup throughout its life cycle. Existing and prospective investors get a lot of comfort knowing that the systems, such as the monthly MIS provide a granular snapshot of the business; that the CFO is on top of his/her game, avoiding any downside surprises (which, btw, is another one my pet peeves. I want the bad news up front, not be blindsided by it). The lack of regular information flow and reporting creates unnecessary confusion, frustration and distrust between investors and management.
One of the hardest things for startups to constantly do is fundraise. The double-whammy is that not only is it difficult, it’s often non-stop. The best fundraising exercises I have experienced are with a combination of the CEO and CFO. There is a balance between the vision and dream that the CEO often presents, with the grounded pragmatism of a seasoned CFO, who gives investors comfort that there is someone acting as an internal reality check.
Let me try to drive the point home by indicating what happens without the CFO or a credible senior finance individual. First and foremost, information doesn’t flow. That sends one of two signals – either management is trying to hide something (perhaps a downside surprise) or that management is incapable of getting the needed information to investors in a timely manner. Neither one is helpful in terms of building a relationship with investors and the Board. Transparency and trust are key building blocks of a long-term relationship not only between management and investors, but within the company and with the entire ecosystem of suppliers, partners and customers. I am not saying that the CFO needs to be the first employee, but as soon as the company is beginning an institutional fundraise and/or is at the cusp of launching a product/service, having the house in order with a senior finance resource is crucial.