You Have to Be Fiscally Responsible

“Friends don’t do this to friends.” – quote from a new client CEO when told his CFO was “taking” money.

For those of you who follow this blog regularly, you know my background as a long-time audit partner with EY. That experience has allowed me to be a trusted advisor to many business owners of all types and to see first-hand the issues I use as content here. I use few, if any, “geeky technical topics” and I usually leave the ugly side of the business out. But there is a disturbing trend I see with too many of this generation’s entrepreneurs that I feel is worthy of exploring. First, let me provide some background.

There is a popular acronym called KPI (Key Performance Indicators) that many owners today rely on to gauge the health of their business. KPIs may include average sales per day or employee, days of sales in receivables, unique users to a site, etc. Many come into favor as early-stage companies may not have revenue but need some objective data to monitor progress. All understood. But this tool is not so new. As a young manager (yes, before the internet but not quite when people used quill pens), I was always interested in what data owners of established businesses used to manage their company. Interestingly, while some referred to monthly financial statements, most used daily information on shipments, cash collections and weekly payroll. As to the last item, even the most unsophisticated owners always knew their weekly “nut” or payroll. They would leave the full accounting and finance function to the CFO but they always had a handle on KPIs. So why the trip through accounting history?

I notice more and more a bifurcation of tasks and responsibilities by today’s entrepreneurs. Once a financial manager of any type is hired, it seems everything finance related is delegated to that hire. Someone in an owners’ blog somewhere must have said this is the right thing to do; that administrative tasks just bog you down and you should abdicate your fiscal responsibility and only spend time on activities that bring value (product development, team and customer building, etc.) to make your venture a success. Not true.

So, the genesis of this quote. We recently landed a new early-stage client and as part of our process did some simple diagnostics. The CFO was a close friend of the CEO founder with complete charge for finance and a few other functions. Without going into details, the CFO was paying himself unauthorized bonuses. No accounting tricks; they were right there on the payroll register; the CFO just felt he deserved more money. We were astonished to find the founder never reviewed payroll; did not know what his nut was. He was devastated. In addition, the bond company is giving them a hard time about covering the shortfall citing inadequate supervision.

So, a simple lesson for owners of all businesses. It is perfectly fine to leave the core of the finance function to others but always have some minimum KPI type of checks and balances in place as your predecessors did. Take the advice from Chris Anderson as relayed in David Kidder’s “Startup Playbook” – “engage in the whole process.” Because in the end, it is a real challenge to be a success if you are not fiscally responsible.

Show Me The Money – The Question Early Stage Fund Seekers Are Afraid to Ask

“Fundraising is the gentle art of teaching the joy of giving.” Quote from Henry A. Rosso – fund raising master

Over a long Holiday weekend, I had the chance to read through and comment on a handful of pitch decks. It may have been my good mood, but I really think the quality of these decks is getting better especially as it relates to early stage fundraisers including most of the basic components of a solid deck. There are plenty of guides out there to show what the contents of a deck should be – – in fact we have a good one at our Withum website if you just go to withum.com and search for “pitch deck.” So as Mona Lisa Vito from My Cousin Vinny would say, “So, what’s the problem?”

Despite the better quality, I was amazed to see that except for one deck, there was reluctance for these companies to address the “proverbial elephant in the room” – – namely stating how much money they are looking for and how they are going to use it. It appears to be like the fear of asking someone out on that first date.

So for our fundraising friends out there, here are five simple Dos and Don’ts when it comes to covering the “ask” in pitches:

  1. Do tell investors how much money you are looking for. Be clear about how much and how you are willing to layer rounds in, say as you achieve certain milestones.
  2. Do support this amount with summary (and detail if requested) calculations including a reasonable reconciliation to your basic cash flow. Provide a summary phrase that is descriptive of each major goal. A phrase like “develop a mobile app” is more helpful than “ramp up operations.”
  3. Do indicate to investors your flexibility as to form of investment. If you are comfortable with convertible notes, or SAFE documents or prefer a straight common stock investment, help guide a potential investor.
  4. Don’t show funds will be used to settle old debts or for significant owner salaries. Paying off old problems like existing debt or back pay does not move a business forward. Setting aside an amount for some minimum salary / payment to owners for their survival is not fatal but it probably helps if this can be avoided.
  5. Don’t imply this amount of funds is all you will need unless your projections clearly indicate this to be the case. Nobody likes the gift that keeps on giving. It is a frustration for investors and it is better to state upfront where you expect to be once the money is spent and how you will be positioned for the next stage of your growth.

The punchline here is not to forget the punchline. Just think about telling a long story and leaving that all important ending out. Listeners will look at you quizzically – – they expect – – in fact they demand you bring the story to a close. It is the same with your pitch deck. Potential investors want to know the punchline – – what do you need and how are you going to use it? Teach them the joy of giving.

Due Diligence and Early Stage Companies

“Surprise, surprise, surprise” – from Gomer Pyle USMC – played by Jim Nabors

I have had the privilege of being involved in due diligence activities (both buy side and sell side) for dozens of companies of all sizes. I had the chance to blog (November 2013) about being prepared for due diligence citing one of my favorite Monty Python sketches, “No one expects the Spanish Inquisition.”  That wasn’t just some pithy quote – a number of my clients used that analogy when describing the diligence process they were going through. However most were established companies with some history for a buyer to digest.

We have now been through quite a few due diligence exercises with very early stage companies. Many think it is a quick process; just answer a couple of questions and then wait for the check to clear. But surprise, surprise, surprise it is a bit more intense than you would expect. Compound this with how off point many of the diligence requests are and the process really gets convoluted.  I recently became involved with one startup that was being acquired and had been in business a little over two years. The potential purchaser’s diligence team requested the last 5 years’ tax returns and the entrepreneurs (taking the request literally) were in the process of getting together their personal tax returns for the earliest three years.

So, what do (or should) investors focus on when doing diligence on an early stage company? I would highlight five areas:

Management team – we always suggest looking at the team both current and future. Do the key leaders know what they have and what they need to get to the next level?

Dashboard report – what has the team laid out in terms of what they are focused on? Burn rates, the competition, a detailed plan to get from MVP to sustainable product and KPI’s are all key aspects to assess.

Traction – I do not just mean unique visitors to a site but customers or near term prospects who will buy your product or service. If you are selling to end users, it’s easy – how many swipes do you get and what is the trend. If you are selling enterprise level software, the sales cycle is longer and the question is how well do you know the status of each pursuit?

Equity – a complete cap table including options, promises and any “winks and nods” for future equity. If there is no equity plans covering employees or future key team members, that is also a red flag

Owners’ mindset – just like mature businesses I often see deals crater over sellers’ remorse. While subordinated notes have allowed all parties to “kick this can down the road” are owners ready for partners or to sell outright?

CPA’s are often retained to complete due diligence but for accountants used to financial data analysis, this type of diligence is not comfortable.  Other than tying down revenue, there is little they feel they can do. So, if you are in a potential deal and sense the acquisition deal team has the wrong focus, don’t be afraid to let the purchaser/investor know.  For many, this is still somewhat virgin territory.  Be prepared.