PRE A ROUNDS / SERIES A ROUNDS / MONETISATION STAGE
The post endeavors to explain, how a startup start to hire finance talent just around their Pre A / Series A / A+ and the successful journey of scale up of finance teams mimicked with the business growth, fund raise and monetization. Last post (I of III) was about seed funded companies and this post tries to build on that to explore how with higher round of funding and monetization role and scope of finance team needs to change.
In the situation of even a Pre A round of funding going through and company now going for monetisation it only makes it imperative for the founder to look out for a financial controller. There is a possibility that an in house accounting professional is taking care of finance and related matters. If such person has scaled to be able to handle finance of a growing and would be complex organization, then he can be tested to take care of financial controllership. Else someone will need to be appointed for the same. In some cases, the organization may have outsourced the operations to third party. In such a case, handover is critical. If there is an existing person it only helps. In such a scenario, when the new person joins it acts as a great buffer to have basic things in place rather than getting a handover from an outsourced provider. Alok of Constellation adds, “At times investors might insist a Big 4 auditor – in house FC might be in a better position to handle this as compared to a plain vanilla accounting support firm. In house resource would also add value even in vendor negotiations etc e.g. Insurance , compliances ( FEMA follow up for FCGPR for e.g.).
At this juncture, finance structure must be developed inhouse. That’s a non-negotiable and it has its merits too. The caliber of the person doing the work at the outsourcing firm is never going to be way too high than the in house person, more so because the hiring of an inhouse person is in the hands of the founder and if he wants his investors. I have happily assisted few of our companies with this and it was a revelation on how much founders trust their investors. The advantage with the in house person is that – half a chance there is a deeper sense of purpose because of a long term career affinity by being in the company and growing with a startup and scaling quickly than being an accounting person and gradually moves up the value chain when a Series A happens. Whilst most outsourcing firms may be able to do a satisfactory job on compliances and accounting entries, it does require someone within the firm to track burn and expense management on a regular basis. While it’s inescapable to burn money at early stages of journey of a startup it’s inexcusable to loose track of the burn and preempt a need to work on raising the next round. More importantly sounding alert that metrics are plateauing or not in line with expectations and force a discussion to consider corrective action is an important function that cannot be outsourced.
While the good founders are equipped to handle all of these, the best founder may not necessarily know it but will empower someone else to drive these with a sense of ownership. The accounting resources in house comes in handy to support such a person. And over a period of time the system can be seamlessly handed over to the Financial Controller as and when he joins. Good FCs can actually set up the processes, put up financial controls in place, estimate cash flows, establish revenue recognition policy, put out guidelines and framework that allows the company to launch into scale at an opportune time. That way founders are not forced to play a catch-up and reactive approach if and when the subsequent funding round happens. A handful of our portfolio has also benefited from appointing veteran mentors from successful biz to help and guide on these areas. These mentors have been successful CFOs and / or founders.
One can always argue as to what’s the point of keeping all this in place if the funding round (Series A) is contingent on factors that are not always within control of founders. And if the round doesn’t happen time and money into setting these up, reporting is kind of waste. Well I only would like to quote a small story here.
The village was going through a drought year for the second consecutive year. The village heads decided to collect money from village and district authorities to perform a ceremony to please the rain Gods. A young boy walked in and people started laughing becoz he was carrying a handful of umbrellas. The villagers asked – in this scorching heat you find it funny to carry so many umbrellas. The boy’s answer stunned the seniors – we are performing the ceremony and prayers for rains to arrive. I thought we shouldn’t get wet on our way back when the rain Gods choose to oblige. That was faith. If founders are optimistic enough to startup, why would they not continue the sense of optimism that it can become a biz. Yes, appointing an FC does mean a cost and at times founders have mentioned that its better to spend money on growing biz rather than make long term investments. Well, this is not an unreasonable point of view just that neither is it a fair argument to not appoint FCs at all.
Moving ahead in the journey of the startup, post the second round of funding (be it Pre Series A or a Series A round) as the company embarks on greater scale and traction, it does become worthwhile now to definitely create the function within the company. No company having raised greater than Rs. 6 – 10 Cr cumulatively should not hire a financial controller and set up the function inhouse is my humble opinion as well as learning from the last few years. It should be earlier if the company has commenced monetisation of its product. The scales should only tilt in favour of adding some more teeth to the Finance function by adding treasury function, day to day cash flow monitoring, product pricing, unit economics assessment, forming quarterly as well as annual budgets, variances analysis between budgets and actuals to top up all of the above areas that have been listed above.
The organisation structure for finance team upon commencement of Monetisation should be Financial Controller heading the Finance function. The ideal focus areas for FCs at this stage of the life of the company should be:
Formation of Accounting policies
Formation of policy and its annual review is a common process for companies but when it comes to startups, at times the company goes through change in business model. This may warrant a change to the agreed accounting policy. Besides, if there is a significant change in the biz model and offering it may also mean that company may have to write off of its IP costs. This could also have a tax impact too and the loss upto that stage may or may not be available to be set off against future biz.
Day to day accounting / tax related processes
Apart from day to day accounting this part also includes taxes (both direct tax ie Income tax and indirect taxes ie GST) management, working out the tax liabilities, deducting taxes, payment to government treasury, filling of returns within timelines. I have already detailed out in my earlier post https://blumeventures.wordpress.com/2017/09/24/journey-of-startup-finance-teams-in-india-outsourcing-finance-teams-to-cfos-part-i-of-iii/
Girish Rowjee, Founder, Greytip adds, “As organizations starting hiring and putting in place the first set of people, it becomes important that they pay attention to a number of hygiene factors around their employee engagement and creating a conducive and high performance work environment for these employees.
Founders generally engage team members well around the work that has to be done. But in other areas like Payroll, Leave Management, providing basic employee services like maybe Payslips for a loan or Address Proof letter for a Credit card, proper attention is not paid. Many times this causes dissatisfaction among employees and impacts productivity and sentiment. Additionally, a primary responsibility of the Founder is also to ensure that all Statutory Compliance that are required are handled. Not handling this well will lead to penalties and legal consequences.
Today good tools are available to eliminate the need on the Founder’s time and energy. These tools can easily help organizations to manage their employee information, help them move many employee processes online so as to reduce any manual work and very importantly give an assurance and peace of mind all statutory calculations that are needed are done and the Payrolls are computed accurately. greytHR is a good example of such a tool and is also widely used among startups and businesses in India. Their very attractive and startup kind of pricing helps too.
In our experience, we have seen organizations gain significant benefits from putting in good processes around HR, Payroll and Compliances at an early stage of their journey. We have seen the Founders at these organizations spend much lower time on routine activities and their employees have far lower queries on Payslips, tax, etc. Compliances are no longer a headache. Additionally, as they go into their Due diligence for their next round of funding, they are able to easily clear these with far fewer queries when compared to others who use a manual or Excel based model to managing their employee processes.”
Financial / Book closure and audit
Significant bandwidth of the Finance team will be consumed at the end of the year in book closures and getting audit done. Given investors are private and it’s well acknowledged that there will be losses anyways it’s natural for founders not to care about financials and audits. To add to it, there is a thrust only on metrics earlier on in the life of the biz and not enough people really seem to care about annual financials and audited reports. Even then, this is not a very smart thing to do. These eventually come to haunt a DD in future or even a potential exit discussion. Besides, things like loose financial processes would largely go uncorrected during the course of the audit if it is not done with some intensity. Eventually, this would result into needless burn and poor use of company’s hard raised resources. Partly due to madness of scale and because that is taken as a norm, the following should be avoided by every Series A founder team / FC of a Series A startup:
There are a high number of resources that the company would go after to chase growth. It is tough to get good people and that means, fairly over priced new hires on board somehow
- There is also a fair bit of wage inflation that hits the company as the salaries of existing team have to be hiked by way of an across the board hike
- Large part of the hiring process happens haphazardly and there is a fair bit of exceptions that become the norm
Setting up of financial controls and policies
How does sales payment flow? What’s the correct method of accounting for inventory? How do we keep a tab on payables? Under whose signature do cheques get processed? Policies for expenses, leaves, reimbursements, travel, onboarding of new joinees, exits of team members, acquisition of fixed assets, lease agreements, credit card payouts, etc. These are things that need to be worked on and process frameworks be put into place to ensure that there are no re revenue leakages and expense management is in line with the intent of the founders. Best of financial controls have the right balance between:
being tight enough not to be broken and in case violated – it does create flags as a part of the process
realistic enough to facilitate the achievement of the company’s midterm goals
Here, I have consciously avoided usage of the phrase long term only because, in the long term, financial controls would have to go through a complete overhaul anyways and savvy experienced professionals would be driving it or the existing team would have matured to fix the gaps.
Cash management / Treasury
Firms typically get chunky amounts as investment rounds close and capital is wired by investors. These monies are meant to last till such time the company manages to raise next round of funding or till such time that it becomes Ebidta positive. Preferably the later and not the former. It’s the responsibility of the financial controller to work with the founders and ensure that the capital raised lasts the period it is meant to. The immediate two to there quarters post a round of funding could mean exuberant hiring, spends on facilities and infrastructure and at times this happens beyond the quantum that was planned or still worse – beyond what is meant to be spent. Best founders would expect from their financial controller to have a tab on this kind of behaviour and make sure that preventive mechanisms are built. Whilst it’s common practice to say – prevention is better than cure, this kind of areas are such that no matter what the cure is, and how quickly it was cured, time and capital are lost irretrievably.
Most businesses have a budget. Startups must have a budget. Many a times a certain plan is pitched to the investor and combination of factors lead to significant deviations from the plan post funding. Startups always evolve in their journey and there could be learnings that lead to these shifts or there is some larger opportunity set that is discovered by founders as they set out with some experiments. Or there are some experiences that lead to the change. All of this is fine and welcome. In fact – it’s critical to adapt in the ever changing environment. What ends up hurting though is when – we do it without a plan and a structured roadmap to change. It doesn’t mean that one has to call a board meeting with a 21 days notice and revisit all cells in the excel of the prior plan, take minutely considered feedback from every person involved. When it comes to budgets and planning – it is always meant to change and realities will be different from what was envisaged. It therefore becomes equally important on how you do it and not only what you do. There needs to be a brief documentation between the core team outlining the projections and a rationale on the numbers that are being projected. The assumptions behind the base numbers and the growth rates assumed are critical aspects to be covered in the note. One also needs to add – key factors that are going to drive these numbers and how would we react to changes in key factors. For example: demonetisation hit plans of a very high number of consumer startups. This could have meant higher burn. One needs to budget for developments beyond ones control and have a contingency fund to be able to tide through such circumstances. At times impact is semi-permanent. Example – GST implementation.
Internal and external reporting / MIS
This is self-explanatory though what I would like to emphasize on is, both quantitative and qualitative aspects of the MIS needs to be brought out.
ERP integrated with accounting systems
A high number of startups have their own systems for backend and operations which is well integrated with the front end. They however opt to keep accounting on tally by simply posting sub-total manually by pulling numbers from systems. This is fine to start with. But as company raises A round, they should integrate the accounting systems. FC and his team will have a role to play in that as well. Creation of GL account heads, sub accounts mapping of entries, balancing, etc will have to be tightly done. As scales grow this becomes tough if not integrated earlier.
All of the above seems like a lot of work. Well, having worked with quite a few of our companies in the portfolio over the last 5 years, I can tell you that a sound financial controller / founder combination will make this not so tough process to implement eventually. I have also had Constellation team take on parts of this role and keep growing with the company’s needs and then keep passing on as there is full time bandwidth in the company. The key is – do it in steps.
In the next write up, i would take up the next phase of growth and a case for a hands on CFO joining hands with the founder and the rest of the team to focus on what is the central function of a CFO – growing shareholder wealth !