Journey of Startup FINANCE teams in India | Outsourcing Finance teams to CFOs | (Part I of III)

Context

One of the key points that signify start up having matured is – Finance team, its functioning, leadership and how it collaborates with the CEO and rest of the core team to achieve the desired goals of the startup.  While working with the founders and Constellation team on solving for these questions, there have been some learning that I feel are good to share as a starting point. Each combination of founder and company creates a different circumstance and some parts of learning may need to be customized to suit your startup. Idea of this is not to create a template but only a framework to consider whilst building Finance organization in the company.  The 3 part post starts with how a startup would work with the help of outsourced finance professionals to start with at the time of their seed funding and the successful journey of scaling up of finance teams mimicked with the startup scale up and fund raise.  In this part, I am summarising the recommendations on early stage finance and accounting teams management with some notes on audit and reporting.

Outsourcing of Finance versus in house finance team – my belief

I have always been a firm believer that finance function is a core function and should always be an in-house function.  Having said that, setting up a full-fledged Finance function is a costly affair and has ramifications for the startup.  Setting it in house may be postponed or the set up can definitely be done in stages.  At a time when company has taken on seed funding and is in the mode of setting up a prototype of its product or beta version development, founders should hire a young accounting professional with experience in book keeping (day to day accounting management).  Founders have expressed concerns over the issue that when there are just a dozen coders and company has not even commenced monetizing, it’s waste of money.  Another genuine concern that has been expressed is – who supervises this person and how do we know what is happening is right.  Thirdly, accountants are young and could lack experience and expertise to do their job well and if we have to hire an expert, it’s a costly affair.  Fair point – if there is literally no more work than processing of payroll of a dozen people and a rent cheque to the landlord, I would gladly concede and acknowledge that it’s only fair to outsource the accounting function to a firm that can take care of it in line with a startup environment and not with conventional biz approach.  There are multiple things that need to be taken care of by such a firm.  For example:

processing payroll of the team (Monthly activity),

  1. Salary workings optimized for tax efficiency. While every member will have to suffer taxes, there are ways and means to optimize taxes on salaries on income and this must be borne in mind whilst building salary packages.  If done with proper thought and care, there are smart tax structuring options well within the ambit of the tax laws to ensure that employees earning as high as Rs. 10 lakhs of salary can save over half of the tax to be paid otherwise.
  2. Leave an attendance workings – earlier on there may not be leave policies but if there is any leave policy, accountants should take care of the same whilst disbursing salaries.
  3. Reimbursements – these must ideally be paid by separate transfers over and above agreed salaries as these are not subject to taxes
  4. Employee benefits like PF, ESIC, Gratuity need to be factored for and payments be made to government bank accounts each month. We had a scenario in a portfolio company where it was discovered during the DD that they hadn’t complied with this.  There is never an intent not to comply in most founders.  Just that its slips out.  Delays can be highly costly and can hurt retrospectively.  And these departments are not the most savvy or friendly government departments who will try and help or empathize with startups.  They would generally be pursuing penalty proceedings and issue notices; trust me its not fun dealing with these.
  5. When a new member on the team has joined, there are some basic processes to follow and ensure that their bank account is integrated to seamlessly process payroll, transfer of their PF accounts from old organization to the new, approval for their salaries, performance payout structures, etc should be in place.
  6. Reversal processes need to be carried out when an old employee has left the organization. There was a stray case that I stumbled on how an employee had left the organization and still the salary was being processed.  There are worse things that happen but here the issue was that the employee was refusing to return the excess paid and claimed that he was entitled to the same.
  7. vendor management (server expenses, infrastructure costs, rent, electricity, miscellaneous costs like stationery, reimbursements of costs for employees, credit card payouts for expenses incurred to overseas vendors (all of it may be monthly or quarterly activities). The tricky thing about these is that any disruption in services could have a catastrophic impact on the business.  We all know the story of how a famed service provider missed renewing of their portal name and then had to pay a fancy sum to renew the same.  These are highly embarrassing moments and are easily avoided.  I have been a big advocate of having an online register that carries various vendors and services taken and all of their details including time duration, renewal timelines, commercial terms, key service areas, etc
  8. tax deduction as well as indirect taxes collection

all of the above payouts have to be made with suitable deduction of taxes and indirect taxes payouts when startups are receiving fees.  There is a common belief that we should deduct these taxes amounts and once deducted rather than paying to the government treasure use it for working capital financing.  This is something that should be strictly avoided.  Creditors’, employees’ and regulatory dues should be paid as due and never end up being used as a working capital finance by any company, leave alone startups.

filling tax returns (both income tax and GST as appropriate),sending monthly or quarterly metrics to investors, tracking cash flows so on and so forth.

Now, let us try and understand as to what would be the costs of such a function that us outsourced.

Most third party consultants have charged costs ranging from Rs. 20,000 to Rs. 75,000 per month for these activities in addition to the annual audit that your auditor will carry out and the secretarial services that you will need to obtain from a Company Secretary.  If the fees of external consultants (put together for all of the services) are actually on the lower side of the threshold mentioned above – great.  Please go ahead and appoint them.  Even if these are in the mid range, it sounds to be a fair proposition if the concerned appointee firm has the requisite experience to handle and manage startups.  Do make sure that in such an environment, you have an independent, strong and a highly experienced auditor who carries out reviews quarterly to ensure things are happening the way they should.  Many a times, small practitioners simply offer an entire package of service including audit etc.  If audit function is led by a separate independent team, this approach is fine.  On the other hand, if you are paying any amount greater than Rs. 50,000, it definitely makes a case to appoint an in house person in charge of all of the above.  You may top it up by having a review by an independent third party on a quarterly or monthly basis as needed to ensure that you are always following best practices and have an expert overseeing the accountant.  Further, in compliances, filings, tax and related matters it also makes sense to have a double check and also the side benefit of such a review is that the third party could act as a mentor / guide for the young accountant.  No doubt it always will be a bit costlier to have this kind of a dual structure but the cost differential is not much and will be no greater than an increase of approximately Rs. 2-4 lakhs per anum at max.  Mind you, this cost is well worth it for one big reason.  If the in house person is a sharp young guy (maybe limited prior experience) he would be able to take care of lot of administrative issues as well.  Because (S)he is a full timer and in house, one can also expect that compliances will be done in a timely manner.  The person could also be made responsible for vendor management if he has that kind of an aptitude.  The icing on the cake will be – when there will be a follow up round of funding, company will have a better readiness to handle the due diligence mandated by most institutions.

 USING DSCs and PHYSICAL COPIES OF FILES WITH FOUNDERS /  TRUSTED AIDES

When working with outsourced providers and even junior accountants, it’s a common practice for startup founders to leave their company seals, Digital signatures with these teams.  This needs to be avoided unless the persons enjoy high trust from the founders.  Also, please try and maintain a clear record on who has it and how they would be using it.  Please note that using DSCs, lot of activities, fillings can be carried out and it’s a good idea to make sure that founders set up a process for themselves on how they would like their DSCs to be used / preserved.  On that note, it is also a good practice to ensure that as and when any fillings are carried out, a physical record is initiated and kept in a file that is maintained by the founder.  We have gone through a horrendous experience when we had appointed someone and they claimed they had been filling all things.  Handful of fillings had been missed out and so there was some notice from the government department.  When founder reached out to get access to the papers, the person who was managing this had already left the organization and it took much more time to procure these papers.  Of course, eventually we were able to submit these and there was not much of a fuss but then it was unnecessary waste of time for all of us.

 USE OF TOOLS

There are a handful of outsourced CFO offerings in the market.  Some of them are 1-2 member teams and come with stints with Big 4 or larger companies and are trying to cater to the startup market.  And then there are others who are trying to operate as a full scale organization.  There are certain tools that our portfolio companies have developed which I find very useful for all startups to try out.  For example – GreyHR solutions.  They support the in house as well as the outsourced finance team structures with their solutions for HR, payroll, leave and reimbursement management for employees.

SECRETARIAL SERVICES & COMPLIANCE / RECORDS KEEPING

It is a common practice for early stage companies to update secretarial records only at the time of a follow on round of funding or end of the year at the time of filling year end forms.  There are two issues with this approach:

  1. reporting and fillings under Company law has changed significantly over the period of last 2-3 years and it is no longer easy to get away with late fillings, back dated fillings and a small penalty or charge on ROC platform.
  2. Even if that were to be easy, it is only helpful for young startups to make sure that they have the long term goal of making a sound company out of their startup. This includes governance mechanism, reporting and timely fillings not for the sake of regulatory guidelines but also for the startups own record keeping and reference.
  3. Board meetings are normally just recorded with standard agendas and fillings are done. This should be fine from the regulatory purposes but from a long term startup story tracking point of view, it does not help.  Ideal board meetings should track the startup pivots as well as key milestones and decisions be recorded.  If done well, the minutes of board meetings can be very useful source of reasons and rationales for the decisions taken.

ANNUAL AUDIT

Audit from time immemorial has been treated as a mere formality, a cost burden and hassle.  If done with a larger sense of purpose, this can be a great utility as well as a detection mechanism of any issues in terms of book keeping, revenue recognition, internal controls, accuracy of profit and loss statement and compliance with financial reporting standards.

I have not been very successful in driving this aspect to my team that audit should be done for better than regulatory reasons and more importantly in a time frame that’s better than the regulatory timeline.  If done well, it can be immensely helpful in detecting issues in financial controls, revenue recognition and process weaknesses.  For this goal to be accomplished:

  1. auditors need to be given a freehand to dig deeper into the processes and push the finance team hard to force accuracy in recognition of revenue as well as fallacy in processes. This does pose a challenge at times.  Auditors would then insist that these weaknesses that are discovered need to be reported.  Well, insofar as these are not disclaimers and qualified audit reports, these shouldn’t be discouraged and be worried about.  Provided founders are going to insist to their finance teams that once an issue is discovered cannot be repeated again.
  2. Quality and costs of audit shouldn’t be controlled beyond a point. Its fine to NOT have a Big 4 as an auditor but it definitely isn’t acceptable to have the most affordable auditor who wouldn’t care to dig and guide the company deeper.
  3. It is not critical to appoint a Big 4 auditor. In fact we have come across issues earlier on when there are auditors who find it tough to relate to startup conditions and attempt to apply every rule in the book on the biz.  There are challenges to report unnecessary detail or disclose issues basis over application on the law.  In turn founders should never shy away from this reporting so far as reporting to the shareholders is concerned because that’s fine.

SUMMARY

INSOFAR AS THE COMPANY HAS VERY LOW LEVEL OF ACTIVITY, THEY ARE GOOD TO START WITH AN OUTSOURCED FIRM FOR AN ACCOUNTANT AND AS COSTS AND WORK INCREASE THEY ARE MUCH BETTER TO HIRE A FULL TIME PERSON.  IT ONLY ENHANCES VALUE TO HAVE SUCH A FULL TIME PERSON BE WORKING UNDER REVIEW OF AN EXPERT / MENTOR / FIRM WHO CAN GUIDE THE PERSON ON DAY TO DAY BASIS.

What’s your Whale Strategy?

Startups are often asked – who are your ‘best customers’ that will ultimately drive a majority of your growth?” 

In a B2B context this could mean “who are those top 10 enterprise clients?”; for a consumer internet startup, “who are the largest core groups within your target user base”?

This article touches upon Amazon’s own ‘whale strategy’ as a starting point. As it outlines, Amazon’s whales are the top 1%: Prime subscribers who buy the Fire Phone. After observing this to be a common question across a large swath of our portfolio (and for all startups broadly), it’s interesting to explore this more deeply.

Who are my Whales, and how do I go about best acquiring them?

Whales are your must-win customers around whom you can build and grow your startup. 

Whales are most often customers, but can also include strategic partners.  For an enterprise B2B startup focused on learning / recruitment / education, who are the top 3-5 entities in each category that I must win?  To cite a gaming example, I recently learnt that Atari, which almost floundered back in the ’80s, got a strategic break when they were able to partner with giant retailer Sears and eventually crack a massive distribution channel.  In Atari’s case, Sears was the big whale (aren’t they all big?) and through its direct distribution and marketing channels, including TV budgets, funneled Atari sales directly into consumers’ homes.

Whales then become your key references.

One point of view is to ‘start safe’ and deploy your products/platforms for tier 2 customers, learn from mistakes, tweak and then go for the big fish (oops, whale). However, given the long sales cycle to land large corporates, especially for B2B startups, you might as well start at the top.  A competitor might even grab your whales while you’re “busy tweaking”.  There’s also an indirect positive effect – each time a new prospect or VC asks you “so tell me who else is using you,” you have a good answer.

Customer discovery is essential.

In the Valley, I’ve often observed startups spend an inordinate time on ‘discovery’ via user interviews, out-in-the-field market research, trying to identify and interest their potential early adopters. While very useful, early adopters may not always be your whales. They may use your products but not always value / pay for them, yet their feedback is critical to developing your whale strategy.  In ‘ad-monentizable content’ businesses, for example, we find two whale segmentsa loyal, fast growing core target base of B2C users via targeted content is the first, but the brands (advertisers) who sign up and value this user base are the second.  Both whales, a massively growing user base and paying advertisers, are essential to success.

Whale Acquisition Strategy (WAS)

Below are key questions central to identifying, targeting and engaging your whales (again, perhaps this applies a bit more to the B2B startup context).

  • Of my Total Addressable Market (TAM), who are the top whales and how much of the market, across them, do they own?
  • Do I know them directly and/or who in my immediate network can help me get to them (investors, advisors/mentors, friends/peers)?
  • How does the market / peer customers see these whales (are they considered market leaders vs followers)?
  • Do I have any unique competitive advantage to acquire these whales?
  • What if I’m not able to win any of these whales – will I still thrive/survive/plateau.  Is it a make or break?
  • Is my team equipped to land these whales or do I need strategically hire to acquire them?

Extrapolating this, this paradigm can be applied to almost any business.  For a globally aspirational startup, often landing the top 2-3 whales in a particular geography can be enough to establish leadership there, and move on and expand into additional regions.

Figuring out your WAS early on can significantly accelerate your lifecycle.

So, spot those Whales and go after them!  

[This post first appeared on YourStory. Follow Sanjay on Twitter]