START ME UP
Young companies look to part-time CFOs to ignite their finances.
George Donnelly, CFO Magazine
June Issue 2000 : Article
In a rented suite on 23rd Street in New York’s Silicon Alley, acting CFO Howard Friedensohn is preparing an investor pitch for WebAppointments.com. The start-up, the brainchild of two doctors and an Internet veteran who saw the potential of using the Web to transform professional appointment-making into a virtual product, has raised about $1 million in private funding so far. Now it’s looking for its next $2 million to $3 million before testing the product in Manhattan.
Friedensohn is the numbers guy. But since accepting the company as a client in May 1999, he’s also had a hand in shaping and reshaping WebAppointments’s business model. Originally, for example, WebAppointments had planned to target the frenetic Manhattan restaurant market, only to back away as better-funded opponents entered the fray. It dropped veterinarians because they make up too small a niche. Now it’s focused solely on doctors and personal-care specialists (hair salons and day spas).
The business is based on the assumption that the inefficient appointment-making process will find a home on the Web.
“Making appointments is a headache in the office,” Friedensohn explains.
Take hair salons. Elizabeth Arden Co., the New Yorkbased beauty chain, for example, may have “three or four people who just sit at the phone, scheduling for one facility,” he says. Eventually, he reasons, consumers will expect 24-hour access–something Web Appointments is poised to deliver. “So if Joe Schmoe down the street has WebAppointments.com and you don’t, you could lose business.”
Friedensohn’s enthusiasm belies his actual position at the company. He’s a consultant. President of CFOutsource, based in suburban Irvington, New York, he works six to eight days a month at WebAppointments, analyzing alliances, reviewing contracts, and, most important, raising capital. At the same time, Friedensohn performs similar work for a half- dozen other start-ups in various stages– companies such as LeatherConnect.com, which hopes to become an Internet market-maker for the global leather industry, and SubRights.com, which sublicenses the rights to printed material and books. And although Friedensohn also has more-conventional clients, he has shaped a career as a start-up CFO who takes on a portfolio of companies, much the way venture capitalists do.
He is not alone. Business has never been better for individuals or firms that parachute into the burgeoning start-up scene and offer financial expertise. With venture money pouring into start-ups–$35.6 billion invested in 1999, up 150 percent from 1998, according to PricewaterhouseCoopers LLP–someone has to manage the money and help find more. And given the high failure rate of start-ups–half fizzle within the first four years, according to the National Federation of Independent Businesses–someone also needs to prepare the venture for its next evolution.
“Historically, you had the closely held business that was owner-controlled. And once a year, the owner would throw everything into a shoebox and bring it down to a CPA,” says Leslie Murdock, of Santa Clara, California- based Murdock & Associates, which employs nearly 100 people to handle part-time assignments in Silicon Valley. “Then along comes venture capital, and you’ve got outside investors, a deep management team, and an outside board of directors. These companies want to be acquired or go public in three to five years, if not sooner. So they have to be squeaky clean right away.”
Moreover, says George Clute, a longtime venture capitalist at Olympic Venture Partners, in Kirkland, Washington, seasoned CFOs provide a dose of reality in what’s often a very heady environment. In addition, the CFO may be the only key executive with prior IPO experience. “Many entrepreneurs have no first- hand experience with the financial community,” says Clute. One of the key roles these CFOs play, he adds, is “the mentoring one, which is absolutely essential in some cases.”
For their part, CFOs taking on this work enjoy the challenges of a start-up, but don’t want to be beholden to any one company. They move from company to company, providing critical advice on business models and financial presentations, as well as introducing young companies to venture firms. And although the basic financial needs are usually rudimentary, start-up CFOs often are on hand to influence strategic business decisions.
“I can reinvent a business model in a day and implement it next week,” says James Johnston, president of Johnston Co., based in Lexington, Massachusetts, which handles about a dozen companies, mostly start-ups, simultaneously. “There’s a wonderful feeling of sitting at the moment of creation and talking about the business and financial implications, and having something to say.”
The start-up climate guarantees that these part-timers are very busy. In several areas of the country, including the San Francisco Bay area, New York, Austin, and Atlanta, “there isn’t enough full-time finance talent to go around,” says Mark Jensen, a partner with Arthur Andersen LLP who works with start-ups in Silicon Valley. “It’s amazing how many companies that are getting ready to go public don’t have CFOs.” Adds Murdock, who estimates that he reviews 10 to 20 new consulting opportunities weekly: “We’re drinking out of the fire hose at the moment.”
So are the clients. And that’s why the finance expertise these CFOs provide, as well as their links to bankers, lawyers, insurance, office space, benefits providers, and audit firms, is so vital. “Anything I can do to reduce the amount of time they have to spend on noncritical items, or increase the amount of time they have to spend on critical items, is a contribution,” says George Pilla, an Arlington, Massachusetts-based finance consultant who has been working part-time with new businesses for five years, after working many years as an auditor and finance executive.
“George is kind of a one-stop shop for all things needed by a start-up,” says Jon Sieg, CEO of AP Engines, a billing software firm for Internet Protocol phone and cable service, based in Maynard, Massachusetts. Pilla joined in January 1999, when the company had three employees; it now has 50, and plans to grow to 100 by the end of the year. Right off, Pilla, who works at AP Engines one day a week or less, created a budget and linked the company up with a bank, an insurance agent, investors, and an auditor.
Of course, no connections are more vital than the ones to the venture capital world. When Pilla signed on at AP Engines, for example, the company was in a position to operate off a small revenue stream. But Pilla was quickly convinced that its growth prospects demanded additional capital, and pushed the company first into an individual-investor round, and then into a $10 million first round of venture. “George looked at what we were doing,” says Sieg, “and said, ‘Let’s end this. And let’s not spend the next two months writing a new business plan to reflect a larger vision, because that will be two months that we could have spent talking to VCs,'” says Sieg. Pilla subsequently led the company to three major investors (all three were venture capitalists; he had worked with two of them before) and provided what Sieg describes as “a heck of a lot of poise at the table” when the company entered into funding negotiations.
Such poise often brings instant credibility to a start-up. At WebAppointments.com, for example, Friedensohn is a much-needed ally of CEO Howard Jacoby when they call on investors. “He brings a major-league CFO track record to the table,” says Jacoby, who asked Friedensohn to serve on the company’s board after sensing investors’ disappointment that he was not a permanent management fixture. His presence, Jacoby adds, guarantees that “we’re not viewed as Internet kids.”
Modeling the Way
Before clients get in front of VCs, however, they need to understand what the venture community wants to hear. George Haytko, a part- time CFO based in Cupertino, California, notes that clarity is key. “My role is to take a critical look at the financial plan and challenge the numbers that don’t make sense,” he says.
At XMarkstheSpot.com, a San Franciscobased Internet start-up, for example, Haytko offers a financial reality check before CEO and president Scott Rozic approaches potential investors. The company pays consumers to register at multiple Web sites, and charges the merchants in its partner network a customer-acquisition fee each time it delivers a new registrant. Recently the company received $4.7 million in first-round venture funding, and it is currently targeting between $15 million and $20 million in second-round financing.
At WebAppointments.com, says Friedensohn, revenue was originally obtained mainly through advertising, a model that has rapidly fallen out of favor as the Internet has become glutted with advertising competition. He recommended shifting the pricing model so WebAppointments would charge doctors and hair salons for the service. “We shifted our pricing model to be more like 50-50. Then we took the portion that was advertising and decided to sell sponsorships to companies that wanted to deliver a marketing message to doctors or hair stylists and, eventually, to the consumers making the appointments.”
A constant consideration for any start-up, he adds, “is asking, ‘What am I doing, and how is that going to be perceived by the finance community?’ Also, ‘Does it make sense, and will I build value for my current investors?’ You have to be constantly thinking of both.” In fact, says James Johnston, pinpointing weaknesses in the model is often the most valuable service he can offer a client. “There are a lot of business models that show that people think if they can just double their volume, they’ll be profitable,” he says. “That turns out not to be true at most businesses.”
And sometimes what a company assumes is a revenue stream actually isn’t. One of Johnston client’s, WaveMark Technologies Inc., of Burlington, Massachusetts, makes software that enables high-speed printing. With Johnston’s help, WaveMark discovered its software implementation process was losing money. “You’d think we would make money on that,” says Tripp Blair, WaveMark’s executive vice president of sales and marketing. “We were underestimating the amount of work and doing it on a fixed-fee basis. Jim convinced us to change the model from fixed-fee to a time-and-materials basis. It was critical for our company’s success to get to the stage where we were at least breaking even on the software implementation.”
Back to Basics
Not all the needs of start-ups are so glamorous, however. Vendors still need to be paid. Payroll still needs to be met. And internal controls still need to be instituted. Some part-time CFOs outsource such nuts-and- bolts work, while others, like Howard Friedensohn, have their own staffs to do the work. Haytko, for example, says his time is split 50-50 between high-end consulting and more mundane, day-to-day transactional tasks. “You may physically do some A/P processing,” he says. “But what you tend to do is a lot of cash-flow management.”
Indeed, the burn rate is the heartbeat of these young companies. “Running out of cash is the worst thing,” says Pilla, “and we are usually working three to six months ahead, trying to figure out when we’re going to run out of cash and how we’re going to fund [the company].” To do that, he says, “we always look at the forward spending rates, not the past spending rates,” as is typical with publicly held companies. “So at every board meeting for my clients, I give out the cash- burnout month, trying to target within a one- or two-month range.”
Part-time CFOs often also serve as systems consultants as companies outgrow their off-the- shelf accounting systems. “They get to the point where they have huge activity, but no formal accounting [system],” says Haytko, who has 25 years of finance experience, including 8 at Arthur Andersen. He recently helped convert XMarkstheSpot.com from QuickBooks to Oracle.
“The process of paying millions of consumers for registering across multiple Web sites is enormously complex,” says CEO Rozic. “Everything, from correctly invoicing our merchant partners to cutting checks for our users on time to correctly recording multiple, simultaneous transactions for each user, demands a huge amount of managerial control and attention to detail.”
One constant in the consulting CFO’s life is the continual change of clients. In fact, success for a start-up–whether it is sold or grows large enough to need a full-time CFO– often spells lost business for the part-timer. But a strong client base and increasing demand offset much of the risk. “My eggs are spread in many baskets,” says Friedensohn, “so I don’t have a problem letting a client evolve to the point where it doesn’t need me anymore.”Friedensohn says he knows a client has outgrown him “when it starts taking up too much of my time. If I’m spending more than 40 percent of my time at a company, chances are they need someone in-house to do what I’m doing,” he says. “I should be managing it.”
But for every robust start-up, several die. To guard against such an outcome, consulting CFOs often help entrepreneurs understand more fully the cost of going into business. Friedensohn, for example, recently worked with a client that thought it would need about $3 million. He convinced the client that it would need $5 million or $6 million instead. When the initial investor realized his investment would become significantly diluted, he got cold feet. “We protected the client from spending that money,” says Friedensohn. “In all honesty, I can’t let a client go into business expecting one thing to happen and then get surprised.”
Taking the Options
For their services, consulting CFOs typically charge between $125 and $275 per hour. But in the start-up world, some are beginning to offset their fees by 10 to 20 percent for a piece of the action.
These grants aren’t making anyone rich–yet. In fact, Pilla lost money on the first two companies that gave him an equity stake. One eventually went into Chapter 11 bankruptcy proceedings, and the other was acquired at a price that was less than the value of Pilla’s equity. But he has a handful of irons in the fire, often taking 20 percent or less of his fees in options. “If I’m with a company a year or more, I can accumulate several thousand shares,” he says, adding that the equity typically “represents half of what an entry- level person would get.” It’s a very small slice, he admits, but “I have no idea what that may be worth down the road.”
CFOs who do take equity prefer spreading their bets, even if the action isn’t very large. Friedensohn figures he could take a bet on a single Internet company, “get a ton of stock options, wait two or three years, and then make a ton of money. The problem is, one company might not make it. Then what do I do? This way, I’m invested in 10 or 12 companies, and maybe a few of them make it. I get in at the earliest stage, so the multiples, if I really hit pay dirt on one, could be huge.”
Unlike the rosy-cheeked entrepreneurs who spring forth from business schools and engineering programs, most part-time CFO consultants bring 20 years or more of finance experience to the table. They learned their lessons the hard way, serving apprenticeships as auditors, rising through the ranks, losing jobs, and watching earlier waves of technology rise and fall.
Rich Brenner, for example, worked for 20 years in Silicon Valley, eventually leading the IPO of Corvus Systems in 1982. In the mid-1980s, he helped turn around a technology start-up called Formaster before deciding, in 1987, to become a venture capitalist. While he was pitching himself to friends at venture firms, a few asked whether he would do some financial consulting. He sensed then that he could turn his expertise and connections into a full-time job. “I realized that I enjoyed the challenge of building and fixing companies,” says Brenner.
Thirteen years later, his company, The Brenner Group, based in Cupertino, California, has 50 employees and an active client list of more than 100 companies. His bread and butter remains his finance team, but he has expanded his services to provide part-time CEOs, COOs, and sales and HR support. His one lament? He keeps losing people to hungry start-ups that need full-time CFOs and controllers. “We lost four people last month–that’s a new record,” says Brenner. “And we raised our recruitment fee to an exorbitant level.”
Brenner believes that to handle multiple assignments simultaneously, “people have to be adaptable.” But an affinity for small businesses helps immensely, says George Pilla of Arlington, Massachusetts. Pilla’s first job after graduating from the Harvard Business School in 1982 was at a 16-person start-up, which a year later was acquired by Bausch & Lomb. Then he joined a 25-person defense and satellite communications firm; from there he was hired as the fourth employee at a venture- capital-backed publisher called Course Technology. Pilla helped it grow to 80 employees before it was acquired by Thomson International Publishing.
After the Thomson acquisition, Pilla had a thick Rolodex and was encouraged by acquaintances to go it alone. “They said, ‘You could start a mini-portfolio,'” Pilla says. “They thought my skill set would be helpful to other companies.” And after five years on his own, several clients have offered him full-time jobs. Although he says he has been tempted on occasion, Pilla is still enjoying being his own boss.
Still, one shouldn’t discount the maintenance and marketing involved in running a CFO-for- hire business. Right now, times are good for established finance consultants, but as George Haytko, another solo practitioner in Silicon Valley, warns, they won’t always be so robust. “The good news and the bad news is that you’re constantly marketing to be on the alert for opportunities, but at times you’re so overloaded you can’t do anything with the opportunities.”