Here an interesting article from London based Seedcamp partner Carlos – great read!
Autor: Nils Seebach
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FolienKnecht – a case study (b)
Business model testing (Is it profitable? Is it scalable?)
Regular checks are important for a start-up. Have your previously set goals been reached and if so, can the business be scaled further? We usually measure the scalability by starting with relatively small trial cases that cover a broad range of marketing measures. Can we generate sales through Google Adwords, mailings, e-mail marketing, tele-marketing, direct marketing events or any other method? If there are a couple of measures that allow us to generate sales with a positive return e.g. if we spend 50 cents we can generate 51 cents in revenue we know that this potentially could allow the business to scale. Once we have found a method that seems to work, we scale the test case – if we can generate EUR10,000 in revenue by spending EUR500 through adwords, could we also generate revenue of EUR100,000? As an eCFO you need to push this test case as quickly as possible to make sure that the business model actually is sustainable and has significant revenue potential. If not – kill it quickly.
eCFO Tips: Make sure that management teams can differentiate between expenses and investments. In our company everybody gets a VOIP phone installed on their computer and uses a headset for calls. We do not have actual phones anymore. Nevertheless, the FolienKnecht team requested to spend EUR40 for an actual phone – it took a long discussion for them to convince me that this was a necessary expense and approval took a while. At the same time I suggested that they should get together with the city of Hamburg and sponsor a networking event. Sponsoring fees here were a small 4 digit amount and they asked why I did not have a problem with such a comparatively large amount, versus all the hassle for the EUR40 phone. The answer is easy – for a start-up it is essential to spend money on the RIGHT things not on those that are nice to have. As an eCFO it is your responsibility to ensure that this principal is actually enforced and that every expenditure is measured.
Investments and financing
I admit – this is a special case since FolienKnecht is a services business, a powerpoint designer, which can grow through its own cash flow generation ability. Therefore, I just needed to make sure that I fully understood the cost structure and what was needed to bring the business to break even cash flow generation without raising significant capital. As with most agencies it is possible to grow with this easy formula: “one employee needs to generate enough cash to pay the salary of two, two for four, four for eight and soon growth is possible”. In addition, your cost structure will mostly consist of salaries and some marketing investment but both cost items should quickly generate revenue. What is more important is that you create structures that are highly efficient and streamlined for cash generation.
For any other type of venture that require significant start-up capital I would suggest that you calculate your financial needs, then add 30% of that total to your numbers and you are good to go. Once you have determined your financial needs, raise a little bit of capital yourself and build a prototype. Investors are much more likely to give you money (even for a higher valuation) if you can show them a working prototype vs. a slide presentation with nice ideas on it.
Overall, I hope that these posts provided some operational examples of how to implement the measures I described in previous posts. As always I am looking forward to receive your feedback and comments!
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FolienKnecht – a case study (a)
Enough of all the theoretical posts! Here is a more interesting, operationally focused case study. I think that my previous posts have theoretically highlighted various aspects of being an eCFO but what does it mean for operational reality? In order to further highlight this I was able to get permission from one of our venture teams to write about them in this post.
Here a quick description of the business model:
FolienKnecht (German for “PowerPoint slide servant”) is focused on providing high quality outsourcing services. Its first line of business is creating, designing, and improving PowerPoint presentations. (www.folienknecht.de; Spanish: www.ppt-express.com)
Its second business line has recently gone online with a video creation/design offering (www.videoknecht.com) and it also provides a range of other outsourcing services through www.165euro.de. The business was initially tested through an intern and eventually bringing it into fully operational mode through incubating it within our company (www.etribes.de).
Timeline of development
FolienKnecht was incubated in the beginning of January 2012. We found a very capable management team consisting of two guys. One is the intern who developed the project and the other is an experienced entrepreneur. Both were willing to take this project forward with the eventual goal of founding a company and creating a business outsourcing company with multiple revenue lines from various business services.
Operationally, they received support from our incubation structure but this case study will focus specifically on the financial aspects. If you are interested to read a case study from another perspective you can find additional insights (sorry, in German only) here: http://www.kassenzone.de/2012/05/30/powerpoint-malerei-outsourcen/
eCFO tasks for a new venture
As the eCFO in our holding company it was my responsibility to take care of the financial aspects. In this role I helped the management team to develop a strong financial understanding to ensure that the company eventually developed into a financially strong independent entity.
Team
Within the team responsibility was shared between the two founders. In start-ups everybody does a little bit of everything to make sure that things get done quickly. This is necessary and a good starting point but fairly quickly set roles should be developed. I asked the founding team to provide only one contact point for all financial questions, analysis, and data points.
Basics
Our incubation services take care of all central basic services. This ranges from office space, to laptops, water/lots and lots of coffee and other basic things you need to run a business. In addition, we take care of central services such as accounting, HR, recruitment, and legal consultation. These services are initially provided free of charge to speed up the incubation process. However, it is important to make sure that the entrepreneurs are aware of the actual (expensive) services the venture incurs. The company therefore needs to track these expenses and needs to start to implement liquidity controls, budgets and financial planning. This is best done through an Excel spreadsheet that mirrors an actual P&L statement.
Controls
Initially, we determined the basic costs incurred by running FolienKnecht and set clearly defined goals we needed to reach in order to move all activities from our incubator into the new entity. Spreadsheets and preparation of financials are also important controlling functions. Here it was important that once a clear goal had been defined, the necessary measures were put into place to ensure that it could be tested on a monthly basis whether or not the venture was successful. We came up with a simple P&L statement that showed expenses, income, and sales funnel in an excel spreadsheet. This is a quick, slightly dirty, way of preparing the necessary financial information. In addition, we provided access to our billing software so that every bill can be generated by the management team but, more importantly, so that they can understand payment cycles and all connected liquidity concerns. If you are incubating a business within an already existing structure, you need to make sure that from the get-go the management team feels the same constrictions and problems it would feel as an independent business.
eCFO Tips: Especially in a start-up environment do not get bogged down in the details. If you are looking to establish financial goals do not say EUR9,287 because your business plan spits out that number – instead just define easy to remember goals e.g. we need EUR10,000 revenue per month with at least 30% EBIT. Do that for 3 months in a row and this business starts to be viable. This is an easy rule for not only you to remember, but it also sets a financial target the management team can work towards.
To be continued in the next post …
Here you can find an example of their work:
Die
FolienKnechte[slideshare id=13542261&w=427&h=356&sc=no]View more presentations from FolienKnecht -
German tax privileges for entrepreneurs under fire…
Very interesting article for German entrepreneurs on Gründerszene.de. Watch out what the tax treatment for your equity shares will change in the coming month!
http://www.gruenderszene.de/recht/gesetzesaenderung-exit-holdings
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Budgeting & Planning or how to explain the world with financials (b)
Top-down: This approach is based more on market growth rates and assumptions that initially tend to be very broad. In this case do not provide cost data right from the beginning. Instead, obtain some general market information that will allow for a good ‘guestimate’ of market size and volume growth patterns. Then discuss a growth rate with your CEO/department heads and apply it to your last actual financials. Once you have determined the growth rate compare your resulting revenue to the absolute size of your market and the monthly/yearly growth forecasted for your business. If there is no obvious problem (your total revenue in Year 2 is larger than total market size etc.) you can now add the cost data to your revenue assumptions. As with the bottoms-up method, discuss the relation between revenue growth/decline and cost increase/decrease with management.
eCFO Tips: This is a good exercise for start-ups in very fast growing markets. It will help to illustrate that if your market is growing by 30% per year and your company has top-line growth of 25% you are underperforming. If your company is not even growing in line with your target market something is wrong. Often your CEO and employees will be surprised by this analysis. A relatively high absolute growth rate is often mistaken as exceptionally good but this is not always the case. This analysis will give you credible arguments for operational improvements and structural changes.
In conclusion, both methods will be valuable. As you can see from my description, the actual goal is not to have the most accurate numbers in the world. Instead, it is important to educate your team how operational decisions will influence your financials. Budgets/planning/ and other annoying torture methods that eCFOs will come up with, can actually help instead of distract from operational issues.
eCFO Tips: Liquidity, controlling, budgets & planning will keep you very busy as eCFO. Once these measures have been implemented and accepted by your team, you can move on to other subjects. In my experience, this will need
a) a great team that supports you
b) at least a year of very closely monitored controlling
c) constant checks if you are still in line with operational reality
Make sure that you never implement a task that will keep you permanently operationally involved. Your team, technology and tools should be doing this work and if you find yourself constantly involved with these tasks RESTRUCTURE and make these tasks completely independent of you.
Often this will create some problems within your department, since it looks like you are designing tasks that are distributing lots of work away from you. Therefore, ALWAYS explain why certain tasks are very important. Make sure to also explain that you will be focusing on other tasks that will help to push the business forward. It also means that if you find assignments (as explained above in point c) that are no longer relevant you should immediately terminate them! On the other hand, if certain measures lead to an operational improvement or cost savings, you should make sure that this is communicated to the employee who actually prepares the data.
This post also concludes what I would consider to be the key operational tools an eCFO needs to have. Having covered the basic checks, controls and planning measures, we can now move to much more interesting areas. Stay tuned for more info on this blog.
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eCFO Tips – a collection!
May 2012
eCFO Tips: Budgets and planning gives you, the CFO, the opportunity to teach people the relationship between financial figures, strategy and operational decisions. As a planning and supervisiory tool, financial planning and budgets are absolutely essential. In a well managed start-up you will be controlling costs through the methods described in the liquidity controls – so budgets are not used in the “traditional” way, more established businesses might be using them, e.g. to allocate resources and prevent overspending. Rather, they help you to raise everybody’s awareness of the impact their actions have on the financial results.
eCFO Tips: This is a good exercise for start-ups in very fast growing markets. It will help to illustrate that if your market is growing by 30% per year and your company has top-line growth of 25% you are underperforming. If your company is not even growing in line with your target market something is wrong. Often your CEO and employees will be surprised by this analysis. A relatively high absolute growth rate is often mistaken as exceptionally good but this is not always the case. This analysis will give you credible arguments for operational improvements and structural changes.
eCFO Tips: Liquidity, controlling, budgets & planning will keep you very busy as eCFO. Once these measures have been implemented and accepted by your team, you can move on to other subjects. In my experience, this will need
a) a great team that supports you
b) at least a year of very closely monitored controlling
c) constant checks if you are still in line with operational reality
Make sure that you never implement a task that will keep you permanently operationally involved. Your team, technology and tools should be doing this work and if you find yourself constantly involved with these tasks RESTRUCTURE and make these tasks completely independent of you.
Pre-May 2012
eCFO Tips: Controlling is all about data ANALYSIS and FOLLOW-UP ACTION. If you cannot effectively collect, store, organize and eventually analyze data you will not be able to install effective controlling measures. Nevertheless, be mindful that all too often management will focus on the process of collecting, storing and organizing data and will forget that the key aspect is the analysis and the changes/learnings/actions you derive from it! Action trumps collection!
eCFO Tips: Be aware of cash accounts outside of your normal banking activity. Paypal, AdWords/Sense, Affiliate accounts, Amiando, e-commerce shop accounts etc. can be a significant source or drain of cash. Make sure that each employee notifies either you or your team when a new account is created. Every account that uses cash should be treated as you would treat a regular bank account. I am sure as CFO you wouldn’t allow everyone to open a bank account by themselves – why should it be different for these accounts?
eCFO Tips: I have found a range of great SAAS products that support this process. Remember it is not your job to collect, store and prepare data for an analysis – as CFO you have to act on this data! Personally, I like the functionality of:
a) easybill.de for organizing my invoices
b) mite.com for time tracking and budget planning
c) highrise.com as CRM tool
Using a SAAS tool makes it fairly easy and inexpensive to keep track of your key data. Confidentiality here is also very important but in general these tools have solid user controls and are well protected from possible hacker attacks – even though there is of course the risk that your data is stored on a server that is not under your control.
eCFO Tips: Don’t have blind trust in your accountants – meet them at least every two months and explain your business model, each large project and what you do – only if you do that will they be able to prepare correct statements. They are not part of your business – especially if you work on innovative projects or in new technologies such as Facebook, Google etc. Therefore, they will not have a strong operational understanding.
eCFO Tips: Especially online focused ventures can easily create a fully functional click dummy, wireframes and a strong web presence to convince investors with more than just nice looking slides. This will help you to move your valuation discussion to a whole new level.
It becomes trickier in the seed financing round. Here the amounts of money needed are more substantial and can often not be contributed by only the entrepreneur or FFF. I would advice to look for a partner in this stage who can contribute more than just capital. This is probably one of the most overused and equally misunderstood statements ever used.
eCFO Tips: ALWAYS make sure you understand what drives a financing partner. The average VC will have a three year fund raising cycle that means they have to go out and raise / pitch for new capital one year after closing their current fund. The VC world has become a significantly tougher place – many VCs failed to raise capital during the financial crisis. If an action that puts your venture in jeopardy but will help their fund raising comes up it will be clear what they will do. Be prepared.
eCFO Tips: Call-options are funny things – you are giving away your company at some point in the future without having any indication, beyond wild hopes and dreams , of its value at the time of exit. Remember that in general there are some things are just as true for a strategic partner in the future as in the present– they will still have more lawyers than you do, they will hopefully still have a substantial strategic interest in your company and they will have cash.
eCFO Tips: Don’t forget about online specific issues such as PayPal, Adwords & Adsense accounts, facebook ad accounts; linkbuilding accounts etc. Here you have a source of expenses and income that can come as quite a surprise.
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Ernst & Young Article
For those of you fluent in German here an interesting article from Ernst and Young in regards to financing phases. http://bit.ly/JOprgC
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Controlling – a CFOs sole purpose in life!
Controlling is a key aspect for each new venture. It starts out initially with a solid understanding of cash flows and moves across various phases as a business growths. In my experience the key aspects for each venture development stage can be summarized with the following headlines:
- Liquidity awareness
- Profitability measures
- Balance sheet optimization
Each of these three steps requires different controlling techniques and management focus on various aspects of the business. As a venture develops it is not only these above mentioned points but also controlling techniques for each key business resource that will keep management busy.
Also be aware that, “measures” and “optimization” have been picked on purpose – your role as a CFO will change with each of the steps listed above. You will move from making decisions that might be bad for profitability but good for liquidity to pure financial engineering actions that will optimize your balance sheet. This also requires a move in your strategic thinking from survival (liquidity), to operations (profitability) to strategic, long-term goals (balance sheet and capital structure optimization).
eCFO Tip: Controlling is all about data ANALYSIS and FOLLOW-UP ACTION. If you cannot effectively collect, store, organize and eventually analyze data you will not be able to install effective controlling measures. Nevertheless, be mindful that all too often management will focus on the process of collecting, storing and organizing data and will forget that the key aspect is the analysis and the changes/learnings/actions you derive from it! Action trumps collection!
Liquidity awareness
As mentioned in previous posts this is a key aspect for each new venture but how do you actually make sure that you are aware of liquidity issues? Based on my experience you can do the following:
Compile a weekly Excel spreadsheet that lists all liquidity in- and outflows for the next 8 weeks. Here it does not matter if it is tax, P&L relevant or a rent deposit – any payment that comes in or goes out is traced. This will provide you with a solid understanding of when you will be running low on cash for the next two months.
This will require that either yourself or an extremely reliable employee is fully aware of all payment cycles (salaries, subscriptions, taxes, customer payment discipline etc.) in your business. It also goes beyond a simple accounting measurement since the person compiling these numbers will have to be aware of all operational aspects of your business. As your business continues to grow, it will be increasingly difficult to get every department head to provide the necessary information – make sure that you install well-thought out reporting structures early on. If people are used to providing information from the get-go, it will save you a lot of trouble later on.
eCFO Tip: Be aware of cash accounts outside of your normal banking activity. Paypal, AdWords/Sense, Affiliate accounts, Amiando, e-commerce shop accounts etc. can be a significant source or drain of cash. Make sure that each employee notifies either you or your team when a new account is created. Every account that uses cash should be treated as you would treat a regular bank account. I am sure as CFO you wouldn’t allow everyone to open a bank account by themselves – why should it be different for these accounts?
In addition, I would recommend that every serious CFO does the following to make sure that liquidity is well understood within the business:
- Check bank balance and transactions for each account EVERY day
- Control any payment that is made as long as the business is below a revenue of EUR500.000 p.a. / once it is above that revenue figure install a limit for each employee e.g. EUR100 per transaction which can be processed without your explicit consentJ
- Be fully aware of every invoice that is issued and when a customer is expected to pay
eCFO Tip: I have found a range of great SAAS products that support this process. Remember it is not your job to collect, store and prepare data for an analysis – as CFO you have to act on this data! Personally, I like the functionality of:
a) easybill.de for organizing my invoices
b) mite.com for time tracking and budget planning
c) highrise.com as CRM tool
Using a SAAS tool makes it fairly easy and inexpensive to keep track of your key data. Confidentiality here is also very important but in general these tools have solid user controls and are well protected from possible hacker attacks – even though there is of course the risk that your data is stored on a server that is not under your control.
Profitability measures
Once a venture has been able to either secure significant financing or cash generation has reached a point where closely monitored liquidity control is no longer a key aspect for survival, profitability moves more and more into focus. Here, it is important that the CFO fully understands all profitability enhancement techniques and makes sure that a good understanding for percentages is established. What I mean by that, is that certain key measures such as staff cost as a percentage of sales, EBIT margin, travel expenses as % of sales, etc. should always move within a certain range – once they move outside of this range you need to take corrective measures. Here a step-by-step recommendation:
- Reduce focus on liquidity by implementing liquidity checks every other week or even every three weeks – never completely stop since your liquidity situation might change
- Budget planning – there will be a whole additional post on this topic so I will stay brief here – you need to get a good understanding of the 12 months forecast. It does not matter if you actually hit these numbers. What does matter is that you can compare your actual vs. planned numbers and understand why they might be different. You can either go bottom-up or top-down on this forecast. Again the method is not that important – it is more important that these numbers are agreed upon by everybody who can actively influence them (top, middle management at least) and that they are regularly reviewed.
- Check out comparable companies and talk to CFOs of larger businesses from your industry. They will have a good understanding of what these percentages should be, once the business has matured. As an example: we work a lot with service agencies and therefore our HR costs should be approximately 80-90% of all operating expenses – if we are significantly below or above we are either underpaying (never!), waste too much money (very likely!) on other expenses or something else is going wrong – now it would be the CFO’s task to find out what exactly is causing the discrepancy.
- Make sure that you get a carefully prepared monthly P&L overview from your accountant so that you have a fairly reliable set of numbers. Make sure that you are familiar with every line item!
- Check, check and check again – calculate some key ratios every month. Check through each statement your accountants send to you.
- In the end profitability is simple – you need to make more money than you spend.
There are two major things you can do:
- Earn more money (increase sales, increase prices for existing products/services and so on)
- Spend less (do you really need: company cars, a desk, new offices, coffee maker that can make latte, Apple computers, , lawyers etc.)
ANY measure you take will either influence A or B – what you specifically do or how creative you get is up to you.
Comes back to an old CFO joke: a young CFO gets hired and the old, experienced CFO gets fired. The young gun asks the old guy: any tips? The old guy gives him three letters and tells him to open each letter if the business is performing really badly and he is suffering. So time goes on and things don’t go well. The young guy opens the first letter: It says “increase sales” and the young guy goes out and does everything in his power to pump up sales – nothing works. He opens the second letter – it says “cut costs” so he cut costs like Warren Buffet himself and cuts and cuts and cuts – no success. So he decides to open the last letter. It says: write three letters!
eCFO Tip: Don’t have blind trust in your accountants – meet them at least every two months and explain your business model, each large project and what you do – only if you do that will they be able to prepare correct statements. They are not part of your business – especially if you work on innovative projects or in new technologies such as Facebook, Google etc. Therefore, they will not have a strong operational understanding.
I had a long chat with our accountant about Facebook fans we acquired in our internal, generic Facebook groups for later advertising purposes. The question was, whether this wasa pure operating expense or were we actually generating lasting value that should be depreciated over time – there is no rule, no case study and no exact guideline for this. Nevertheless, if your accountant understands the concept she can apply “old” rules to “new” technologies and that might be very positive for your business.
Also make sure that you do not only talk with the head of the company or some senior members –training and discussion should be aimed towards the employees/accountants who actually work with your numbers every day. They are the ones who make the decision how something should be booked in the first place – so they need to be informed first.
Balance sheet optimization
By now you should be feeling pretty good about yourself. You have conquered liquidity problems and you are running a highly profitable business. Now it’s time for the real CFO stuff – balance sheet optimization and financial engineering. Before you call Goldman Sachs and invest into derivative products I would recommend that you fully understand what you are trying to achieve – you have probably gone for the low hanging fruits of liquidity and profitability with nothing more in mind than survival and solid operational goals.
Balance sheet optimization is far more strategic. There is no right or wrong answer to: “What should my optimal capital structure be?” “Which assets should I show on my balance sheet?” “Equity vs. assets vs. liability ratio analysis.” “Should I lease all my equipment or buy?” “Rent or build office space?” In order to be good at this you need at least a strong three-year strategy that guides your action – do you want to increase your debt level, sell the business, acquire other businesses etc. These are all questions that will determine how your balance sheet should be build. Remember that all the financial engineering is not worth anything, if it does not lead towards a specific goal.